by Mish Daniel | Free Information
There are many different types of commercial property that you can invest in, from office space, to warehousing and retail. So the question begs, do you know how to value a commercial property investment?
The Benefits of Commercial Property
One of the primary reasons why investors choose commercial property is the rental income and the potential for some capital appreciation. Investing in commercial real estate usually requires more sophistication and more significant amounts of capital than residential real estate. However, the benefits include:
- Ensured steady cash flow
- The building of substantial equity
- Substantial leverage for future investments
- Excellent appreciation value.
When it comes to valuing a commercial property, several methods can be used. These methods include:
Comparable Sales Method
This method is also called ‘direct comparison’ and is a popular way to appraise commercial property. It involves comparing the property with others of similar types and standards that have been recently sold.
This direct comparison is generally the basis for sales analysis, and this method relies on actual market evidence. Direct comparison is pretty simplistic in operation and forms an integral part of other appraisal methods. Comparable market analysis (CMA) or direct comparison method is best used for appraising industrial strata units, as they are often highly similar. Other forms of commercial property can vary greatly, making this appraisal less reliable. Factors commonly reviewed in this method include:
- Date of sale
- Location of property
- Size of the property
- Physical characteristics (clearance, access, etc.)
- Amenities and services (proximity to public transport, infrastructure, etc.)
- Zoning of the property
Income Capitalisation Approach
The income capitalisation approach is a valuation method that puts the expectation of future benefits first and foremost. The Income Approach determines value by taking into account the market rent that a property can reasonably be expected to generate, as well as the potential resale value of the property. Essentially, this method converts income into value by placing payment as the primary determiner of value.
Value Per Door
Like the GRM, this method is fast and easy, although maybe not the most accurate compared to some of the other valuation approaches on valuing commercial property. This method takes the total value of a comparable building and divides that amount per door to find a point of reference for another similar property.
This method is only helpful if you are using relatively equivalent comparisons. It falls short by not taking into account apartment size and square footage differences, the quality of the housing and other ongoing costs associated with running a multifamily property.
What Is The Cap Rate On Commercial Property?
Once you have worked out the value of a commercial property you can work out what the Capitalisation rate or ‘cap rate’ is. A cap rate is an index that represents the relationship between the annual net income produced by a property and its value which can be determined using the above methods.
It is considered that it includes the return “of” and “on” the capital invested in the commercial property.
The capitalisation rate can be calculated by dividing the net income by the property’s purchase price. The cap rate is the property’s net income ratio to its original purchase price or cost of capital. The cap rate is expressed as a percentage.
A reasonable cap rate is a calculation used by real estate experts and commercial buyer’s agents to determine the profitability of commercial real estate. This indicator allows you to know the flow of money that you can obtain annually concerning the property’s value. Therefore, to understand how long you will need to cover your investment.
Need help valuing commercial property?
When investigating a commercial property’s value, it is important to ensure that you do your due diligence.
Whether you’re a seasoned investor or new to commercial, having a checklist of things to consider will give you the confidence that you are considering a property that is right for you and your portfolio.
Knowing this is a key area that trips people up, we created a FREE Due Diligence Checklist for you to reference. CLICK HERE to download it now.
You will succeed in commercial property investment as long as you seek the right education and advice, and learn how to value a commercial property before you buy it.
Revolve Commercial helps clients and investors like you step into their dream lifestyle by building their commercial investment portfolio with safe, cashflow positive properties. Not only do we walk you through every step of the way, as part of our buyer’s agent clientele, you also get access to our comprehensive education, giving you the opportunity to learn in-depth along the journey.
Ready to get started but don’t want to go it alone? Find out how we can help you buy commercial investment property today!