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Methods for Commercial Real Estate Valuation

By 14/02/2023 0 Comments

A building’s appraised value is often crucial in purchasing, selling, or borrowing commercial property. In today’s economic atmosphere, estimating a building’s value has become more difficult, whether it is an apartment building, a factory or industrial complex, a mall or a privately owned business centre. Commercial appraisals are more subjective than the residential property value. 

Essentially, commercial values are influenced by uncontrollable factors such as the market price for which spaces rent, the availability of comparables, and overall maintenance costs, which may vary by industry. And there is also a tricky question about the affordability of buyers. 

The following are the main methods that can be utilised to find commercial property value. 

Cost Approach

This valuation method considers the cost of rebuilding the structure from the start. Considering the current value of the associated land and construction material utilised. This also includes other costs associated with the replacement of the existing structure. 

It is generally applied when it is difficult to locate appropriate comparables (recently sold assets used to value similar purchases), such as when there are relatively unique or specialised improvements on the property or when renovated structures have significantly enhanced the underlying land. 

 Sales Comparison Approach

The sales comparison approach is also known as the “market approach”. A buyer hopes to determine a fair market value for the property in negotiations by comparing sold buildings with similar properties in the same market area. This method relies on recent sales data for comparable properties. 

For instance, an apartment building with 10 units might be compared to one that sold just a few months earlier in the same neighbourhood. While this valuation method is typically utilised to value residential real estate, it has one significant drawback: general and localised market conditions; it can be hard to find recent comparables for similar properties.

Income Capitalisation Approach

Investors use this method primarily to determine the amount of income they can expect from a particular investment property. The projected income could be derived partly from comparing other similar local properties and an unexpected decrease in maintenance costs

Suppose a building is purchased for Rs. 1 million, and the expected yield is 5%. Based on local market research, Rs. 50,000 per year is the anticipated income which can be increased by tightening inefficiencies or passing some associated costs to the tenant, like electricity or water usage. All expected forecasted income is discounted to reflect present value. 

 Value per Gross Rent Multiplier

The Gross Rent Multiplier (GRM) method measures the property’s potential valuation by considering the property’s price divided by the gross income. 

In other words, if you purchased a commercial property for 5 Lacs and it generated 70 thousand in gross rent each year, your GRM would be the original value ( 5 Lacs) divided by the gross income (70 thousand). This commercial real estate valuation formula mainly identifies low-price properties relative to their market potential income.  

 Cost per Rentable Square Foot

Rentable square footage means the usable square footage (the space occupied by the tenants) with the common facilities tenants benefit from, such as stairwells and elevators. Using this method, you can determine the cost per square foot of rental foot, compare it to the average lease cost per square foot and evaluate the building’s value. 

For example, if the building’s total square rental square foot is multiplied by the average cost of each rental square foot annually, then a purchase price will generate gross rental yield. 

To conclude, every buyer values property differently. Still, commercial property valuation has a subjective component that needs to be understood. The best commercial real estate investors must do deep research to find the most attractive deals and effective valuation methods for each particular type of transaction. 

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