What's The Best Way to Find the Market Value of Commercial Property?

When you're stepping into commercial real estate, one of the most crucial things is figuring out the fair market value of a commercial property. Whether you're buying, selling, or leasing, knowing the value is key to making smart investments and deals.

It's also important for ensuring fairness in transactions, where all parties have the right information and approach the deal openly and fairly.

There are different ways to determine the fair market value of commercial property, each with its pros and cons. Your chosen method depends on your investment goals, financial situation, and preferences. For example, the cost-per-unit approach is commonly used for apartment buildings.

Look at the various approaches available for determining the fair market value of commercial properties and find the one that fits your business needs best.

1.    Income Capitalization Approach

The income capitalization approach is widely used in commercial real estate because it calculates a property's fair market value based on its income potential given current market conditions.

First, you know the property's net operating income (NOI) by subtracting expenses like utilities and maintenance from its effective gross income (income under current market conditions). Then, you divide the NOI by the current cap rate to find the property's fair market value.

But sometimes, it's hard to determine a property's NOI. This might happen if the property has been vacant for a while or if investors need more detailed projections. You can estimate the NOI by looking at similar properties in these cases. If the investor plans to upgrade the property or reduce expenses, those changes are factored into the NOI projection.

The cap rate is influenced by many factors, including the property's age, condition, location, and sales price. It can be calculated by dividing the property's sales price by its NOI. If you can't determine an accurate cap rate for a property, you can use the cap rates of similar properties in the area.

2.   Replacement Cost Approach

The cost approach to determining the fair market value of commercial real estate considers the current value of the land and the cost of rebuilding the property, minus depreciation. It also factors in the most profitable property usage, which can be limited by zoning laws in some areas.

One advantage of this approach is its reliance on current values and conditions, making it a preferred method for tax assessors and lenders financing multi-phase developments. It's also useful for insurance valuation or when comparable properties are scarce.

The cost approach is often used alongside the sales comparables approach to help investors decide between buying a property or building new. However, one downside is that it doesn't account for potential income from the property if it's used for generating revenue. This could lead to overestimating the property's value in some cases.

3.   Sales Comparables Approach

The sales comparables approach is the simplest way to determine the fair market value of commercial property. It relies on recent sales or listings of similar properties to establish a value range. This figure is then fine-tuned by considering the property's age, condition, location, and size, concerning current market trends.

However, one drawback is that it doesn't include potential repair or maintenance costs, building expenses, or occupancy rates. Also, the method's accuracy depends on the freshness of the data - if the comps are outdated, they might not reflect current market conditions accurately.

Fortunately, technology has made it easier for brokers to access comprehensive commercial real estate data online, allowing for more accurate comparisons and insights into local market trends.

The sales comparables approach is often used alongside the replacement cost method to decide whether to buy a property or build a new one. It's also useful for properties with low occupancy rates, where income has little influence on the market value determined through this approach.

4.   Discounted Cash Flow Approach

While the income, sales, and replacement methods are effective for determining the fair market value of commercial properties at a specific time, they have drawbacks. They don't account for changing market values or the equity gained from selling a property at the end of the holding period, which is a significant income source.

On the other hand, the discounted cash flow (DCF) approach considers various factors like the difference between the purchase and sale prices, time value of money (including inflation and risk), net cash flow, tenants and lease terms, management, and market trends such as occupancy levels and rent rates. Financing aspects are also crucial, as many commercial deals involve debt financing.

5.   Gross Multiplier Approach

The gross rent multiplier (GRM) approach is similar to the income approach but uses gross rent instead of NOI, which excludes expenses like maintenance and taxes. This simplicity is both an advantage and a disadvantage. While it's easy to use and project potential income, it doesn't consider operating costs, making it less accurate.

Another difference is the use of the gross rent multiplier instead of the cap rate. If the property's multiplier isn't known, comparable properties' multipliers in the area are used.

While the GRM approach is straightforward, finding enough comparable properties to determine a market multiplier can be challenging. Therefore, it's often used alongside other valuation methods for commercial properties.

6.   Price Per Square Foot Approach

While not typically used alone to determine commercial real estate market value, the price-per-square-foot method is a quick way to evaluate potential investment opportunities.

There are three types of this approach:

1. Pure price per square foot: This is common for office, industrial, and retail properties. The property's square footage is multiplied by a predetermined price per square foot to determine its value.

2. Price per unit: This method is for apartments and condominiums. The value is calculated by multiplying the price per unit by the number of units.

3. Price per key: Used in the hospitality industry, this approach values properties by multiplying the price per key (guest room) by the number of rooms.

If specific prices per square foot, unit, or key aren't available, a range can be estimated based on comparable properties. Then, adjustments are made for factors like age, condition, and location.

The price per square foot method can also be integrated into other valuation methods like gross rent multiplier and discounted cash flow. It's often used in property development or renovation to quickly assess costs and how changes affect value.

Final Thoughts

Determining the fair market value of commercial property often involves using multiple methods to capture all relevant details that could affect a deal. Whether it's initial estimations or more in-depth research using online tools, investors and brokers must conduct their due diligence.

This means employing at least two different valuation approaches that complement each other, considering as many variables as possible before finalizing any decisions. This thorough process helps ensure a well-informed and accurate assessment of the property's value.

You can also contact Terra Alma for a professional commercial real estate advisory in Atlanta. Our team of experts has years of local experience in Atlanta and can help you get your dream property quicker and better than anyone else.