How to Value a Commercial Property

Commercial Property

Commercial property is very lucrative to have. It can prove to be a smart investment if managed right. However, issues often arise with its valuation. Determining the true worth of a commercial property is more complicated. When getting a residential valuation from Melbourne Property Valuers Metro, for example, location is usually the primary factor in addition to the physical condition of the property. With a commercial property, you have to consider the following.

This is a crucial factor when valuing commercial properties. By nature, they’re money-making ventures, unlike residential properties. This means that any transaction involving such commercial properties will consider its future earnings not just based on the projected rate of appreciation but also any commercial activities that take place on the property.

  • Location

Just like with residential properties, location is a crucial factor. Take a piece of property located in a busy business district, for example. Such a business district will likely have shopping malls, convenience stores, access roads, and numerous other establishments that provide needed services. Therefore, a commercial property located in such an area can benefit from all these services and amenities. Such a commercial property will likely command a much higher asking price.

Determining the market value of a commercial property

Property valuation does not have a system that fits all scenarios and properties. Even experienced property valuers have difficulty pinning down one particular method that works in all situations. Different commercial properties may require one or several appraisal methods to determine their market value. It all comes down to the property appraiser’s discretion.

These are the common methods used for commercial property valuation:

  • Cost Approach

This is a favorable approach to a commercial property appraisal. It is based on the premise that the total cost of a property is equal to the cost of land and all construction materials. Theoretically, if the commercial property in question were destroyed and rebuilt from the ground up, the cost should be identical to that of the destroyed building. This assumption, of course, factors in depreciation in land value due to any factors like environmental degradation. It consists of two methods:

  • Reproduction method: This method assumes the construction of an identical property to the one being valued. It assumes the cost of using the original materials.
  • Replacement method: This model adjusts for new construction materials and updated designs. It assumes a scenario where these materials and designs are used to construct a commercial property of an identical function.
  • Income Approach

This valuation method relies on the assumed potential income of the property and its cap rate. The cap rate is the commercial property’s annual rent income expressed as a percentage of its current valuation. The cap rate is obtained through a survey of similar commercial properties in the same geographic location. Depending on the specific or unique features of your property, the cap rate can be adjusted accordingly. This approach is very conducive because it can rely on available data on the income generated by similar properties in the same neighborhood. While variations can occur, potential deviations rarely exceed a half percent margin.

  • Sales Comparison Approach

The sales comparison method seems straightforward enough: you get the average sales prices of similar commercial properties in the same area and use it to get a valuation for your property. However, this can be a little tricky. Several factors like the age of the building and special features can throw this figure off. A commercial property that’s been built using expensive construction materials, for example, will have a higher price than a normal one. Such a scenario and other unique features will require an experienced appraiser to match all the features properly to their correct valuation.

  • Gross rent multiplier approach

Much like the income approach, this method uses the yearly gross rent instead of the net operating income. The annual gross rent is then multiplied by the gross rent multiplier instead of the cap rate, as is the case with the income approach. This approach can be used for similar properties in the area.

Basically, the gross rent multiplier is a factor greater than 1. In comparison, the cap rate is a figure less than 1. Property expenses and physical conditions are not considered in these calculations.

  • Value per door

This approach is simply about determining the cost of a single unit in one building and then using this as the basis for the calculations of the prices of identical units in another building. A commercial building with 100 units, for example, means that the current market value of that property is divided by 100. That figure acts as the basis for the calculation of the value of a similar commercial building.

Ultimately, your property appraiser will determine which method will work best for your commercial property.