It is important to understand the clients objectives and make sure the client understands them.  I recently had a cash buyer who's instructions were to find a commercial property below replacement cost and in a good location.  Sounds easy enough, right?  So after much research I came across a property well below replacement cost in a great location.  The property was a retail center with about 60% occupancy and it's management had just made one mistake after the other.   The upside was big and the time frame to hold the property was about 3-5 years.  

The client loves the property and makes an offer.  The problem is that the clients offer price is based off a current Cap Rate rather then current Replacement Cost.  With the retail center 60% leased and the current leases under market rate the Cap Rate approach brings the price per square foot to $85.00 SF and the replacement cost approach puts the value closer to $100-110.00 SF on the low end.  The center is 30,000 GLS BUILT IN 2002.  The property is located on a major artery with 50,000+ cars per day. The entrance is at a stop light and has excellent visibility. 

I think that there is room for both methods and it is important to calculate the future rental rates in real terms.  It is important to bring fact to the table showing the market rental rates over the last 5 years.  What are the construction cost to duplicate the building, the value of the land itself and the improvement made to the land all go into replacement cost.  It is good to work with a contractor to come up with this numbers.

The client needs to decide whether they are looking for capital appreciation or income.  It is possible to have both of course, but distressed property buyers need to look at capital appreciation as their main objective with income as their second objective that will come over time as the property and the economy turns around.