How to Value Commercial Real Estate?

Knowing how to "calculate" commercial property value is essential if you are a commercial real estate agent for advising your client; or if you are a potential commercial property buyer to know how much to pay; or if you are a commercial property vendor for selling at the right price

Two of the three main methods of valuation used by commercial property valuers when used together, will give a reliable commercial property value figure to offer as either a selling or a buying price for a commercial property. These methods are:

1
Income Capitalisation Approach
2
Sales Comparison Approach

A third approach, the Cost Method or Summation Approach is sometimes used as a check method in calculating commercial property value when there is scant sales evidence.

Income Capitalisation Approach

Using this approach, the value of a property is based on its projected future rental income plus any recoverable outgoings, and the deduction of all unrecoverable outgoings and expenses, including appropriate vacancy allowances to determine the net income derived from the property. The net maintainable income is a forecast of income deemed to endure in perpetuity, and is discounted using a suitable capitalisation rate derived from the analysis of sales evidence.

Two important points when calculating commercial property value using the income capitalisation approach

If the commercial property is deemed vacant at the time of valuation, for the vacant possession assessment allowance is made for letting-up and lease incentive costs that could be incurred to lease the property.
In calculating commercial property value, if the passing rental of the commercial property is not equivalent to its market rental value, adjustments have to be made for under- or over-rents.

When calculating commercial property value, the Income Capitalisation Approach is usually used as a primary method

Sales Comparison Approach

This approach bases the value of a property by analysing sales evidence of similar properties and comparing these properties with the property being valued

Two important points when calculating commercial property value using the sales comparison approach are:

Only consider sales of properties that have actually been sold (that is, contract signed, deposit paid and fully settled); properties listed for sale or under contract should only be considered when there is little or no other market evidence.
In practice, properties are seldom similar and therefore adjustments have to be made in the comparison process that result in a level of subjectivity.

Cost Method or Summation Approach

When calculating commercial property value commercial property valuers often use the Cost Method or Summation Approach as a check method.

In this approach, the property is appraised by summing the depreciated replacement cost of improvements to the underlying vacant land value.

Three main issues that affect this method when calculating commercial property value are:

Determining the applicable rate of and accumulative depreciation for the improvements.
The estimated cost of construction.

Replacement cost of the improvements might be quite different from their added value.

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