3 Best Valuation Methods for Commercial Real Estate

Do you frequently have trouble gauging whether you should include a particular commercial property in your investment portfolio? The ability to correctly assess acquisition properties and your holdings is an essential survival skill in the CRE game.

It can either make or break your portfolio as well as your reputation in the market. Research has shown that fluctuations in property values, among other factors, affect the demand for CRE industry services. Here’s how you can value commercial real estate to decide whether you should invest in it.

The Cost Method

This approach considers the cost of rebuilding the property, the present value of the associated land, construction material, and other expenses that you could incur by replacing the current structure. It can help you assume a property’s cost based on its optimal use.

Imagine you own a property with clean running water, fertile soil, and a high potential for agricultural use. The cost approach would establish the property’s cost based on agricultural use, rather than shopping or residential as the former would be most profitable for you.

When upgraded structures have added significant value to the underlying property, or when a property contains specialized or distinctive improvements, the cost approach is useful in valuing commercial real estate.

Sales Comparison Method

Using recently-sold comparable lands or asking prices of currently listed properties, you can ascertain the current value of the property you’re interested in.

This approach is useful for residential and multi-family sectors, when comparing two 30-unit multi-family buildings with similar features and square footage.

For example, if you’re comparing a 12-unit apartment building to a similar one that was sold a couple of months earlier in the same neighborhood, this “market approach” would come in handy.

Income Capitalization Method

You can determine a property’s value by the expected income you can derive from a particular land. By considering the market rent that a property can practically be expected to generate and the possible resale value, this approach can convert income into value. The estimated income can be obtained either by comparing other similar local properties, or an anticipated drop in maintenance costs.

Imagine that you purchase a building for $1 million and based on market research, the expected return is five percent. The $50,000 in estimated income could be improved by improving the property’s defects or transferring associated costs of water or electricity usage to the tenant. In this case, the projected future income is reduced to exhibit the property’s present value.

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