Buyers, sellers, and lenders all need to know the value of a commercial property. Here’s how to value commercial real estate.
We previously wrote an article about finding hotels for sale including valuation methods. But these methods and more can apply to all types of commercial property.
What Is Valuation And Why Is It Important?
Valuation is the process of determining how much a commercial property could probably sell for in the present-day market. There are a number of ways to determine a property’s market value with varied strengths and weaknesses. The best way to value a property will depend on how it’s used, the surrounding area, how much income it can bring in, and other factors. In some ways, it can be more of an art than a science. But you’ll still want to take into account hard numbers when you can.
Commercial property valuation is an important tool for buyers, sellers, and lenders alike. Buyers need to know that the property they plan to purchase is going for a reasonable price. Sellers need to ensure they make good returns on the transaction and that the property will move in a timely manner. Lenders want to know if the property is valuable enough to serve as collateral on a loan.
Most of the time, commercial property valuation is very different from residential property valuation. Read on to learn about some of the more common methods of assessing a property’s value.
Commercial Real Estate Valuation Methods
Income Capitalization
This is one of the most common commercial property valuation methods across the board. It uses the property’s expected income as the primary valuation factor. Expected income is determined by market research including a look at comparable properties.
Replacement Cost
The replacement cost method (or “cost approach”) takes the value of the land only, then adds the cost to re-create the building from scratch.
This valuation method works best for properties that are more remote and don’t have other property sales for comparison. It also works for new construction or properties with substantial upgrades. A good candidate for replacement cost valuation would be land intended for agricultural use. Retail properties should use a different method.
Market Value
This is the simplest method for commercial property valuation, and similar to determining the value of a residential property. You consider the sale prices of comparable properties in the area based on use and size. Add or subtract value depending on certain values such as the age of the property, local tax policies, land to building ratio, and so on.
It’s most often used to value multifamily units, and it works best if the property has many similar units around to draw comparisons. If the property is more isolated or has significant losses due to maintenance, vacancies, or collections, it’s best to skip this method.
Value Per Door
The method is most commonly used for apartment buildings. Similar to the market value approach described above, it starts by looking for sales of comparable buildings in the area. Take the sale price and divide it by the number of units, and you have a value per door. You can then use that number to determine the value of another building based on how many units it has.
For example, if a 12-unit building sells in your area for $3 million, the value per door of that building works out to be $250 thousand. Using the same metric to determine the value of a 20-unit apartment building, the valuation becomes $5 million.
It’s a quick, easy valuation method, but it has significant limitations. It only works if you pull numbers from a comparable property in the area. It also ignores many factors that can alter the final value of a property, such as differences in square footage or operating costs.
Gross Rent Multiplier
This is another valuation method that takes into account the value of comparable properties first. To calculate the gross rent multiplier, simply divide the price of a property by its gross income. You can then apply this value to a different property to assess its approximate value.
If a similar property in the area sells for $500 thousand but brings in $70 thousand a year, its gross rent multiplier is about 7.14. Using this multiplier to assess the value of a property bringing in $80 thousand a year, the value of the second property would come out to just over $607 thousand.
This method has similar drawbacks to the value per door method, in that you need to have a comparable property to draw numbers for your calculation in the first place, and won’t account for maintenance and operating costs for the property.
How To Start Valuation
You’ve seen the term “comparable property” several times in the article, but where do you begin to find them? The best place to start is on the ProspectNow platform.
ProspectNow’s system makes it easy to find residential and commercial properties in your area, and for a lower price than competing lead generators. But the most innovative feature is the identification of likely sellers, properties that the system identifies as likely to sell soon but aren’t yet on the market.
Sellers can use these lists to get a baseline for market values in the area, which come in handy for most of the valuation methods above. If you’re looking to buy, you can use the same numbers to determine whether a property you’re interested in is a good deal. And off-market properties those “likely sellers” are a good place to start with finding deals.
Operating since 2008, ProspectNow gives you more data and unique analytics at a lower cost than the competition. Sign up for a free trial today and get the edge you need. We’re here to help you close more deals and make more money.