Founder
Understanding how the market value of commercial property is determined helps both parties during contract and price negotiations. Regardless of the purposes for which you intend to use the property, it’s essential that you have an understanding of the most commonly used valuation methods. An experienced attorney can explain more about the value of the specific piece of property you are looking to buy or sell. LaFountain & Wollman P.C. is your full service commercial real estate law firm.
Method 1: Cost
This approach takes into account the current value of both the land and any buildings that are on it. Construction costs may also be considered if there is a need to tear down and rebuild existing structures. Depreciation of any building must also be looked at. This includes such factors as the age of the building, required maintenance, normal wear and tear, and others.
Cost valuations are useful for new commercial properties on land that was recently sold, or for properties with unique features. However, the older a structure is, the harder it becomes to determine its depreciation. It is also more difficult to estimate the value of land in an area that has been fully developed.
Method 2: Sales comparison
This is sometimes called the market value approach and it uses data from recent sales of similar properties in the area. Using this method should give a reasonably accurate value for the real estate in question, provided that the other properties are similar with respect to:
- Size
- Age
- Location
- Neighborhood demographics
- Condition of buildings
The sales comparison method is most effective for commercial real estate that is located around similar properties, especially if the area has a high volume of commercial property sales. Three to five comparable sales should suffice in most instances. This approach may be limited if comparable properties have unique features.
Method 3: Income
Income-generating properties can be valued using an income approach, the objective of which is to help investors understand how much they may be able to earn. This method usually incorporates data from comparable sales along with expenses (e.g. regular building maintenance) that are associated with generating income.
Unique property features such as the condition of a building’s exterior can be accounted for. Comparable sales data can also be more heavily relied upon if needed. In other words, depending on the real estate being purchased, the income method of valuation can be flexible.
Method 4: Gross rent multiplier
Similar to the income approach, this method looks at the gross rent of the property instead of the total income. It does not account for maintenance costs or losses associated with vacancies. The price of the property is divided by gross income from rent to derive the gross rent multiplier, or GRM.
The real estate’s GRM is then compared with those of comparable properties to give a better understanding of where the property ranks in the broader market. Without comparable properties the GRM method may not be as effective. Also, this approach is often used in combination with other appraisal methods to determine the property’s fair market value.
Method 5: Discounted cash flow (DCF)
DCF examines projected differences between the potential purchase of the real estate in question and its estimated sale price after a holding period. It includes such factors as inflation, reinvestment potential, risk, and more.
DCF takes a look at cash flow, usually over a period of several years, and can account for changes in market trends and property values. This method can help someone determine if the commercial property will be worth the investment in the long term.
Method 6: Price per square foot
Finally, if the real estate is an office, retail business, or industrial property, it may be helpful to use the price-per-square-foot method. This method is typically used in conjunction with another one to gauge the true worth of the property, especially when it is being considered for investment purposes.
If there is no price per square foot already listed for the property, surrounding properties with similar features can be considered instead. Adjustments can be made for the property based on factors like its age, location, condition, and potential uses.
Which Method Is Best For You? We Can Help You Decide
Choosing among the above methods can be confusing, and you may be uncertain which is right for the real estate you are looking to buy or sell. The real estate attorneys of LaFountain & Wollman P.C. are here to guide you and assist with all aspects of your commercial property transaction. Call us today.