Whether you are a commercial property buyer or owner, estimating commercial property value is important. But how is value determined for commercial real estate? And can you use a commercial real estate calculator to estimate the value of a property?
Why Commercial Real Estate Valuation is Important
If you are looking for commercial property as an investment, wish to sell an asset, or are a lender. Estimating the fair marketing value is critical. Estimating commercial property value can help you determine a purchase price, evaluate potential value and opportunities. And decide if a property is a strategic fit in a commercial real estate portfolio.
Remember, there is a difference between cost and value. Factors that affect the value of a property include desirability, utility, scarcity, and effective purchasing power.
How Commercial Real Estate is Valued
Determining the value of residential property is relatively easy for buyers. You simply log into MLS or check Zillow for comparable properties in the area. Estimating commercial property value isn’t nearly as simple.
There are four common ways to determine the value of commercial real estate:
- Sales comparisons
- Capitalization rates
- Replacement costs
- Gross rent multiplier
Let’s dive a little deeper into each of these and look at the equations to use when estimating commercial value property.
Sales Comparisons
This is when commercial real estate is valued based on comparable sales with similar assets. Such as square footage, location, year built, acreage, etc. When using this method, compare pricing per square foot. And adjust the value based on various different aspects of each site.
Price per Square Foot multiplied by Square Footage = Property Value
Capitalization Rates
This method is the most popular for estimating the value of commercial property. When it comes to investing in a commercial property, value is based largely upon the amount of income a property can bring to the owner. In other words, investors are purchasing the stability of the cash flow of the asset. A capitalization rate is the anticipated cash on cash return if the asset was purchased in cash.
Annual Net Revenue divided by Total Purchase Price = Capitalization Rate
Replacement Costs
Some commercial real estate buyers purchase an asset based on what it would take to replace it. This method works hand-in-hand with sales comps. Because it helps determine if the building is worth buying or if it should simply be replaced. This method is often used for commercial real estate properties that require some sort of renovation.
New Construction Costs minus (Acquisition Cost plus Renovations) = Delta
Gross Rent Multiplier (GRM)
This method will tell you how many years it would take to pay off the property based on the gross rents received. In this case, a lower number means the investment is a better opportunity.
Total Purchase Price divided by Gross Rents = Gross Rent Multiplier
Additional Methods for Estimating the Value of Commercial Property
There are two other methods for evaluating the worth of commercial real estate. Cost approach determines value by considering the cost of building the property from the ground up, including the land’s current value, materials, and construction costs.
The second additional method is cost per door. This is used to assess the value of apartment buildings. You can estimate the cost per door by dividing the total price by the number of units. Note that this method doesn’t consider factors such as unit size or the number of bedrooms per unit.
Why Working with Commercial Realtors is Better
While having a basic understanding of how commercial real estate is valued is important. Calculating the value on your own can be tricky as there is room for error. Whether you are investing in a commercial property or selling commercial real estate, working with commercial realtors is better for your bottom line. These industry professionals have in-depth knowledge of their local commercial real estate market and can better determine a commercial property value estimate, ensuring you invest in the right property or sell at the right time.
Ready to work with a pro? JP Powell has more than 20 years of experience in Middle Tennessee’s commercial real estate market. He believes that commercial real estate investing doesn’t have to be complicated. He’ll guide you through the entire process and help you invest in the right properties for your portfolio. Contact him today to learn more.