Building cost/sqm indicating market bottom

[fudosan]

I recently heard of an approach to assessing whether we are at the bottom of a property cycle -- by comparing selling price/sqm of buildings with replacement cost/sqm (that means building cost/sqm?). The logic goes like this. If the selling price is close to the building cost, that means no one is bidding up the price. Therefore, there is no boom yet and so is a good time to buy.

Have you heard of such approach?

Also, where can I get the building cost figures?

[kyotolaw]

This is similar to the Tobin's Q concept.

Check this out on wikipedia - http://en.wikipedia.org/wiki/Tobin%27s_q - usually used for equity analysis rather than real estate, but the principal is very much the same. I can't help you out with the building costs, sorry...

[Mr_bond]

Have you heard of such approach?

One of the agencies, may have even been us, put out an article recently on the economic yields and economic rents ie the rent and yields required for a new building to be constructed. I will try and find the article/link.

Also, where can I get the building cost figures?

From a friendly valuer or quantity surveyor. We use a publication put out by Rawlinsons a national quantity surveying firm. Excerpts from the 2009 edition, which are plus gst, professional fees, etc are as follows:

Low rise 3-5 storey office, basic services $1,425 - $1,650 psm (auckland)
High rise office up to 15 levels, full services $2,450 - $2,750 psm
Office fitout $450 - $1,050 psm
Basement carparking $1,450 - $1,650 psm

[fudosan]

Thanks guys for the good info.

High rise office up to 15 levels, full services $2,450 - $2,750 psm

More questions...

For example, a vacant unit in Old South British Building at 3 Shortland Street is asking $680,000 on 240sqm, or $2,830/sqm. Using a rent of $250/sqm based on recent ads, the cap rate is 8.8%.

Another vacant unit in CTS House at 175 Queen Street is asking $800,000 on 400sqm, or $2,000/sqm, which is below the replacement cost of $2,450 - $2,750/sqm. However, if I use a rent of $150/sqm based on recent ads, the cap rate is only 7.5%.

Based on the replacement cost approach, the two units look attractive. However, would you consider 7.5% to 8.8% cap rates for vacant units still attractive? (The rent may further drop as the market worsens.)

In this case, is replacement cost a good tool to use?

[Mr_bond]

Its definitely worth having regard to, but there are a couple of other variables which make it a hard measure to implement in reality. ie;
- underlying land value
- depreciation
- construction time
- planning restrictions

Depreciated replacement cost is officially one of the methods we (valuers) can use to value a building in the CBD, but our primary approach is almost always going to be Direct Capitalisation (ie rent/yield) with a secondary approach of Discounted Cashflow.

[Mr_bond]

Link to economic and market rental article;

http://www.cbre.com.au/NR/rdonlyres/DC87998D-0B46-4718-9FC4-7BBD4D532589/782163/ViewPointAucklandEconomicandMarketRentTrends.pdf

The graph on the front page relating to the makeup of office development costs is interesting as well.

[fudosan]

Very interesting article. So if you want to find bargains, wait until market rents are well below economic rents.

Look at the chart "CBD Tower Economic vs Market Rent" on page 3. Since 1992, the market rent is never well above the economic rent, but there are still a number of office buildings developed over that period. How do you explain the logic here?

[Davo36]

Developers! Basically they just build too much. Enemies of us investors.