To understand commercial real estate values, you must understand how an appraiser professionally values a property. An appraiser is responsible for estimating or giving an opinion on the value of a commercial property. He can apply his techniques to estimate value.
Comparable sales approach
The first, and probably the easiest, method of valuing commercial real estate is called the comparable sales approach. If you remember when you bought your first home, the bank had an appraiser come out and give the property a value that they hoped would at least equal your purchase price. The same applies to commercial property. The commercial appraiser goes out and compares the prices of recently sold local properties that are similar in form and function to the property they are appraising. The analysis will produce an average price and that price is the price at which your property will be valued. In commercial properties, they don’t just look at the price, but they also look at the sales price per square foot of the building.
Although the comparable sales approach is the easiest method of calculating the value of a commercial property, there are some problems with using this approach.
• When values go up and down or do not stabilize, this may negate the use of the comparable selling approach.
• In some small markets, there are no or only a few comparable sales due to a lack of overall sales.
The income approach
When determining commercial real estate values, this is the most important thing to learn.
You will find that commercial properties are valued primarily by the amount of income they generate. To be more precise, it is actually the net operating income that is the most important factor. When you have accurate financial and operating information about the property, the income approach can be used.
This approach is based on the capitalization rate that is calculated for a property. To calculate the capitalization rate, you must first know the sale price of the property and your net operating income.
After calculating the property’s capitalization rate, compare the capitalization rate to the capitalization rates of similar properties that sold in the area. The appraiser goes out and finds the capitalization rates of the other properties and averages them. It then uses that average capitalization rate to calculate the value of the property given the net operating income.
The cost approach
The final approach to calculating the value of a property is the cost approach. This approach is the least commonly used, as you are trying to calculate the value of the property based on what it might cost to build in today’s market, plus adding the value of the land. The cost approach is more accurate for newer buildings because when determining the value of older buildings, you must take into account depreciation, which can be difficult to determine.
The calculation you make for this approach is that the value of the land plus the cost of construction minus depreciation equals the assessed value of the property.
Understanding these approaches to commercial real estate values will help you get started with the valuation process.
