Whether you’re looking to buy or sell a commercial property, it’s important to establish a clear value. There are many methods in determining commercial property value, the following are some common approaches to help determine the most feasible price the commercial property could potentially earn in an open and competitive market.
The Sales Comparison Approach
The Sales Comparison Approach, also known as the Market Value Approach, is the easiest method of determining commercial property value. This approach compares the property to other surrounding properties in the area. Depending on the current market, the value is based on physical characteristics like square footage, condition of the building, size and age, and surrounding land. Other characteristics will come into play based on importance and the effect they have on the property being evaluated. The buyer will ultimately make personal assessments determining what they are willing to pay for the property according to their needs but comps will always be a factor when assigning the overall value. The one thing to keep in mind when it comes to comps taken for commercial properties is that they have been known to be assessed outside of the surrounding market, causing a varying degree in numbers and leading to inaccuracies in commercial property value estimates.
The Cost Approach
The Cost Approach, or Replacement Cost Approach, is not a method used very often but it is a beneficial approach when the commercial properties location renders data insufficient. It’s a complicated approach compared to the Sales Comparison Approach because of the steps needed to determine value but can still be effective. First, land value is assessed, then costs are determined to build an exact replica of the existing building and is added to the land value assessment. Finally, the depreciated value is determined at which time will then reflect the actual property value estimate. An equation of this approach looks like Property Value = (Land Value + Cost to Build New + Depreciated Value).
The Income Capitalization Approach
The Income Capitalization Approach is the method of approach most commonly used in commercial property valuations. The value is based on how much revenue the property is expected to generate but in order to understand this approach you must first look at some real estate terms. NOI or net operating income and cap rate or capitalization rate. These are key concepts used in the income capitalization approach. NOI is the net income generated by a property, equating to effective gross income minus any operating expenses. The cap rate is a ratio of net operating income to a properties value and is used to express the anticipated return over the course of a year prior to factoring capital costs, debt service and taxes. An equation of this would look like Value = NOI/Cap Rate.
In order to effectively place an accurate value on the property, the owner or appraiser has to show the anticipated NOI at which point a cap rate will then be assigned. Keep in mind that If the NOI is assessed inaccurately, the numbers will be skewed. It can also get tricky when individual investors have differing views on the cap rate but the overall benefit to this approach is that it allows the investor to determine what they are willing to pay for the commercial property.
In conclusion, what property valuations will boil down to is the appraiser and/or real estate investor having an acute understanding of property value equations. They will most likely use multiple methods in their determination, taking an average of numbers based on varying approaches. With multiple methods to choose from, determining a commercial properties value shouldn’t be a problem.