Commercial Property Valuation: An Overview
Calculating your commercial property value may seem puzzling, but it’s not rocket science. You simply need to look at a handful of factors that affect value, then develop your own estimate. If you plan to sell your property, the main factor to consider is market demand. Sometimes there’s a significant demand for fixer-uppers, and other times investors desire new construction.
No matter what value you determine for a commercial property, you need at least one interested party to execute the sale. The best scenario is for the property to be in good shape and attractive enough to create a bidding competition.
Understanding CRE Valuation
Corporate real estate (CRE) valuation is a metric that concerns investors and lenders. It’s an estimate of the fair market value of a commercial property. CRE is used for weighing real estate options and opportunities. It’s also the basis of a CRE loan and affects the loan-to-value ratio (LTV), which usually tops out around 70 percent. The lender’s valuation estimate shapes the down payment amount and mortgage term.
What Affects Commercial Property Value?
Commercial properties are different from home properties in the sense they must be resourceful sites that don’t inhibit productivity or profitability. Selecting appropriate workplace environment is key for staff to work in comfort and enjoy their work. These factors contribute to business value, which can affect property value.
It’s usually presumed that location is the most crucial factor that affects property value, but by itself isn’t guaranteed to be a selling point. Location is also something you can’t change, whereas other factors are variable. Here are the four other broad factors that affect commercial property value:
- Demand – Are there any buyers interested in the property?
- Utility – Is the property useful for producing products or services?
- Scarcity – Is there a low commercial land supply in the area?
- Effective Purchasing Power – Does the market support players with adequate purchasing power to invest in the property?
These factors alone do not create value for a commercial property, but when they work together they each convey and contribute to value. If you are the only property seller in the area and someone wants to run a business there, you have a competitive edge.
Yet other factors that can make a difference in a sales transaction are interest rates, rent growth, and capitalization rates. Capitalization rates are often used by commercial brokers for cash deals.
How to Evaluate Commercial Real Estate
Real estate agents and commercial property investors take various approaches to determine the value of a commercial real estate property. Here are the six most common approaches:
- Market approach – Comparison of recent sales of similar properties
- Cost approach – Analysis of building costs and land value
- Income capitalization approach – Focus on net operating income (NOI) the property generates
- Cost per rentable square feet – Compares average lease cost with cost per rentable square feet after subtracting the rentable square footage from the property’s total square footage
- Cost per door method – This calculation compares the value of different apartment complexes
- Value per gross rent multiplier – GRM is a metric for comparing one property with another as a strategy to narrow down real estate selections
- Cap rate – Divide annual NOI by property value
- Debt service – Annual repayment of a mortgage loan’s principal and interest
- Fair Market Value – Estimated current value of a property based on market trends and various valuation factors
- Gross rent – Total annual rent revenue from a commercial property
- Net Operating Income: – Subtract operating costs from annual income generated by the property
- Price per square foot – Divide the asking price by the square footage
Commercial property owners must know the value of their assets to make sure they are backed by sufficient commercial property insurance. Contact us at Remland Insurance for more information about protecting your commercial property value with the proper coverage.