Determining Worth: Methods for Accurate Commercial Real Estate Valuation
Commercial real estate can be an unforgiving industry. In 2016 alone, a study showed 97.8 million square feet of retail space was vacated in the United States.
It can be hard when it’s time to sell, so you want to make sure you price your property accurately.
You can’t make deals based upon your emotions. That will hurt you financially. So, you need to know how to assess the fair market value of your property before agreeing to a sale.
There are tried and true methods for commercial real estate valuation.
The more you are familiar with the following methods, the better the process of selling your investment will be for you.
Commercial Real Estate Valuation
A property’s value estimate must take into account economics and social trends, governmental regulations, and environmental conditions.
First, what determines property value?
There are four essential elements of value in real estate:
- Demand: the number of people who want the property vs. the means to satisfy the desire
- Utility: the use to which a property can be put
- Scarcity: the supply of real estate available (more scarce equals more valuable)
- Transferability: the ability to transfer the title of the property to a buyer
Sellers, aspiring investors, and experienced real estate pros should all be familiar with these popular valuation methods.
Value is not the cost or price of your property. Cost refers to the funds spent (materials or labor), while the price is the amount a buyer pays. You can sell a property for $200,000, but the value could be much lower. This is why it’s important to be familiar with commercial real estate valuation methods.
Then there is the market value. This is the figure you will receive from an appraisal report. This is the most probable price your property will bring in a competitive, open market.
The more methodical the collection of data, the more accurate the property appraisal. Appraisers use several approaches for determining a property’s value.
Keep reading to determine what the best method will be for determining the value of your real estate.
The cost approach valuation method takes into account the current cost of the land, construction materials, and other costs to determine the price of rebuilding the structure from scratch.
This is a popular approach when comparable properties are non-existent or hard to locate. It’s also applicable when improvements have been made that add substantial value to the land.
The cost approach heavily relies on the accurate determination of depreciation. This refers to any condition that negatively affects the value of the property and physical deterioration (painting, roof replacement, structural problems), functional obsolescence, and economic obsolescence.
Functional obsolescence refers to features of the property that are no longer considered desirable. This could include appliances, dated fixtures, or odd layouts.
Economic obsolescence is caused by external factors, including noise pollution or being close to undesirable structures such as factories.
Sales Comparison Approach
The approach relies heavily on the data of recent sales for comparable properties. By finding acceptable comparables, a buyer hopes to assess the fair market value of their property.
For example, a main street storefront location might be compared to another storefront that sold a few weeks earlier.
There are several factors that affect value, including:
- Building age and condition
- Economic changes that occur between the date of sale of comparable and appraisal
- Location (prices might differ from neighborhood to neighborhood)
- Physical features (lot size, quality of construction, kitchen upgrades, AC, etc.)
- Terms and conditions of sale (i.e. the comparable was sold at a discount between relatives)
Sometimes it is difficult to find comparable properties, especially in the commercial real estate market. In these cases, the market value estimate will fall within the adjusted sales prices of the applicable comparables. Weighted consideration is usually given to the comparables that have the least instances of adjustment.
Income Capitalization Approach
The third valuation method is called an income capitalization approach. This method is based on the projected income that a buyer will make from the sale of a particular property.
This projected income might be calculated from a comparison of similar, local commercial properties or from an expected decrease in maintenance costs. Basically, all future expected earnings are discounted to reflect actual value.
When using this direct capitalization approach, appraisers will first estimate the annual potential gross income. When doing so, they take into account vacancy and rent collection losses – this provides the effective gross income.
Appraisers will then determine the annual net operating income by deducting annual operating expenses. This allows them to estimate the price an investor would pay by determining the capitalization rate.
Finally, they apply the capitalization rate to the commercial property’s net operating income. This will form an estimate of the property’s value.
Value Per Gross Rent Multiplier
Another method, called the Gross Rent Multiplier (GRM) method, measures potential valuation by taking the price of a property and dividing it by the property’s gross income.
This is a method usually used in cases with properties with a low price relative to potential income.
Value Per Door
The Value Per Door commercial real estate valuation method is typically used for apartment buildings. That’s because this method determines worth based on the number of units within a building.
Make an Informed Decision
You will find that at least one commercial real estate valuation method will be beneficial in making an informed decision. Now, you will be better prepared and able to sell your real estate with confidence.
If you’ve been frustrated by brokers who don’t communicate with you or make big promises without delivering, we’re here for you. We’ll help you sell your property like it’s our own.
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