How Much is Your Commercial Property Worth?

by CoyDavidson on December 2, 2009

Estimating Market Value for Commercial Real Estate

I am often asked for opinions of value from property owners or clients seeking to purchase commercial real estate. So how do you go about estimating the market value of a commercial property? The answer is there are three approaches to assigning value to commercial real estate. The key is to apply the right approach to the particular property given the property type and its particular characteristics as they relate to the market.

Definition of Value: The most probable price in terms of money or any other acceptable “value in use” which the property should attain in a competitive, open, and active market under those conditions requisite to a fair sale without unusual, unique or undue stimulus and with both buyer and seller acting knowledgeably and prudently.

The conventional, traditional and acceptable approaches to assigning value to real property are as follows:

  • Income Approach
  • Replacement Cost Approach
  • Market Value (Comparable) Approach

Income Approach

The income approach is based on the present value of the future benefits of ownership.  Future benefits are the net operating income an informed investor can assume the property will produce over its remaining economic life.  This approach converts anticipated benefits (dollar income or amenities) which will be derived from the ownership of property into a value estimate.  The income approach typically is applied in appraising income-producing properties.  Anticipated future cash inflow or outflows are discounted to a present worth figure using capitalization rate based upon reliable market indicators and comparable properties.

Gross Potential Income:$420,000
Less Vacancy Factor (10%): $42,000
Effective Gross Income:$378,000
Less Operating Expenses:$180,000
Net Operating Income (NOI):$198,000
Capitalization Rate:8.0%
Market Value: NOI/Cap Rate$2,475,000

Replacement Cost Approach

This approach is based on the proposition that an informed purchaser would pay no more than the cost of producing a substitute property with the same utility as the subject property.  It is particularly applicable when the property being valued involves relatively new improvements which represent the highest and best use of the land or when relatively unique or specialized improvements are located on the site and there exist no comparable properties on the market.

Land: This site is valued based upon its highest and best use.

Building: The building’s value relies upon the concept that prudent buyer would pay no more for an asset than the amount he would pay for another asset of similar utility. In calculating the appropriate replacement cost, we make a determination of the replacement cost of a new building.  Adjustments are made to this figure reflect loss in value resulting from physical deterioration (depreciation), as well as functional, external and economic obsolescence.

Market Value (Comparable) Approach

The market approach to value is determined by comparing the subject property to similar properties which have been sold or offered for sale.  Adjustments are made for differences in date of sale, age, condition, size, location, land/building ratio, local tax policies, and other physical characteristics and circumstances influencing the sale.  The adjusted values of those sales considered most comparable (based on physical appearance and condition) establish a range of values for the subject property.

Ultimately, market value is the price in an open competitive market a purchaser is willing to pay. What a property is worth to specific buyers can vary for several reasons (user value or required rate of return).  However, these approaches are how both knowledgeable buyers and sellers and property professionals go about assigning market value to a commercial property.

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