In order to understand commercial real estate values, you must understand how an appraiser professionally appraises a property. An appraiser is tasked with the responsibility of estimating or giving an opinion of the value of a commercial property. You can apply his or her techniques to estimate the value.
Comparable Sales Approach
The first and probably the easiest method in valuing commercial real estate is called the comparable sales approach. If you recall when you bought your first house, the bank had an appraiser come out and give the property a value that you hoped would at least equal your purchase price. The same applies to commercial property. The commercial appraiser goes out and compares 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 what your property will be valued at. In commercial properties, they not only 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 for figuring out a value for commercial property, there are a couple of problems when using this approach.
• When values go up and down or aren’t stabilized, this can nullify the use of the comparable sale approach
• In some small markets, there are no or only a few comparable sales due to the lack of overall sales
The Income Approach
In determining commercial real estate values, this is the most important one that you should learn.
You will find that commercial properties are chiefly valued by the amount of income they bring in. To be more precise, it is actually the net operating income that is the most important factor. When you have accurate operating and financial information on the property, the income approach can be utilized.
This approach is based on the capitalization rate being calculated for a property. In order to calculate the cap rate, you must first know the property’s sale price and its net operating income.
After you calculate the cap rate of the property, you then compare the cap rate to similar property’s cap rates that were sold in the area. The appraiser goes out and finds the cap rates of the other properties and averages them. He then utilizes that average cap rate to calculate the property’s value knowing the net operating income.
The Cost Approach
The final approach to figuring out a property’s value is the cost approach. This approach is the least often used as you are trying to figure out the value of the property based on what it might cost to construct in today’s market, plus adding in the value of the land. The cost approach is most accurate for newer buildings because in determining the value of older buildings, you must account for the depreciation which can be hard to determine.
The calculation that you do for this approach is land value plus building cost minus depreciation equals the estimated property value.
Understanding these approaches to commercial real estate values will help you get started with the valuation process.