Tokyo and nine regional cities

Tokyo and nine regional cities

Presented here are overviews of Tokyo and nine major cities, including land price changes over the long-term and snapshots of major macroeconomic indices. For details of each city, click the red dots on the map below left.
(1) Land Prices
(2) Rental Office Market
(3) Population
(4) Retail and Household Income
(5) External Resources
(1) Land Prices - Recovery from the bubble burst
After the collapse of the bubble economy, the Japanese economy entered a period of stagnation called the "lost ten years." Looking at the fluctuations of the price change rates in commercial districts (sites for offices and retail stores), it is apparent that the three major metropolitan areas had particularly significant rises and falls from the late 1980s to the early 1990s in comparison to the national average. This tendency is particularly prominent in the Tokyo and Osaka regions.

Annual changes of standard land prices in commercial districts of metropolitan areas

Source: The Ministry of Land, Infrastructure, Transport and Tourism

During the bubble economy, surplus funds held in Japan due to the appreciation of the yen were directed to land investment. It was a time when the "land-price myth," which asserts that land prices will never go down, was widely believed. After the collapse of the bubble economy, few buyers showed interest in real estate properties for which prices kept falling. The recovery of land prices started only after drastic liquidation of bad loans by financial institutions. This process was helped by the general adoption of the DCF method, which enabled objective appraisal of real estate and the securitization of properties by the Asset Liquidation Law, which came into effect in 1998. The market was led by foreign-based funds such as Morgan Stanley and the recovery of the macro economy supported land prices.

Standard land prices for commercial districts

Source: The Ministry of Land, Infrastructure, Transport and Tourism, 2007

Data shown in the above graph is based on the land prices for roughly 30,000 locations assessed by real estate appraisers appointed by the government every July. The survey is conducted for the purpose of taxation and there is some divergence from the actual transaction prices over the short-term.
Looking at the standard land prices of commercial districts, for which national averages reversed their declines in 2007, Fukuoka recorded the highest at 769,000 yen per m2 among the nine major cities, except Tokyo. It is followed by a similar value of 767,000 yen per m2 in Osaka. These are about one third of the price appraised in the wards of Tokyo, which was 2,036,000 yen per m2.
The standard land prices in commercial districts over previous years in Nagoya, Kyoto and the wards of Tokyo started to rise from 2005, while all of the nine cities reversed their declines from 2006 to 2007. In particular, Sapporo, Kyoto, Osaka, Fukuoka and the wards of Tokyo recorded increases of more than 10% two years in a row. The growth of land prices are saturating though, particularly in Nagoya and Kyoto.

Annual changes of standard land prices in commercial districts

Source: The Ministry of Land, Infrastructure, Transport and Tourism, 2007

(2) Rental Office Market - Vacancy rate records the lowest in Tokyo
Among the nine cities, Yokohama recorded the highest asking rent for offices, roughly 12,000 yen per tsubo, while Kyoto and Kobe recorded asking rents at the 11,000 yen per tsubo level, followed by the 10,000 yen per tsubo level of Osaka, Nagoya and Fukuoka (Tsubo equals to 3.3m2, or 36 ft2). Sapporo and Sendai dipped below the 10,000 yen per tsubo level. Standards in the five central wards of Tokyo (Chiyoda, Chuo, Minato, Shinjuku and Shibuya) are close to reaching the 16,000 yen per tsubo level and the standard of Osaka was about two thirds of that.

Asking rents of office buildings

Source: CBRE Research Institute, December 2007

The vacancy rate as of the end of 2007 was lowest in Yokohama at 4.2%, which was followed by rates at the 5% level in Osaka and the 6% level in Nagoya and Kyoto. While the actual standard rent of Kobe exceeds that of Osaka by roughly 1,000 yen per tsubo, the vacancy rate in Kobe is higher than 10%. The vacancy rate for the major five wards of Tokyo remains at the low level of 1.7 %.
The vacancy rates in the nine cities peaked in 2003 and have been declining since then in general. The vacancy rates in Yokohama and Nagoya drifted without exceeding 10% in 2003, the year which saw vacancy rates increase nationwide. Although the vacancy rates in the two cities had a downward tendency after 2004, they went up slightly in 2007. Meanwhile, the vacancy rates in Kyoto and Osaka, which exceeded 10% from 2002 to 2003, rapidly decreased and recovered to the 5% to 6% level in and after 2006. Although Sapporo and Sendai once exhibited a downward trend, they have remained at roughly the same level for the past year or two.

Changes in vacancy rates of office buildings

Source: CBRE Research Institute, December

(3) Population - Centralization progress while Japan shrinks as a whole
As of June 2008, Yokohama has a population of roughly 3.64 million, which is the largest among the nine cities. It is followed by Osaka with a population of roughly 2.65 million and Nagoya with a population of roughly 2.24 million. The smallest among the nine cities is Naha, which has a population of roughly 310,000.
When compared with the wards of Tokyo, the population of Yokohama is equivalent to roughly 42% of that of the wards of Tokyo, while the populations of Osaka and Nagoya are roughly 30% and 26% respectively.

Estimated populations

Source: published data of each municipal office, 2008

Looking at the changes in the population growth rates for every five years, cities in major metropolitan areas showed significant decreases in population as demonstrated by Nagoya, Osaka, Kobe, Naha and the wards of Tokyo, all of which recorded negative growth in a comparison between 1990 and 1995. The major reverse in growth between 1990 and 1995 in Kobe is due to the Great Hanshin-Awaji Earthquake.

Changes in population growth rates

Source: Ministry of Internal Affairs and Communication, Statistics Bureau

In a comparison between 1995 and 2000, however, Nagoya, Kobe and the wards of Tokyo reversed their negative trends as their growth rates moved upward. In addition, all of the nine cities and the wards of Tokyo recorded increases in the 2000 and 2005 comparison. An apparent trend of centralization became common among the major cities, though population of the country is declining as a whole.
The highest growth rate in the 2000 and 2005 comparison was the 4.5% recorded by Yokohama and Fukuoka, which was followed by the 3.8% of Naha and the 3.2% of Sapporo. The wards of Tokyo remained at 4.4%, roughly at the same level as Yokohama and Fukuoka. Osaka, which had a population that had been in continuous retreat, reversed its negative growth increasing by 1.2%.
(4) Retail and Household Income
In a comparison of the number and total retail space of large-scale retail stores with floor space exceeding 1,000 m2 in the nine cities, the largest number of stores is 361 in Osaka, followed by 336 in Yokohama and 335 in Sapporo. As for total retail space, Yokohama has the largest amount of space, exceeding 2.26 million m2.
The number of large-scale retail stores in Kyoto, which has a population roughly the same size as Kobe and Fukuoka, is only 138 and the total retail space is also small at roughly 750,000 m2.
The wards of Tokyo have 911 retail stores and the total retail space exceeds 4.69 million m2. In a comparison between Yokohama and the wards of Tokyo, the number of retail stores in Yokohama is roughly one third of the wards of Tokyo, while the total retail space in Yokohama is roughly half that of the wards of Tokyo.

The number and the total retail space of large stores

Source: Toyo Keizai, 2007. Stores with retail space in excess of 1,000 m2

Sales turnover of large-scale retail stores (department stores and supermarkets) was the largest in Osaka among the nine cities, surpassing 1 trillion yen. It was followed by the roughly 930 billion yen in Yokohama and the roughly 800 billion yen in Nagoya. The total of the wards of Tokyo reached 2.85 trillion yen and the turnover of Osaka is equivalent to roughly one third of that.
In comparison to the previous year, each city remained at approximately the same level and there is little difference between cities. Sapporo, Nagoya and Kyoto slightly increased their totals over the previous year.

Sales turnover and the comparison with the previous year

Source: Ministry of Economy, Trade and Industry, 2006. Department stores with retail space of more than 3,000 m2. Supermarkets more than 1,500 m2.

As for the annual income of households consisting of two or more persons in each city, Yokohama recorded the highest annual income of 7.68 million yen, followed by 7 million yen in Fukuoka and 6.66 million yen in Nagoya. The lowest was the 4.25 million yen of Naha. The standard of Yokohama was roughly the same as that of the wards of Tokyo.

Comparison of household income

Source: the Ministry of Internal Affairs and Communication, Statistics Bureau, 2006. Households of two or more persons

(5) External Resources
For investors who wish to learn about Japanese property market from the ground, a comprehensive handbook published by the Real Estate Companies Association of Japan may be helpful. “REAL ESTATE in Japan” is issued annually in English and offered online for free.
REAL ESTATE in Japan

Those who want to check recent updates of rents and vacancy data may try “Office Market Report” published by CB Richard Ellis Research Institute. It is a quarterly report that covers metropolitan and regional cities. Note that the rents CBRE reports are asking rents, instead of actual closing rents which we offer proprietarily on the Closing Rent Survey page.
Office Market Report

The Association for Real Estate Securitization (ARES) provides online J-REITs information, by compiling public information regularly. "J-REIT View" abounds with outline of each REIT and statistic data, such as share price and dividend yields, updated weekly. "J-REIT Property Database" is comprised of indices and a database of REIT owned properties, based on the disclosed information. ARES also offers "Japanese Real Estate Market Overview", a webpage of its survey on cap rates, construction stats, etc.
The Association for Real Estate Securitization

The Japanese Real Estate Investor Survey, conducted semi-annually by a leading real estate appraisal institution Japan Real Estate Institute (JREI), provides expected cap rates of buildings in the Tokyo's central business districts, as well as regional cities. The report represents aggregated-base information of viewpoints and expectations, and does not reflect the actual transaction. However, it often referred as a key indicator for capturing market trends. The PDF files include English translation printed side by side with Japanese text.
The Japanese Real Estate Investor Survey

"Land Price Look Report" is the most recent effort of the Ministry of Land, Infrastructure, Transport and Tourism(MLIT) to improve transparency of the market. It represents an aggregation of the report on the quarterly trends in land prices of urban centers by local real estate appraisers. Quarterly changes are expressed by up and down allows on the map.
Land Price Look Report

160 large-scale office building development projects currently in progress in Tokyo.

 The map of Tokyo below represents 160 large-scale office building development projects currently in progress in Tokyo. The survey was conducted on buildings with more than 10,000 m2 of floor space that will mainly be used for offices in the 23 wards of Tokyo in April 2010, regardless of whether they would be used by their owners or leased to tenants. A total of 126 office buildings with a total floor space of at least 10,000 m2 are to be completed in Tokyo's 23 wards in or after 2010 for an aggregate total floor space of 7.6 million m2.
Click on the map to expand.

A total of 31 buildings with a total floor space of 1.1 million m2 will be completed in 2010. Thereafter, more buildings will be completed in 2011 and 2012, with more than 1.8 million m2 of floor space being supplied in 2012.

Construction plans for an additional 38 buildings were added to the data in the latest survey. Of those buildings, 25 will be completed by 2011. As was the case in the survey carried out one year ago, the construction of single buildings, which require shorter construction periods, was more active. Meanwhile, the buildings being completed in and after 2012 will mostly be large buildings with more than 100,000 m2 of total floor space. In our latest survey, plans for an additional six buildings came to light as parts of redevelopment projects.
Click on to expand

Click on to expand picture.

Tokyo Class A Buildings Rents Hitting Bottom Soon.

ASIA PACIFIC CONTINUES TO LEAD
GLOBAL OFFICE RENT REBOUND
EMEA region follows closely, with rents turning up.

More than half of the office rental markets in Asia Pacific either stabilized or moved into the growth phase during the second quarter (Q2) of 2010, demonstrating that the region continues to lead the global real estate recovery, according to CB Richard Ellis’ (CBRE) latest quarterly Global Office Rental Cycle report.

According to the rent estimates for model buildings envisioned by the institute for each major area, rents for the Marunouchi and Otemachi areas have already fallen to a level equal to that marked at the time of the "2003 problem," when there was an excess supply of office buildings.
In particular, the rent drop for Class A buildings in central Tokyo is significantly noticeable and the difference in rent compared with smaller buildings and buildings in the surrounding areas is rapidly diminishing.
The latest report points out the possibility of rapid growth in demand for Class A buildings, which now seem to be undervalued after rent adjustments, since there has always been strong demand from tenants for Class A buildings in central Tokyo.
Nevertheless, despite the fact that the rent for Class A buildings in such areas is nearing the bottom, the report did not revise the forecast that rents for large office buildings in broader Tokyo will not bottom out until 2011, as an overall recovery of office space demand is considered to take more time.
The report states that rents for small to medium-sized buildings and buildings in the areas surrounding central Tokyo may fall in an increasingly stronger downward trend for the time being.
Tokyo,Japan The Long Road to Recovery

Vacancy peak still to come, rental revenue to hit bottom in 2011.

Best 20 Deals -In Review 2009

Best 20 Commercial Real Estate transactions in Japan, based on proprietary data made in 2009. The Big Bertha being the Pacific Century Place Marunouchi Deal was the biggest (Hit for 6), not far behind was the AIG Otemachi Building. As big acquisition deals go, such as the Shiodome Building (#5), the Resona Maruha Building (#8) and the TOA headquarters (#13) resume in the end of the year, the real estate market is showing some signs of recovery with foreign funds on the hunt many are acquiring or ready to pull the trigger.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

#1 SECURED Acquires Pacific Century Place Marunouchi for 140 Bil.

SECURED CAPITAL JAPAN announced on December 15 that it will be acquiring the office portion of Pacific Century Place Marunouchi. The acquisition price has not been revealed but it is estimated to be about 140 billion yen ($1.6 billion). This is the largest real estate transaction of 2009 in Japan.

#2 AIG Sells Otemachi Building for 115 Bil.

On May 11, AIG announced that it will sell the AIG Otemachi Building in Tokyo for approximately 115.5 billion yen (US $1.2 billion). The buyer is NIPPON LIFE INSURANCE. "The sale generated substantial interest from both Japanese and foreign investors, resulting in a very competitive bidding process," Edward Liddy, AIG’s Chairman and Chief Executive Officer said.

#3 NTT URBAN Obtains Leasehold for Land for 86 Bil.

On March 10, the Tokyo Metropolitan Bureau of Sewerage selected the NTT URBAN DEVELOPMENT group as the developer of an office and commercial building. The building will be developed above the Shibaura Water Reclamation Center in Shinagawa-ku, Tokyo.

#4 ASAHI LIFE Sells HQ to MITSUBISHI for 80 Bil.

In March 2009, ASAHI MUTUAL LIFE INSURANCE sold the Asahi Seimei Otemachi Building in Otemachi, Chiyoda-ku, Tokyo. The buyer is a special purpose company belonging to MITSUBISHI ESTATE and the price is slightly less than 80 billion yen (US $790 million).

#5 JRE Acquires 30% of Shiodome Building for 54 Bil.

JAPAN REAL ESTATE (JRE), a REIT, announced that it will acquire 30% quasi joint ownership of trust beneficiary interests in the Shiodome Building, located in Kaigan, Minato-ku, Tokyo. The acquisition price is 54.6 billion yen ($590 million) and will be delivered in January 2010. JRE already acquired a 10% ownership interest in the Shiodome Building in December 2008. Through this acquisition, it will own a 40% interest.

#6 HULIC Selling System Center for 46 Bil.

In April 2009, HULIC, a real estate company affiliated with MIZUHO FINANCIAL GROUP, announced that it will sell an information system center in Naka-Meguro, Tokyo. The property will be sold to its tenant, MIZUHO BANK.

#7 ACCOMMODATIONS FUND to Acquire 43 Bil. 

Apartment Portfolio

NIPPON ACCOMMODATIONS FUND, a REIT of MITSUI FUDOSAN, announced that it will acquire 18 rental apartment buildings in Tokyo and local core cities. The total acquisition cost is 42.6 billion yen ($460 million) and this transaction by NIPPON ACCOMMODATIONS will be the first large-scale acquisition by a REIT in quite some time.

#8 MITSUBISHI Acquires Otemachi Building for 42 Bil. 

Otemachi Development TMK, a special purpose company which MITSUBISHI ESTATE and other firms are shareholders in, decided in December 2009 to acquire 27% of compartmentalized ownership in the Resona Maruha Building, an office building located in Otemachi, Chiyoda-ku, Tokyo, from TOKYU REIT. The acquisition price is 42 billion yen ($470 million) and the property will be handed over in January 2010.

#9 DAIMARU Acquires Store in Osaka for 38 Bil.

On February 26, department store DAIMARU announced that it would acquire its rival’s flagship, the Sogo Shinsaibashi store in Osaka City for 37.91 billion yen (US $410 million). The store will be closed at the end of August and reopen as DAIMARU in November.

#10 KENEDIX Sells Building to CARLYLE for 34 Bil.

On June 30, major asset management firm KENEDIX announced its sale of KDX Toyosu Grandsquare, a large office building in Shinonome, Koto-ku, Tokyo. The buyer is a fund managed by the CARLYLE GROUP. The price was slightly less than 35 billion yen ($350 million).

#11 JPR REIT Acquires Olinas Tower for 31 Bil. 

In June 2009, JAPAN PRIME REALTY (JPR), a REIT sponsored by listed developer TOKYO TATEMONO, added Olinas Tower to its operating assets. The office building in Sumida-ku, Tokyo, was obtained for 31.3 billion yen (US $320 million) from the sponsor and several other owners.

#12 KANSAI URBAN BANKING Selling Headquarters for 24 Bil.

On September 24, KANSAI URBAN BANKING CORPORATION announced that it would sell its headquarters building in Chuo-ku, Osaka City. The large office and retail building near the busy Shinsaibashi intersection will be sold to KEIHANSHIN REAL ESTATE for 24.4 billion yen ($250 million).

#13 Kojimachi Dev Site Sold for 23 Bil.  a 39% Decline in Price

NIPPON TELEVISION NETWORK decided to acquire the building site of the TOA headquarters in Yonbancho, Chiyoda-ku, Tokyo, for 23.15 billion yen ($260 million). The seller is a special purpose company of real estate company SHOEI. The handover of the ownership is scheduled for March 2010.

#14 TOSHIBA Selling Parking Lot in Kawasaki for 22 Bil.

In March 2009, TOSHIBA decided to sell a 9,765 m2 parking lot adjacent to LAZONA Kawasaki Plaza, a large-scale commercial facility in front of JR Kawasaki Station. The buyer of the hourly parking lot is NREG TOSHIBA BUILDING, which is a consolidated subsidiary of NOMURA REAL ESTATE HOLDINGS.

#15 NOMURA REIT Reshuffles assets

In January 2009, NOMURA REAL ESTATE OFFICE FUND, a REIT, announced that it would acquire four office buildings in Tokyo including the Nomura Ueno Building. At the same time, it announced that it would sell three properties in Osaka, Sapporo and Hiroshima.

#16 ORIX JREIT Invests 18 Bil. Yen, Reshuffles Assets

In March 2009, ORIX JREIT acquired the ORIX Nishi-Shinjuku Building located in Shinjuku-ku, Tokyo and the Omiya Miyacho Building located in Saitama City. Both properties were acquired from ORIX REAL ESTATE and the total acquisition price was 18 billion yen (US $180 million).

#17 Mizuho Affiliate HULIC Acquires Building for 13 Bil.

In September 2009, HULIC, a real estate company affiliated with the MIZUHO FINANCIAL GROUP, acquired a rental office building in Kudankita, Chiyoda-ku, Tokyo. The Price is 13.5 billion yen ($140 million). The seller is a fund established by SIMPLEX INVESTMENT ADVISORS, an affiliate of GOLDMAN SACHS and AETOS CPITAL.

#18 Kuwait-backed ST MARTINS Acquires Apartment for 13 Bil.

In February 2009, U.K.-based ST MARTINS PROPERTY acquired a large-scale rental apartment building offering 281 residential units in the Tsukiji area of Tokyo. The acquisition price was 13 billion yen (US $130 million) and the seller of the property was DAVINCI ADVISORS.

#19 TOP REIT Acquires Kanda Building for 13 Bil.

TOP REIT decided to acquire the Sumitomo Shoji Nishikicho Building in Kanda-nishikicho, Chiyoda-ku, Tokyo. The price is 12.7 billion yen ($140 million) and the seller is major trading company SUMITOMO CORPORATION.

#20 PROLOGIS Builds Logistics Facility for 11 Bil.  in Misato

Prologis announced its plan to sell ProLogis Park Misato II to an affiliate of GIC, the Government of Singapore Investment Corporation, for 12.5 billion yen ($138 million). The contract is scheduled to close in April 2009.

Security is mostly a superstition

This video relates to both (Property Investment = Risk) and (Jazz = Improvisation)  there fore it belongs in this Blog.  enjoy.


"Security is mostly a superstition. It does not exist in nature, nor do the children of men as a whole experience it. 
Avoiding danger is no safer in the long run than outright exposure. 
Life is either a daring adventure, or nothing." Just do it!!!






With out a doubt....the BEST most crazy sh*d on the net...I LOVE IT !!!!!!!!!!!! But im gunna stick to my Snowboard as my balls are 32% the size of his.. ( i just did a quick calc... )

Why is there so much interest in Japanese real estate?

Prices vs Rents
On Friday, The Economist revisited its 'fair-value measure for property' based on the ratio of Real Estate acquisitions to rents, which is similar notion to the price-to-earnings ratios used by stock market analysts to value companies.

It found that prices looked cheap only in Japan, where steadily falling property prices mean the price-to-rents ratio is 34% below its average since 1975. Switzerland's ratio is also less than its long-run average and possibly also in Germany.

It also estimates that even American Real Estate prices are now 3% below their fair value by the third quarter of 2009 - based on the S&P/Case-Shiller house price index - following big falls from the peak of 2006.

But it said that in Britain, where prices are increasing again, Real estate still looks 'expensive':

Overvalued property markets

Spain - 55%
Hong Kong - 53%
Australia - 50%
France - 40%
Sweden - 35%
Ireland - 30%
Britain - 29%
Canada - 20%
Italy - 15%

Undervalued property markets

US - 3%
Switzerland - 9%
Germany - 15%
Japan - 34%

As The Economist admits, 'no valuation measure is perfect'. The data goes back different lengths for each country:  'If the average price-to-rents ratio is calculated from 1990 onwards, Spain's market is overvalued by 24%, rather than the 55% shown in the table (based on figures from 1975),' the report said. 'That would make both markets similarly overpriced.'

It's also worth noting that rents, which recovered slightly in 2009, are also likely to come under pressure in 2010 unless a strong economic recovery materialises.

Source: The Economist 

Sun Not Rising on Japan's Flat Real Estate Domain

Business Monitor International reports the global economic recession impacted Japan severely and especially affected the real estate industry. A weak economic recovery is now under way, helped by government stimulus spending and tax reforms.

"We expect growth to remain weak, just managing to stay in positive territory, to reach about 1.2% year-on-year (y-o-y) in 2012 and 2013," the research group states.

However, the economy has racked up chronic fiscal deficits and a huge public debt worth around 200% of GDP. "The outlook is not bright, as the country moves from net saver to net debtor status," according to Business Monitor International.

The real estate market is also problematic. Japan's residential sector is suffering from record low levels of new construction.

According to the Japan Real Estate Institute (JREI), residential land prices have slid more than 40% from their 1991 peak and land prices in Japan's six largest cities fell 7.8% (9.2% in real terms) year-over-year (y-o-y) in H109.

The Tokyo office market has reached its highest vacancy level for six years. There were dramatic rental falls in Tokyo office space to late 2009: Tokyo (Inner City) rents plunged 23.3% y-o-y, while Tokyo (Outer Central) rents dropped 21.9% y-o-y. Osaka saw a similar tale of increases in vacancies.

In Tokyo, retail rentals dropped by about 50% y-o-y in 2009, and industrial rents were down by 10-20% y-o-y. In Osaka, retail rentals dropped by 15-20% y-o-y in 2009 and industrial rents were down by 10- 20% y-o-y. In Yokohama, rental rates for all types of commercial property fell by 20-30% y-o-y in 2009.

In the longer term, while the weakness in the economy and the lack of funding seem likely to keep housing prices under downwards pressure, demand, driven by population necessity, will pick up, requiring supply to meet it, according to the research group.

In general, commercial real estate rents and prices also seem likely to soften further, given the rising vacancy rates and the tendency for companies to downsize.

Also, "there is little scope for improvement in the industrial sector, given the likelihood that the economy will remain fairly stagnant over the next year or so. However, there are signs that retail property may be on the rebound, as a result of increasing consumer spending as the economy recovers," states Business Monitor International.

Lee Ritenour - Papa was a Rolling Stone - Funk yeah!!!

This is some serious Funked up brain calculus stuff that can be appreciated by Miles Davis fan all the way across to the monosyllabic block head.
The vocal contributions by Kenya Hathaway in particular, and Grady Harrell are superb like everything else about this concert - beautifully on point. Each musician makes a meaningful statement on their instrument that stands out without being overpowering.
Feel the Funk.

Very tight Funk groove.

Cap Rate Follies

Avoid These Pitfalls When Calculating Commercial Property Values.

Capitalization rates are often controversial and misunderstood variables in commercial real estate valuation equations. To value properties, most buyers and sellers prefer an income approach, which analyzes cash flows to determine debt service and investor return — typically the internal rate of return — so it's easy to see why cap rates are scrutinized.
In fact, no other valuation aspect is debated as heavily as cap rates because unsupported data often lead to inaccurate commercial property valuations. By understanding the fallacies that exist, real estate professionals can perform more thorough financial analyses for their clients.
Valuation PrimerEssentially, a cap rate converts income into value: A property's net operating income is divided by the cap rate, and the resulting figure reflects a return on and of capital. The income approach begins by estimating property income and subtracting a vacancy/collection loss allowance and expenses to achieve the NOI. Then the NOI is divided by the cap rate to obtain the property's value.
Commercial real estate owners, lenders, analysts, appraisers, and assessors typically obtain similar projections for a property's income, vacancy/collection loss, and expenses. Minor variances in these figures have little effect on a property's value, especially when compared to historical projections on a stabilized income stream. However, value opinions usually differ in the cap rate selection.
The importance of the cap rate to a property's value conclusion using the income approach is significant. In Table 1, the value conclusion ranges from $3.6 million to $5.3 million — 44 percent — depending on the cap rate. Even a 1 percent or 0.5 percent difference in the cap rate can affect a transaction's outcome.

Cap Rate FallaciesSince cap rates strongly affect properties' values, commercial real estate professionals should avoid the following fallacies that can blunt their projections' accuracy.
The Cap Rate Is Always 10 Percent. Many in the industry consider a 10 percent cap rate as a good rule of thumb for a quick estimate of a property's performance. Although this shortcut may be helpful at times, even a small variance is critical to the actual value. Set cap rates should not be relied upon as a firm industry benchmark.
Data Services Are Accurate. A decade ago, obtaining sales transaction data from a national or local service was almost impossible, but today several companies gather and sell comparable sales data. Though services may claim to provide verified data, commercial real estate professionals should conduct their own due diligence by carefully reviewing financial details, such as income, vacancy rates, expenses, NOI, and cap rates, in data service reports. Beware round numbers: If the income is a round $200,000, vacancy an even 5 percent, and the expense-to-income ratio a flat 50 percent, the data cannot be trusted.
Data services' use of unique terms also points to inconsistencies. For instance, data probably are unreliable if the service provides potential gross income when the property owner only reported effective gross income. Potential gross income typically indicates the service has used rounded figures in the cap rate calculation, which likely results in inaccurate data.
Sale Disclosures Are Valid. About a dozen non-disclosure states do not require sellers and buyers to document sales prices. Unless a state requires a separate disclosure instrument for determining the sales price, actual sales prices must be verified.
A problem in many non-disclosure states is inconsistent sales data. The buyer, seller, or another party involved in the transaction should be a reliable source for verification. At least two different sources should confirm the sales price.
All Cap Rate Components Are Included. Data services usually only report sales above a certain dollar amount — generally $500,000 to $1 million minimum. These sales frequently include business elements that are not denoted in the sales price. For example, car dealerships often include a business value component as part of the price, but this is rarely separate from the real property value. Comparing sales prices that mix real estate and business values to real-estate-only situations produces skewed results.
Historical Projections Are Reliable. Real estate professionals frequently overlook this fallacy, but differences become magnified when using older data. Cap rates usually are calculated based on the prior year's income and expenses. Although the income projection is for the next 12 months, the cap rate is based on the prior 12 months. This discrepancy can produce inaccurate results when the economy or the local real estate market is changing.
Buyer Expectations Are Clear. A common explanation for low cap rates is unclear buyer expectations. Did the buyer expect to expand a business or renovate the building? Was the purchase price heavily based on upside potential? Was there a particular reason why the buyer needed this property, such as its unique location? Buyer compulsions might result in higher selling prices and lower cap rates. Therefore, if a market shows a wide range of cap rates, rely on the median rate for the most accurate assessment.
Cap Rates Reflect Total Value. Some types of real estate, such as hospitality properties and marinas, allow owners to pocket cash that does not appear on financial statements. Such properties' listing prices may reflect value that is both on and off the books. When data services use financial information that reflects only value on the books, the resulting cap rate may be skewed significantly lower.
The Math Is Correct. Investors often want to know an appropriate cap rate for a particular property type or market. However, real estate professionals' cap rate conceptions can result in market values that do not provide buyers with sufficient return on investment.
For instance, consider the investor's requirements in Table 2. The property has a 70 percent loan-to-value ratio, an 8.5 percent interest rate, monthly mortgage payments, and a 25-year amortization rate.

The investor's equity return ranges from 7.45 percent to 20.79 percent depending upon the cap rate. The equity return then must be compared to more-liquid, safer investments to determine if capital would be attracted to this investment. If the first-year equity return is not sufficient for investors to compare it with other investment vehicles, the only way to generate that return is to bank on appreciation, which no longer is considered a good investment strategy.
When real estate is listed at prices resulting in poor equity returns, financially savvy owners and investors may make significantly below-market offers. These low-ball offers reflect the purchaser's return on investment requirements without considering appreciation factors. Many potential buyers refuse to make an offer on properties in these situations because the spread for negotiation is too great.
Frequently when a property's projected equity return is very low or negative, the cap rate also is too low to attract capital to the project.
Cap Rates Always Should Be Developed From Sales. Several techniques other than sales prices, such as the band of investment technique, mortgage equity technique, and hybrids of these two approaches, can be used to derive cap rates.
Like sales-based calculations, these techniques build cap rates from the components necessary to create a deal. Each attempts to model investor and lender requirements by weighting the cap rate for each deal participant. For example, using the loan terms in Tables 1 and 2 and a 15 percent return for the purchaser, a built-up cap rate would be calculated as shown in Table 3.

Mortgage equity and other techniques use the general calculations shown in Table 3 with modifications for variables such as equity increases for paid-down loans and property value appreciation if applicable.
In today's low interest rate environment, it is critical to note that the calculations in Table 3 imply cap rates are heavily dependent upon the current mortgage interest rate. Although this is accurate to some degree, risk parameters are difficult to gauge. For instance, examining the cap rates reported in the Korpacz Investment Survey during the past five years shows relatively little variation, yet during this time a recession began and several other factors affected many commercial real estate markets' performances. Therefore, when relying on these cap rate calculation techniques, fully consider the risks inherent in the equity rate portion of these equations.