Value of Commercial
Real Estate Today
By Dean Willmore, SIOR
By far, the biggest challenge I
have today (and maybe in my
career) is how to determine the
value of commercial real estate.
This is especially difficult with
all of the market turmoil we
have recently experienced. As
an industrial real estate broker
in Las Vegas, I have seen valu
ation swings for commercial
property in Las Vegas increase
and decrease by more than 400 percent, in just the past three
years. Why? Commercial real estate has historically been one
of the most stable, longterm investment vehicles available,
and typically, has not been susceptible to the rollercoaster
highs and lows of the stock market, the bubbles and busts of
the commodities and precious metals markets, or the shocks
and crashes of bonds and currencies.
So, what factor, or combination of factors, has the most
impact on commercial real estate value?
Later on, I believed the single most important factor
to commercial real estate appreciation was rent growth.
Appraisers use rent (or income) to determine what is known
as the “income approach” to value. This rent growth trans
lated into higher sales prices and valuations for commercial
real estate. In commercial real estate, rent demand is elastic,
meaning that it can change quickly, while rent supply is inelas
tic, which means it takes a long time to bring
new product on line. This supply and demand
inelasticity commonly creates about 15 to 20
percent more variation in real estate cycles
than in other normal business cycles.
Therefore, increasing tenant demand can
force rents (and values) to spike very
quickly. Rent growth and its
partner, operating expense
containment, are still con
sidered by many investors
as the fundamental method
to increase the value of
any commercial real estate
Location, Location, Location
I have been a commercial real estate broker for 30 years and
have witnessed several periods of real estate highs and lows.
I have brokered during the greatest bull market I believe the
commercial real estate industry has ever seen, (from 2004 to
2008), when buyers worked in a feeding frenzy, outbidding
each other (and the purchase price) by hundreds of thousands
of dollars, just for the chance to own commercial real estate
in Las Vegas.
When I was new to the business, the phrase “location,
location, location” was drilled into me by my mentors. I was
taught that location was the most important factor in deter
mining real estate value. I still believe that, at the end of the
day, a property’s location (to transportation arterials, retail
services, amenities and rooftops) is one of the key determin
ing factors (along with its highest and best use) in determin
ing ultimate value and price.
After a few years working in the business, I was sure that
interest rates had the biggest impact on commercial real estate
valuation. After all, interest rates work in tandem with CAP
rates and when interest rates are high, so are CAP rates, which
force values down. The reverse is also true (low interest rates),
which is why we are still seeing low CAP rates today.
We know that market value
is a theoretical concept (very
distinct from the market price),
which is the price at which the
buyer and seller can or do transact.
What I am trying to determine is how to
arrive at the “true underlying value” of commercial
real estate. Making this determination can be a bit tricky.
For example, the true underlying value is not what appraisers
might call the “intrinsic” value, which is a concept most com
monly used with land speculation. For instance, what was a
citrus grove a few years ago might very well be a booming
Regional Mall today. A wise land speculator might be able to
spot this intrinsic value, while still a citrus grove.
I am proposing “true underlying value” as a concept that
should be invoked in situations like we have today, where
there are inefficient markets or disequilibrium situations and
prevailing market prices are not reflective of the true under
lying, or “real” value. But how do you determine the true
underlying value of commercial real estate today?