What makes a commercial building valuable? It is the return delivered to its owners/investors. How are these returns maximized? Simplistically, this is done by maximizing the net operating income (NOI). The NOI is the gross operating income minus expenses. Generally, this is the total rents received from tenant occupancy (the gross operating income information is not generally publicly available.)
The real estate capitalization rate (i.e. the Cap Rate) is the NOI divided by the purchase price of the building or similar buildings. Cap rates are important tools in the buying/selling of real estate, and are often established by using data about recent transactions. It’s worth noting that a lot of considerations go into expense projections, and many of these are established by doing appropriate due diligence on the physical condition of the property.
Beyond Cap Rates and NOI: Determining the Value of Iconic Buildings
Where the notion of “similar buildings” breaks down, is when the architecture of a building is so distinctive or iconic that it has an impact on the occupancy history and – if determinable – the rental rate of the building. Consequently, this affects its gross income.
The old axiom “Beauty is in the eye of the beholder” is certainly appropriate here. The value of the architecture of a building is determined by how its design is perceived by the public and the industry (as well as by things such as its cultural symbolism or history). Therefore, to determine the value of an iconic building we must consider what influenced the original owner or developer’s design choices.
Case Study: Lever House
The Lever House is one of the two iconic International Style buildings located on Park Avenue in New York City, built in 1950-1952 as the US headquarters of soap company Lever Brothers. It was designed by G. Bunshaft and N. de Blois from US architectural firm Skidmore, Owings and Merrill. The architects were selected by Charles Luckman, president of Lever Brothers and himself an architect (in fact, after leaving Lever, Luckman started his own architecture firm delivering several famous designs that include the Theme Building at Los Angeles International Airport and the new Madison Square Gardens.)
Together with the Seagram Building, the Lever House set the pattern for the rare public ground level plaza scheme that later was adopted as a standard by the New York City Department of Zoning (for more about how New York building codes influenced the architecture and its skyline, read this blog here).
Determining the NOI for the Lever House is complex, as data about lease rates and prices differ depending on who you ask. The current owner of the Lever House, New York-based RFR Realty, reports that the building is currently 100 percent leased, while commercial brokerage Cassidy Turley says vacancy rates in the Park Avenue District are at 10.1%. Cassidy Turley also reports that landlord asking rates are averaging around $92/sf, while Compstak reports that recent 390 Park Ave tenants such as hedge fund Third Point are paying $140/sf.
There are only two office buildings currently for sale within a 2 mile radius and neither has pricing available. Without the iconic, recognizable design of the Lever House, neither of these buildings would be considered to be “similar”. This is exactly the point: there are some buildings which appear to the real estate industry as having a particular visual design quality that differentiates it from the rest of the market. Many commercial developers and their architects want to create buildings with values that go beyond CAP rates and NOI calculations, but it is rare that a design is so generally appreciated that it reaches this status. Beauty is in the eye of the beholder, after all!