Commercial Real Estate Valuation Methods: Helping Investors in Taking Informed Decisions

As a commercial real estate investor, the bottom line in your decisions is the return on investment or the perceived profit that a deal can bring to you. You are prohibited from taking decisions based upon your emotions as they can backfire to hurt you financially. You should know the fair market value of a commercial property when agreeing to pay its price. You must remain dependent upon important commercial real estate valuation methods whether you are an experienced pro or an aspiring investor.

Let’s discuss some popular and commonly used commercial real estate valuation methods:

 

Cost Based Approach

This is a valuation method that takes into consideration the cost required to build the property and deems it equal to its value that an investor should pay. In this method, the value of the land is added to the cost of construction to arrive at the total value of the commercial property. It tries to arrive at an amount that the investor requires should he decide to construct the building form a scratch. This method is usually applied when comparables are not available. It is also used in the case of buildings where substantial upgrades have been undertaken adding to its overall value. Hospitals, school buildings, churches etc are some examples where cost-based valuation method is applied by commercial real estate appraisers. These structures are rarely sold and as such it is impossible for these appraisers to come up with comparable.

 

Sales Comparison Approach

This is a very popular valuation method adopted by commercial real estate appraisers. It considers prices of comparable properties recently sold in the area to arrive at the value of the property. It is evident that this valuation method can be used when there is enough data or comparables available to the appraiser. It is commonly used for ascertaining the value of residential buildings such as apartment complexes and buildings containing condominiums. The commercial property of which value must be found is compared with the similar buildings recently sold and the appraiser adds and subtracts amount based on features in the property.

Sales comparison valuation approach is also referred to as market-based approach as it is heavily dependent upon sales figures of comparable properties in the area. It only provides a rough estimate of the value of a commercial property as it difficult to find exact comparables. Also, the appraiser must be experienced enough to identify differences in comparables and accordingly add and deduct amount from the value of the property.

  

Income approach

This is another popular valuation method adopted by appraisers when finding the value of a commercial real estate. As an investor, your goal is to find out whether the project would give you profits on investment or not. This method calculates the het operating income by adding the average monthly rental incomes of all the units in the building and then deducting the operating expenses form this amount. According to this approach

Value of the property equals the ratio of the net operating income and the cap rate. However, there is a drawback in this formula in the sense that if any of the figures are inaccurate, the resulting value of the property will be incorrect. The most important variable in this ratio is the net operating income (NOI). There are many components of NOI and they vary from one property to another. As such, it is difficult for an appraiser to calculate NOI with precision or accuracy. Also, the cap rate is the assumed return on investment which is a subjective figure depending upon the objectives of the investor. The appraiser should be careful in calculating gross annual income from the property as he needs to consider the vacancy rates.

In addition to these three basic valuation methods, there are two more approaches that are commonly used by appraisers.

These are:

 

Value Per Door

As the name implies, Value per door considers the annual income per unit. For example, if the value of an apartment building is $1 million and there are 20 units in it, value per door is deemed to be $50000. This method does not consider difference in sizes of individual units.

 

Value per Gross Rent Multiplier

In the last method called Gross Rent Multiplier, the appraiser divides the price of the property by its gross rental income. Appraisers utilize this valuation method to identify properties that are profitable for the investors as they are low priced as compared to their potential for income generation.

 

Pros and Cons for Each Method

The important thing to remember is that all valuation methods are not purely scientific, and they have their own pros and cons. Each of these valuations methods is suitable for specific properties and the circumstances. The method an appraiser uses depends upon the kind of property, its location, its age, and the amount of information available to the appraiser. The valuation method used by the appraiser also depends upon the objectives of the investor.

Sometimes, the appraiser must use not one but several methods of valuation. He arrives at different values of the same property and then finds a mean based upon the condition of the property and the data available to him. In the end, no matter what method of valuation is used, the value of a property remains an estimate or an approximation according to the appraiser.

 

Real Estate Valuation Model Templates

eFinancialModels.com has created financial model templates fort the help of investors. These templates can be used to find out the value of any commercial property. All that an investor has to do is to enter the corresponding figures in the formulae to find out the fair market value of the property. These financial models are presented in Excel templates that are easy to understand and use. We have applied our deep knowledge of finance and real estate to create these templates. It is in your own interest to make use of these templates to get an idea of the value of commercial property that you are interested in.

 

The Residual Land Value Calculation model allows you to determine the value of a piece of land from a developer's point of view.

Add to wish list
Purchase Excluding 7.7% tax

The Mini Storage Business Plan Templates provides a financial plan to start a mini storage business. Enter your expected rent roll and cost structure and calculate Project IRR, Investor IRR and required funding.

Add to wish list
Purchase Excluding 7.7% tax

Average rating:

This financial model can be used to evaluate the financial feasibility of a real estate development project and present it in investor grade quality to your partners. There is everything in there which is needed…

Add to wish list
Purchase Excluding 7.7% tax

Average rating:

Dynamic financial model for calculating cash splits to sponsors/investors based on various IRR hurdles getting reached.

Add to wish list
Purchase Excluding 7.7% tax

A top-down based financial model to plug in various assumptions about multiple real estate investments and see the resulting effects over 20 years.

Add to wish list
Purchase Excluding 7.7% tax

Average rating:

The commercial real estate valuation model template can be used to quickly value a commercial property such as an office building, industrial site, logistics or storage or a retail building via DCF valuation.

Add to wish list
Purchase Excluding 7.7% tax

The financial model provides an excel template for a multi-year financial plan, DCF valuation and IRR analysis for a serviced office operator or co-work space.

Add to wish list
Purchase Excluding 7.7% tax

This Financial Model Template provides an easy way to compare three different development scenarios for a real estate development project such as the the construction of residential apartments on a piece of land.

Add to wish list
Purchase Excluding 7.7% tax