Investing in commercial real estate is quite lucrative if you are an intelligent investor, who has a property purchase plan from the beginning. Before you ever make a move to begin the purchase process, it is wise to take a look at the property to project the potential value of your investment.
Not all valuation methods are created equal
Before discussing the actual valuation of commercial property, it is prudent to know the different methods of real estate valuation. The first is the market valuation, or sales comparison method. Residential homes are usually valued using the sales comparison method since the value of a home is directly related to the price a buyer is willing to pay compared to the sales price of similar homes.
Another method is the Cost Valuation Method, which is simply land value plus an estimate of what a building or other improvements would cost to reproduce in todays dollars.
And the last method, which is used most widely in commercial and investment real estate valuation, is the income capitalization method, or cap rate method. Using this method, commercial property is valued by determining the rate of return on an investment, or capitalization rate, divided by the average net operating income (NOI) for the property. NOI is the gross income for the property less expenses, but not including debt service or mortgage payments.
For instance, you as an investor find a nice retail strip center for sale. The current owner provides details of the previous 12 months net operating income, and you find that the average yearly NOI is $75,000. The capitalization rate for the area you are looking is about 10%. Therefore, by dividing $75,000 by 10%, you can figure that $750,000 is a good estimation of the value of the property.
Enlisting professional sidekicks for your commercial portfolio
Remember that this type of quick estimate is a ball park figure only. A true and accurate valuation can be performed by a licensed commercial real estate appraiser. Also, if you use a commercial mortgage broker to help finance an investment, the broker can provide a clearer estimated cap rate valuation because he has access to databases that provide critical information, such as accurate cap rates in the area of your potential investment, typical vacancy rates, and average rent per square foot for an area.
Keep in mind that the seller may provide financial statements and data that are overstated or exaggerated. For instance, he may indicate no vacancy contingency in his expenses. Or gross rents may be higher than the average for the area. It is wise to carefully analyze the income statement and use the experience and knowledge of a broker or appraiser to figure accurate numbers when calculating the potential NOI for a property.
Befriending the PPU for valuation
Another type of commercial real estate valuation is the price per unit or PPU. The PPU may be used on commercial property, such as apartment buildings, where excessive vacancies may skew the financial data and the final NOI cap rate. By using the sales comparable method mentioned above, a commercial real estate appraiser can more accurately determine the value of an apartment building by comparing the recent sales of similar apartments, and determining an average price per unit. Simply multiplying the PPU by the number of units in a potential investment can provide an accurate valuation.
Source: Brice Sheppard
Dy Associates is an Oakland Real Estate company specializing in commercial, home and investment property in the Oakland and East Bay Area. We provide real estate services including buyer agent, seller agent, short sales, commercial and investment acquisitions, loan facilitation, hard money lending, financing assistance property management. Articles are provided as information only. We do not provide legal or general investment advice.