A Guide to Valuing Buildings Amid Less Debt and Changing Cap Rates

It’s no secret that as we sit here in May of 2023, there has been a significant deterioration of values across asset classes in commercial real estate. In fact, I haven’t been in a meeting or on a call in the past several months where the level to which prices have fallen has not been a topic of conversation.  Questions about office buildings dominate these discussions since their value has clearly decreased the most and some of the basic going forward assumptions are a guess at this point. Time will give us the answer of course, but by simply looking at some big picture metrics we can start to get a sense, which gives us a lot to think about.  

Early in my career, a well-known investor sensed my nervousness as I was presenting a set of cash flows and told me something along the lines of: “Don’t be intimidated by the math in real estate, you basically learned everything you need to know in 10th grade algebra, we are always just solving for X.” That may well be an oversimplification, but there is some truth to it. In fact, if we isolate the key variables in a basic valuation, we can get a sense of how much values can move. Move them all at once, and the results can be staggering.