Costco Club wants to buy a 320,000-square-foot distribution facility on the southern edge of a large city. The subject facility is presently renting for $4 per square foot per year. Based on recent market activity, two properties have sold within a two-mile distance from the subject facility and are very comparable in size, design, and age. One facility is 350,000 square feet and is presently being leased for $3.90 per square foot annually. The second facility contains 300,000 square feet and is being leased for $4.10 per square foot annually. Market data indicate that current vacancies and operating expenses combined should run approximately 50 percent of gross income for these facilities, as well as for the subject. The first facility sold for $9.4 million, and the second sold for $7.9 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?