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6 Methods Used for Commercial Property Valuation

The purchase, sale, or leasing of a commercial property is based on its appraised value. The process of assessing this value is not quite simple. There are some complex matters involved in the appraisals of commercial properties compared to residential ones. Commercial values depend on certain elements that cannot be controlled. 

Among them is the current market price, availability of fewer comparable properties, and costs involved in maintaining the property. Besides, the question of how much the buyer is willing to pay always remains. Here, we’ve listed the methods that the appraisers use to determine the value of commercial properties:

1. Cost approach

The cost involved in rebuilding the structure from scratch is considered during the valuation. The current value of the land, the construction material, and other costs are also taken into consideration. Generally, the cost approach is used in the absence of appropriate comparable properties. 

Besides, certain properties may contain some specialized improvements. The cost approach is also applied when the value of the underlying land has been raised owing to upgraded structures.

2. Income capitalization

This method of valuation is primarily based on the income an investor can expect from the property. This can be derived partly by comparing the property with other similar properties in the area. It can also be derived from an expected decrease in the costs of maintenance. 

For instance, let us take an example of a building purchased for $1 million. Based on local market research, the expected yield from the building is 5%. This expected income of $50,000 every year can be enhanced by passing other associated costs to the tenant. It can also be enhanced by tightening inefficiencies.

3. Sales comparison

This method is also called the ‘market approach’. It relies heavily on the latest sales data of comparable properties. The appraiser seeks buildings with similar features that have been sold recently in the same market area. By comparing the properties, a fair market value is ascertained for the property in question. 

This method of valuation is typically used for residential property valuation. It can be difficult to find comparable properties when it comes to commercial real estate.

4. Value per door

This method of commercial property valuation is primarily used for apartment buildings rather than single-unit buildings. It determines the value of the entire building based on the number of units. For example, a building with 20 apartments priced at $4 million would be valued at $200,000 ‘per door’. This would be irrespective of the size of each unit.

5. Value per Gross Rent Multiplier

The Gross Rent Multiplier (GRM) is a valuation method that measures and compares a property’s potential valuation. This is done by taking the property’s cost and dividing it by the gross income. Let us understand this with an example. You have purchased a commercial property that is worth $500,000. 

It generates $70,000 every year in gross rents. In this case, your GRM would be 7.14 or 500,000/70,000. The GRM method is used to identify properties with a low price relative to their market-based potential income.

6. Cost per rentable square foot

Rentable square foot is the combination of usable square foot and the common areas tenants benefit from. They include elevators and stairwells. You can estimate the cost per rentable square foot using this method. You can also compare it to the average lease cost per square foot. The evaluation of the commercial property’s value is done based on these factors.