When investing in commercial real estate, it is essential that you know what every business property is worth before you actually buy or sell. Yet determining the worth of commercial property can be easier said than done.
There are three methods generally used to value commercial properties, each of which holds a different weight in a variety of investing circumstances. To get the best overall idea of the worth of a commercial real estate property, you must evaluate it by using market, cost and income generating methods.
Market Approach to Property Valuation
The market approach to valuing commercial real estate is the most basic method used to determine a property’s value. This approach considers the price of other business properties that have sold in the same local market and how your property compares to those previously sold listings.
Valuation can be determined by comparing similar properties while making adjustments for individual qualities known to positively or negatively affect the value such as size, condition, location, amenities, demand, and other details. Understanding how to adjust for these variations is a critical factor in properly determining value.
Cost Approach to Property Valuation
The cost approach of valuing commercial property combines the value of the land and the cost to replace any structures or improvements, then reduces that value by the amount of depreciation. Calculating an accurate value by using this method involves three steps.
- Establish market value of the commercial real estate based on size, location, zoning, and more by comparing it with similar lots, then adjusting for any disparities.
- Work with experienced contractors and commercial appraisers to determine the cost of replacing the improvements.
- The property must be evaluated for depreciation, condition of the improvements, and anything else that reduces value.
Income Generation Approach to Property Valuation
The income approach to valuing business property involves a fairly simple formula that can be used to assign value based on a property’s income-producing ability and future potential. The formula used is the net operating income (NOI) divided by the capitalization rate to get the commercial property value.
NOI differs for every property. Your cap rate differs according to your personal investment goals. Considering these variations, you can determine an accurate value for your own properties or any other investment based on how it will fit your objectives.
By using these different methods, you can get a clear idea of whether a property is actually worth its asking or selling price and if it can help you achieve your own investing goals. If income generation is most important to you, the income approach will be accurate for your needs. The market approach is useful if you plan to own and use the property. The cost approach is used for single-purpose real estate where specific improvements are essential to its value.
Commercial real estate can have different values to different owners depending on property use and investment goals. Whether you are valuing your business property to offer it for sale or are interested in purchasing a commercial property, it is important to look at the values that can be calculated to make the best investment decisions!