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  • Writer's pictureRealFacts Editorial Team

Calculating Valuations Beyond Cap Rates

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Amidst the uncertainties and fluctuations in the commercial real estate (CRE) market, the quest for accurate property valuations has become increasingly challenging. In a recent analysis by CBRE, alternative approaches to traditional cap rate-based valuations were explored, shedding light on the complexities of determining property worth in today's volatile landscape.

As the demand for CRE financing persists, lenders find themselves grappling with the dilemma of accurately assessing property values. Factors such as fluctuating property types, concerns over inflation and interest rates, and the continuous decline in property values have made this task particularly daunting.

Traditionally, cap rates derived from property appraisals have served as the go-to method for estimating property values. However, in the current climate characterized by limited transaction volumes and reduced market liquidity, relying solely on appraisal-based cap rates has become increasingly unreliable.

CBRE proposed several alternative valuation methods to supplement traditional cap rate approaches:

1. Spread-Implied Cap Rate: This method involves calculating the average historical spread of cap rates over 10-year Treasury yields to determine the current property yield.

2. Fair Value Cap Rate: By utilizing the Gordon Growth model, this approach combines the risk-free rate and risk premium, subtracting expected income growth to arrive at a fair value cap rate.

3. Debt Service Coverage Ratio (DSCR) Implied Cap Rate: This method seeks the yield necessary for the property to maintain an adequate DSCR.

4. REIT-Implied Cap Rate: Comparing current REIT share prices with a property's expected income to derive an implied cap rate.

CBRE applied each of these methods to various property types including office, multifamily, retail, and industrial, comparing them to traditional appraisal-based cap rates. The results yielded valuable insights:

- Office cap rates may have more room to rise: This suggests a potential increase in office property yields.

- The rise in industrial cap rates may have peaked: Despite the recent surge in industrial capital flows, the spread-implied rate indicates a higher yield, implying a possible stabilization in industrial property values.

- Current fair-value cap rates are low for retail: Indicating downward pressure on retail property yields, possibly signaling an improvement in the sector's performance.

- Mixed signals for the multifamily market: The outlook for multifamily pricing varies depending on market and asset selection, indicating the need for careful consideration.

While determining the most accurate valuation method remains challenging, the combination of these approaches provides a broader context and deeper insight into market conditions and property valuations. In conclusion, amidst the volatility and uncertainties in the CRE market, leveraging multiple valuation methods can offer a more comprehensive understanding of property values and market dynamics.

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