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PasadenaNative says

What I don’t understand about commercial property is why is value so contingent on rental income and expenses?

Because commercial property isn't sold on emotion?

Do you buy GOOG at $800 because you really like the symmetry of the letters and it reminds you of your infant child? :)

quesera says

PasadenaNative says

What I don’t understand about commercial property is why is value so contingent on rental income and expenses?

Because commercial property isn’t sold on emotion?
Do you buy GOOG at $800 because you really like the symmetry of the letters and it reminds you of your infant child?

What the hell is "GOOG"?

PasadenaNative says

What the hell is “GOOG”?

http://www.google.com/finance?q=GOOG

Not that the stock market is devoid of emotion, but my point is that commercial real estate investors are doing more smart math than retail homebuyers.

Anyway, sorry to hear about your mom, and assuming you're getting a decent income from rent, I can think of no good reason to sell any time soon. But before you do, getting the rents up to market will make a big difference in demonstrable value.

GOOG is the stock ticker symbol for Google...

The value of a rental property is primarily based on rents & expenses because those are the primary factors in determining net income. When someone buys a property to rent it out, they are (usually) interested in the monthly cash flow...It's an investment. They want to know how much money they have to put down, how much risk they are assuming, and what the monthly rents/expenses are. If the price is too high for a given rent level, then their return on investment may not be as good as some other investment (say, bonds), and they will choose to put their money in better performing investments.

There are other factors -- tax deductions, appreciation, etc...but for the most part there isn't a big emotional influence. Someone buying a house ("home") to live in is usually not as savvy as a real estate investor, and is emotionally bound up in the decision...they rationalize a much higher price for the property than it would be worth to an investor.

I see, this makes sense. Thank you for your thoughtful comments!

quesera says

PasadenaNative says

What the hell is “GOOG”?

http://www.google.com/finance?q=GOOG
Not that the stock market is devoid of emotion, but my point is that commercial real estate investors are doing more smart math than retail homebuyers.
Anyway, sorry to hear about your mom, and assuming you’re getting a decent income from rent, I can think of no good reason to sell any time soon. But before you do, getting the rents up to market will make a big difference in demonstrable value.

Thank you. Yes, we are doing pretty well, no mortgage of course and no loans. It's enough to live on.

Other reasons that a commercial property might value lower than an SFH of the same size:

a) commercial property is generally finished less expensively
b) commercial rents are often lower per ft^2 due to the differences in markets
c) SFHs are always at a premium over condos, commercial space is more like condos

Et cetera.

If you have a commercial appraisal done you will see the difference. They typically value property 3 ways replacement cost, comparable recent sales and the NOI (net operating income/capitalization rate). My experience is that the appraiser puts most emphasis on the cap rate, next if there are decent comparable sales on comparable sales and not at all on replacement costs. A commercial appraisal is a very much more complicated and expensive animal as opposed to a residential appraisal, particularly if done by a MAI appraiser. That is not to say that some of the same shenanigans dont occur it is just that they are more nuanced. One always tells the appraiser, at least in passing, what the purpose of the appraisal is

rdm says

If you have a commercial appraisal done you will see the difference. They typically value property 3 ways replacement cost, comparable recent sales and the NOI (net operating income/capitalization rate). My experience is that the appraiser puts most emphasis on the cap rate, next if there are decent comparable sales on comparable sales and not at all on replacement costs. A commercial appraisal is a very much more complicated and expensive animal as opposed to a residential appraisal, particularly if done by a MAI appraiser. That is not to say that some of the same shenanigans dont occur it is just that they are more nuanced. One always tells the appraiser, at least in passing, what the purpose of the appraisal is

So does that mean it can be higher? Lower? I just wanted a ballpark figure, since we are not looking to sell. I did give him a lot of info. re rents and repair costs.

Whoa Nellie!! Pasadena Native! In my area, local commercial developers put in typical "el cheapo" tilt-ups (like warehouse construction) in several NEW -2007- medium sized shopping centers. These greedy developers grabbed cheap formerly non-productive agriculture land and found a sucker who wanted to play "anchor store". The anchor store can throw away high lease money because they are part of a large national chain. Why do I mention this? THE SAME BUILDER pleads he will go bankrupt (who cares) unless the city lets him build MORE commercial buildings only a few miles away allegedly to "stimulate" the local economy. The vacancy rate on his existing structures is ~80%! The leased square footage is a small portion of the mega buildings that REMAIN EMPTY. The builder /leasing agent REFUSES to negotiate one dime on any property lease. Its disgusting! The only "stimulus" is to the selfish and greedy developer-leasing company. Does it make any sense, to keep building more and more...when their own NEW properties, almost the same design and size...sit VACANT -for YEARS?
This is criminal..!
Small businesses....are closing DIRECTLY because the builder/property management firm would rather have NO INCOME (HUGE VACANCY---thousands of sq ft) ....and more building activity than actually having reasonable leases. Consumers in this economy are price buyers A small business MUST have high prices just to satisfy the cravings of a developer. The result....many local retail stores are closing. I spoke with the manager of a national hardware chain who said THEY had to close their store because the lease was just increased 30%...! They moved out...leaving only one store when there were over twenty...and now the shopping center is a ghost town.. THE SAME BUILDER...who wants to build more boxes...as long as they keep paying off politicians and playing back room games with banks.

Many speculate the real reason is the cozy relationship with the lender bank---who gets its free money from us taxpayers. I smell kick-backs all over the place. This is TYPICAL of the construction-banking- Real estate cartel. Lower leases, so small business can florish. But NO the developers and their ilk want it all.

quesera says

Other reasons that a commercial property might value lower than an SFH of the same size:
a) commercial property is generally finished less expensively
b) commercial rents are often lower per ft^2 due to the differences in markets

If residential is more expensive than commercial, the residential is overpriced - everywhere I have lived (which does NOT include Southern California, but does include someother nice areas), commercial purchase and rent prices are significantly higher than residential rent/ purchase costs, often 2x to 3x the cost per square foot.

People who buy commercial real estate are typically sophisticated, high net worth investors. They are buying a cash flow and that is their only interest. Therefore, there are only two numbers they are concerned with: the cap rate and the cash on cash rate.

The cap rate represents the hypothetical net income that you would derive if you paid all cash for the building. The cash on cash rate represents the return on investment of the actual cash used, taking into account the actual financing.

For the sake of example, let's suppose you have a building that is for sale for $1,000,000 and has a net operating income of $100,000. That makes it a "ten cap," meaning the cap rate is 10%. This number can then be compared to other investments, notably the treasury bond rate. Typically, buildings in more desirable neighborhoods (e.g., Beverly Hills) will have much lower cap rates than buildings in less desirable neighborhoods because there is less risk. To put it in terms of Los Angeles area real estate, a prime grade A apartment building in Beverly Hills might be a 4 cap and a dilapidated brick building in Westlake might be a 13 cap. There is much more risk with the Westlake building so the rate of return must be higher to compensate.

The other number that investors look at is the "cash on cash" rate. In the example above, if you put 30% down on the 1M dollar building, your "cash on cash" rate would be 33 1/3% (100/300). That means that you are getting a net 33 1/3% return on your investment - pretty damn good.

My dad had his small business (pharmacy) in this building from the 60s up until the early 80s. He paid around $30,000 for it and didn't have a mortgage on it; he made payments directly to the owner, who was his buddy. He bought it so we could live in one of the apartments above the business and he knew when he died, that it would take care of my mom, which it did. No greed there! My dad was a thoughtful, good man, and I miss him so much still. If he had a customer who was short on cash, he let him slide until he was able to pay...ah, the good old days :-)

Oh yeah, we had a soda fountain too! :)

Seems to me that if the economy is in the toilet, you don't want to risk losing good tenants by jacking up your rents. Ours are lower but we never have vacancies. This is a beautiful 1915 Tudor Revival with all the original hardwood floors, moldings, and built-ins. Sooo many businesses around here have empty storefronts for years on end - - no joking. I see many apartments sitting empty until landlords ease up on the asking price. I think for now we are doing okay. We most likely won't sell for about ten years, so who knows what things will be like then...if we are even alive, for god's sake!

And you get to keep your parents' subsidized property tax level, while someone else acquiring the property would have to pay 1% of the sale price, plus some additional in parcel taxes. Theirs would be based on $2.1 million. Yours are based on whatever the assessment was in 1976, plus 2% per year. Say, $50,000 in 1976, plus 2% annual increase for 32 years -- about $92,000 if my calculations are correct. So you're paying property taxes of LESS THAN 5% of what a new buyer would have to pay.

So your grateful neighbors are subsidizing you!, and you are passing part of your subsidy to your tenants.

Is this a great country, or what? A 95% subsidy!

Maybe not, if you're one who doesn't get subsidized by your neighbors, and end up paying for city services via taxes on wages and purchases, in addition to what you pay in rent or property taxes.

Isn't there a better way to fund our services, such as a tax on land value, applied to every site, leaving the buildings untaxed?