Valuation is central to commercial real estate investing. Whether you’re buying, selling or lending, you must have some way to gauge a property’s worth.
As an investor, a commercial real estate valuation allows you to choose between investments, helps you understand a property’s current market and aids in obtaining financing.
Residential homeowners can evaluate their properties based on the sale of surrounding properties, but investors in commercial real estate draw on several methods of valuation that consider a property’s location, age, condition and other factors.
What Is Commercial Real Estate Valuation?
Commercial real estate valuation uses objective measures and experience in real estate to determine the value of a piece of property. There’s no one right way to value a property, and appraisers often use more than one method.
5 Methods for Commercial Real Estate Valuation
If you’re considering investing in commercial real estate, you may be confused by property values. Here’s an overview of five distinct approaches to commercial real estate valuation to make things clearer.
1. Sales Comparison
If you’ve seen how residential property values are determined, you’re familiar with the sales comparison method. It can be used to find the current market value of commercial properties when sufficient data is available. Often, there aren’t comparable surrounding sales, so adjustments must be made for size, condition and location.
2. Income Approach
The income approach compares the net operating income (NOI) to the purchase price or property value. The NOI includes operating expenses but not mortgage and interest payments, repair costs or depreciation expenses.
This method gives you the capitalization rate or the return on the rental property. You divide the NOI by the purchase price or property value to get the cap rate.
3. Cost Approach
The idea behind the cost approach is not to pay more for the property than you would to build the same structure.
To find the value of a given property, take the total cost and subtract depreciation and the land value. Reconstruction costs use the same materials and floor plan, while replacement costs account for new materials and a new floor plan.
4. Gross Rent Multiplier
The gross rent multiplier (GRM) is fairly straightforward. You can find it by dividing the property price or value by the gross rental income. The quotient tells you how many years it might take to recoup your investment. Note, however, that it doesn’t account for operating expenses.
5. Capital Asset Pricing Model
The capital asset pricing model (CAPM) is a complex method that compares your potential return to other investments with zero risk.
The CAPM considers a property’s age, condition, location, rental income and more. If the expected return on a risk-free investment exceeds the potential ROI on the property, it won’t make sense to take the risk on the commercial property.
Get the Commercial Financing You Need
As you can see, there are many ways to value a property. If you’re in need of a bridge loan or commercial real estate financing, contact Barrington Commercial Capital. We provide tailored strategies to help.
