Cost Minus Co. wants to buy a 580,000-square-foot distribution facility in the outskirts of the city of Boring, OR. The subject facility is presently renting for $4 per square foot per year. Based on recent market activity, two properties have sold within a several-mile distance from the subject facility and are very comparable in size, design, and age. One facility is 550,000 square feet and is presently being leased for $3.80 per square foot annually. It sold just a few days ago and is in very close proximity to the subject, which makes it twice as important in determining the subject’s value as the second comp. The second facility contains 600,000 square feet and is being leased for $3.50 per square foot annually. Market data indicate that current vacancies and operating expenses combined should run approximately 60 percent of gross income for these facilities, as well as for the subject. The first facility sold for $8.5 million, and the second sold for $9 million.
a) Using the direct capitalization rate approach, how would you estimate the current value for the subject distribution facility? Calculate and explain.
b) What are some of the flaws associated with using this approach to estimate the value of the subject property?