How to Value Commercial Real Estate: Cap Rates, Comparables, and Costs
Valuing commercial real estate can be a complex process, but it is an important task for anyone looking to buy, sell, or invest in a commercial property. In this blog, we will cover some key concepts and approaches that can help you accurately value a commercial property.
Key Terms: Appraisal Report, Cap Rate, Comparables
First, let's define some key terms that will come up in this discussion:
- Appraisal report: An appraisal report is a written document that establishes an objective third-party estimate of the value of a property. It is usually prepared by a professional appraiser who has been trained to assess the value of real estate.
- Capitalization rate (cap rate): The capitalization rate is a measure of the expected return on an investment in a property in relation to its value. It is calculated by dividing the net operating income (NOI) of a property by its current market value. For example, if a property has a NOI of $100,000 and a market value of $1 million, its cap rate would be 10% (100,000 / 1,000,000).
- Comparable properties: Comparable properties, also known as "comps," are properties that are similar to the subject property in terms of location, use, size, age, and other characteristics. These properties can be used to help estimate the value of the subject property.
Now that we have defined these terms, let's discuss some of the three key approaches to valuing commercial real estate:
The income approach is based on the idea that the value of a property is equal to the present value of the future income it is expected to generate. To value a property using the income approach, the appraiser would need to estimate the net operating income (NOI) of the property, as well as the appropriate capitalization rate. The NOI is calculated by subtracting the property's operating expenses (such as taxes and insurance) from its gross potential income (such as rent from tenants). The cap rate is then used to convert the NOI into a value estimate for the property.
- Value = NOI / Cap Rate
Comparable Sales Approach
The comparable sales approach involves comparing the subject property to similar properties that have recently sold in the same market. This can help you determine the current market value of the subject property by looking at what similar properties are selling for. To use this approach, you will need to find several comparable properties and adjust their values for any differences between them and the subject property (such as size or location).
- Value of Multifamily = Comparable Price Per Unit x Subject Property Unit Count
- Value of Commercial = Comparable Price Per Square Footage x Subject Property Square Footage
Replacement Cost Approach
The replacement cost approach values a property based on the cost of replacing it with a similar property. This approach is typically used for newer properties that are in good condition. To value a property using the replacement cost approach, you would need to estimate the cost of building a new property with similar characteristics to the subject property, and then adjust that value for any differences between the two properties.
- Value = Land Value + (Cost to Build New - Accumulated Depreciation)
Valuing commercial real estate can be a complex process that considers a variety of factors and uses a variety of approaches. Ultimately, the best approach will depend on the specific characteristics of the property and the information that is available. By obtaining an appraisal report from a reputable appraisal firm, you can make informed decisions about the value of a commercial property.
Good luck out there my friends.
I’m happy to engage with you in the comments so that everyone can learn. If you prefer to share privately, feel free to email me at firstname.lastname@example.org
Our expert Capital Advisors help you secure your ideal capital stack, resulting in a lower cost of capital for your investments in less time and with more transparency than a traditional commercial mortgage brokerage. Learn more at StackSource.com.