The subject site is an office property in Oakville, Ontario. It can be sold either in parts or as whole, and this report will consider the whole. The size of the whole building is 4016 square feet. The property is located on the service road adjacent to the Queen Elizabeth Way (QEW), a major highway in the region that links Toronto with the cities of Hamilton and Buffalo. The property can be subdivided into multiple units, at least three. There is a current tenant occupying 839 square feet and room for two more tenants or one primary occupant.
The market for this type of property is relatively soft at present. The prevailing economic conditions are for sluggish growth, with some observers predicting a protracted housing correction and "muted business investment." The recent federal government budget has more cuts than spending, and the lack of fiscal stimulus is likely to harm the economy for the next year or two as well (CP, 2013). With an expected decline in business investment, the market for office property is likely to be weak as well.
Oakville is a suburb located to the west of Toronto, which is Canada's business hub. Its population is around 180,000, compared with 6 million for the Greater Toronto Area (GTA) overall. The Oakville economy has traditionally been driven by industry, including a major Ford plant. The service roads along the QEW have long been hubs for office space, with developments lining virtually the entire 50km between Hamilton and downtown Toronto. The situation is the same for other freeways in the area. The GTA is Canada's economic hub, and its economic performance therefore tends to mirror that of the nation overall. A large portion of Canada's non-resource economy is situated in southern Ontario.
The market for office space in Toronto is becoming saturated. While the Canadian economy has not suffered to the same degree in recent years compared with the U.S., UK or Europe, there has been a downturn. This has led to a prolonged low interest rate environment. Given low interest rate conditions, but a fairly healthy economy overall, there has been an office building boom in the Toronto area. It is expected that by 2014 the Greater Toronto Area will add 1.59 million square feet of office space, much of it at the AAA level, which is the highest quality. Demand is coming from a wide range of industries. In recent transactions, a record price of $749 CAD per square foot was paid for the TD Canada Trust Tower in downtown Toronto. The new supply entering the market should suppress such high prices over the course of the next couple of years (Dmitrieva, 2013). This growth is also spurred by a healthy banking sector that is willing to lend.
The predictions that there is a bubble that will burst also derive from the nature of the new supply. The low interest rate environment has compelled many real estate investment trusts -- REITs -- which are a common investment vehicle in Canada, to undertake new spending. There is not always going to be demand to absorb the new supply and the market may be out of equilibrium for a few years after the building boom ends. With a glut on the market, the value of older, less desirable properties is likely to decline. The property in Oakville is precisely the type of property likely to suffer. It is older, and though well-equipped is removed from the area's prime real estate. The downturn may already be occurring -- commercial real estate investment is down 8% to start 2013. Though still above historical averages, this trend is clearly unfavorable for the market in general (RealNet, 2013).
Office rentals in Oakville typically come in between $0.90-$1.00 per square foot per month, for generic buildings such as the one described. Heritage buildings can rise towards $2 per square foot per month. Thus, the annual rental income for this property is around $48,192 per year. The tax burden is low as the result of government policy to attract office buildings to diversify the civic tax base away from the Ford plant. Total costs are around $11 per square foot for taxes and utilities, and these can be passed onto the client.
The building is situated on a rectangular lot fronting the North Service Road, with one driveway providing access. There are office buildings on either side of this property. There is substantial traffic and the location is convenient for workers who live in the area. The property has been subject to interior upgrades in recent years in order to improve its market value. Fixtures and furnishings have been modernized. Inspections of plumbing, electrical and HVAC systems have found that they all have passed. The building has several parking spaces and a small square footage of landscaping in addition to the interior square footage. There is no usable exterior square footage.
The feasible use of this building, given the physical building and the zoning, is as office space. The site is not zoned for light industry. It may be possible to re-zone for retail use, though the building is not suited for retail.
The land is on the North Service Road, which is adjacent to the QEW and to Ford Road. Property on this stretch of road is licensed for either office space or light industrial, and there is substantial square footage of office space available, much of it dating from the 1980s and 1990s. The land is flat, elevated slightly from the level of Lake Ontario a few kilometres away. There are no significant environmental issues with this property. The property is subject to property tax from the City of Oakville.
The first method for determining value is the income approach to value. Using the net present value method, the property's value would therefore reflect the current cash flows, discounted in perpetuity. The current discount rate for most buyers is around 4-6% given the low interest rate environment that prevails. The discounted cash flow method gives the valuation of the property as between $800,000 and $1.2 million. This is calculated as free cash flow / discount rate. At the midpoint of $1 million, this figure equates to $249 per square foot. This figure is much lower than prime real estate in downtown Toronto.
It is also worth considering what comparable properties sell for. This is the sales comparison approach. While this property clearly should be valued at a discount to real estate in downtown Toronto, it is important to understand the local market characteristics as well. A nearby property that was built in 1969 sells for $57 per square foot, showing the disparity in the region with respect to office real estate prices. For a building that was constructed in the 1990s, the price would be around double that, depending on the location.
A nearby building with a size of 6700 square feet has sold for $1.5 million, which equates to $223 per square foot. This indicates that the investment valuation method may have overvalued the building somewhat. The nearby building is of the same age and has comparable fixtures and furnishings. Thus, it makes a great comparable. The lower price may also be attributable to the surplus of office rental property and concerns about a slowing economy in the country. The market for prime real estate may be hot, but for suburban real estate of older pedigree, the range is clearly lower. If $223 per square foot is used, our building has a value of $895,458.
A third approach to valuation is the cost approach to value. The cost approach begins with the value of the land if undeveloped. There is a property on the market that is nearby, zoned for office use,…