Valuing buildings with significant vacancy is a common challenge for today’s real estate investor. A simple capitalization rate methodology is of limited use as it will not reflect the intrinsic value of the vacant space.
A discounted cash flow (DCF) analysis is the preferred valuation approach, yet has the limitation of generating a single internal rate of return for the blended cash flows of both existing and vacant-space tenants. You should require a higher IRR for cash flows associated with the vacant space due to increased commensurate risks.
In this period of economic uncertainty, it may make sense to be aggressive on your pricing for in-place leases to quality tenants, and extremely cautious about the prospects of leasing vacant space. A segmented DCF analysis will help you price this strategy appropriately.
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