Determining the value of a commercial property is notoriously difficult for both buyers and sellers. As a seller, you don't want to overprice your property and scare buyers, but you also don't want to lose money. As a buyer, you don't want to overpay and waste your investment. Below are several approaches players in the real estate industry use for pricing commercial buildings.
The cost approach considers the amount needed to construct a similar property from scratch. Those who favor this approach reason that it would be irrational to pay considerably more for a property than it would cost to build in the same area.
The cost approach is the sum of the land's value and the building's replacement, less the depreciation cost. Since depreciation increases by age, similar buildings with different ages would fetch different values under this approach. The older building would attract a lower cost due to its higher depreciation.
As the name suggests, the income capitalization approach greatly depends on the commercial property's revenue. In this approach, the valuer determines the building's net operating income and divides it by a capitalization rate. The capitalization rate is usually the return rate the buyer can expect on the property after purchase.
There is no definite way to determine the capitalization rate. You can determine the rate by considering figures from comparable properties in the same neighborhood. You can also use capitalization rates from real estate market surveys.
Consider a commercial property that generates $400,000 in gross revenue and incurs $150,000 in expenses. These figures generate a net operating income of $250,000 ($400,000 less $150,000). If you use a capitalization rate of 10%, then the building's value becomes $250,000 divided by 10%, giving $2,500,000.
The sales comparison approach is more common with residential than commercial buildings, but it can also work for the latter. In this case, the valuer considers the selling prices of comparable buildings in the area. For accurate valuation, the building on sale and recent comparable sales should have comparable:
- Square footage
- Construction material's
- Design or architecture
- Maintenance quality
For example, if comparable buildings have recently sold for a million dollars, the building on sale's price should be comparable. This approach works best if you can find comparable recent sales. Sales in the distant past, out of the neighborhood, or of different buildings will lead to erroneous valuation.
Both buyers and sellers can benefit from working with real estate agents. The agents can use their experience and skills to help you determine reasonable property prices.