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Choosing the best commercial property valuation method

On Behalf of | Oct 20, 2023 | Real Estate |

Every business owner knows how important it is to assess the market value of a commercial property before buying it. It is to make sure that the property aligns with their financial goals and expectations. Through proper evaluation, they can determine whether the asking price corresponds to the property’s true worth. The process prevents them from overpayment and financial setbacks.

There are three primary valuation methods. Understanding the principles behind each one can equip you with the knowledge needed to make well-informed decisions and secure the optimal commercial property.

The income approach

The income approach is a fundamental method for valuing commercial properties. It is often used to valuate income-generating properties like office buildings, retail spaces or apartment complexes. The center of this approach is the capitalization rate (cap rate), which represents the property’s potential return on investment. A higher cap rate means higher risk and, therefore, a potentially higher return.

To use the income approach, you calculate the property’s Net Operating Income (NOI). This is the income generated after deducting operating expenses. You need to divide it by the cap rate to determine the property’s value.

The sales comparison approach

As the name suggests, the sales comparison approach evaluates a property by comparing it to similar properties that have recently sold. Real estate professionals look at comparables or “comps,” which are properties similar in size, location and condition, to gauge the subject property’s value. Adjustments are made for differences between the subject property and the comps. These adjustments help arrive at an accurate valuation.

The cost approach

Considering depreciation, the cost approach values a property by calculating how much it would cost to rebuild it from scratch. It works by estimating the replacement cost to build an identical property. This includes the land value.

Then, you will factor in the accrued depreciation. This refers to any wear and tear, outdated features or other depreciating elements that reduce the property’s value. The final valuation is determined by subtracting accrued depreciation from the replacement cost.

Making informed decisions

Valuing the property is vital to protect your interests as the buyer. You can make smart decisions and negotiate well for future returns by grasping the three key valuation methods. It is wise to consult legal and valuation professionals to ensure real estate regulatory compliance. With their guidance, you can confidently assess your property’s value without fear of any legal consequences.

Founding Partners Damaso W. Saavedra and Allyson D. Goodwin