Commercial Real Estate Valuation: Capital Rates, Comparables, and Expenses

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The CRE industry presents a lot of opportunities for those who are ready to grab it. However, it requires a lot of understanding of the industry.

Right from knowing the correct type of property for investment to real estate valuations, one must be prepared with all the CRE evaluations.

In simple terms, it is usually the process of understanding or estimating the worth of the CRE property. It is done with the purpose of selling, buying, tax assessment, or financing.

There are a lot of aspects that go into CRE valuation. In fact, various factors influence things such as condition, location, size, income potential, and age of the property. Also, economic and market trends will influence the final results.

Understanding the key essential aspects is important here to come up with the right valuation and make the most of the available opportunity. But if you are unaware of it, read ahead to get proper insights. 

Is CRE valuation important?

As a first-time investor, you might not feel it important to go ahead with a valuation, given the amount of time and energy it requires. However, it is quite crucial and must be performed to get the best from the investment property.

Accurate valuation should be helpful to make decisions about the value of the property, the opportunities involved, and the associated risk. Also, it will help get appropriate pricing for selling, buying, or funding the commercial property.

Ultimately, the valuation will provide valuable information to the stakeholders. It will ensure one can go ahead with transparent and fair transactions.

However, one thing to remember here is to go ahead with a qualified professional with the experience and expertise to provide a reliable and accurate valuation that will clearly reflect the market conditions and trends.

When it comes to CRE evaluation, understanding three crucial approaches is important. It includes the sales comparison approach, income approach, and the cost approach. They are all important to make the right decision. If you are ready, then go deep into the information to get the help you need to understand things better.

The cost approach

When talking about the cost approach, it is based entirely on the principle of substitution. It states that the buyer will not pay any additional amount for the property than the actual cost of constructing a similar property with all the similar utilities.

Essentially, this method is used to determine the value of the property by estimating the cost of replacing it with a similar one. Thus, it also considers land value, depreciation, and other factors. The process involves the following steps.

  • Estimate the cost of new property construction

The step involves identifying or determining the current labor and material cost along with the other expenses that will be undertaken to build a similar property.

  • Make adjustments for depreciation

Depreciation here refers to any loss of value due to damage or other factors. The expert will estimate the amount of depreciation and then reduce it from the estimated new property cost. Depreciation is typically calculated based on three methods.

Physical deterioration happens when there is a decrease in the value of the property due to wear and tear, such as damage to walls, roof, or foundation. Functional obsolesce happens when the property value decreases due to functional issues such as outdated floor plan

External obsolescence happens when the property value decreases due to external factors like those surrounding the area or the economic conditions.

  • Access the land value

In the final step, the expert will identify the value of the land where the property is located. It will be based on comparable sales and other factors. The final value is found after adding the estimated land value to the building’s adjusted cost.

The Income approach

The income approach method is used for successfully estimating the value of the property based on the income-generating potential. The approach will provide an estimate of the present value of the future cash flow that the property can generate over the economic lifetime.

This approach is commonly used for valuing various types of income-producing property such as office buildings, industrial properties, shopping centers, hotels, etc.

Here, the appraiser can use two methods for calculating the property’s value.

  • Capitalization

When using this process, the appraiser will divide the net operating income of the property by the capitalization rate. Thus, it will help get the estimated value.

  • Discounted cash flow analysis

In Discounted cash flow analysis, the appraiser will project the future cash flow of the property over a specified period, generally 5 to 10 years. Now, he will discount cash flow to the present value of the property using a discount rate.

Now, here are the steps involved in completing the income approach process

  • Identifying the potential income from the property

The appraiser will estimate the potential income from the property based on the occupancy rate and the market trends for similar properties located in the area.

  • Reducing operating expenses

Now, the appraiser will go ahead and subtract the property’s operating expenses. This will include insurance, property tax, Property management fees, and others.

  • Identifying the net operating income

The step involves getting the difference between the potential income of the property and the operating expenses. It will be termed the net operating income.

  • Using a capitalization rate

The appraiser will now use the capitalization rate for the property’s net operating income. The cap rate will be the percentage that clearly reflects the return and the risk of the property. Remember, the higher the risk, the higher will be the cap rate.

  • Calculating the value of the property

Finally, the property value is calculated by dividing the NOI of the property by the cap rate.

Important formulas

  • Net operating income (NOI)= Potential income- operating expenses
  • Capitalisation rate (Cap Rate) = Net operating income/ Property value
  • Value= Net operating income/capitalization rate

The sales comparison approach

It is the most common method that is used to appraise the CRE properties. The process involves comparing the property with a similar property located in the same market that has been sold with the adjustments made.

It is done to notice the difference between the subject property and the comparable. In general, the sales comparison approach will be extremely effective for CRE with sales data available in the local market.

Also, it will be helpful when the properties are relatively similar in terms of condition, size, and location. Some of the most common examples of commercial property that can benefit from the approach include multi-family, office buildings, centers, etc.

Here are other steps that are followed to complete the process.

  • Find the subject property

To begin with the process, the expert will start by identifying the property that is being appraised. They will gather all the required information about the condition, size, and location.

  • Find comparable properties

The appraiser will also look for recent sales of properties that are similar to the subject property in terms of size, location, and conditions. They will be referred to as comparable.

  • Analyze the comparable data

The appraiser will go ahead to analyze the data of the comparable. He will look for differences and similarities between both properties to know the result.

  • Make necessary adjustments

The appraiser will make adjustments to the comparable sale data. It is made to account for any difference between the comparable and the subject property. It will be based on factors such as condition, location, amenities, size, and other factors that can impact the value of the property.

  • Finalize a report

Finally, the appraiser will identify the property’s market value through data analysis and then present the final report.

Important formulas

Adjusted sales price of comparable= Sales of comparable +/-adjustments

Price per square foot= Sales price/ property size

Price per unit Sales price/ number of units

How long does valuation take?

The time required will depend entirely on the approach you have chosen. For this, you will have to consider the market conditions and the specific property to identify the best one. Here, an experienced appraiser will help you choose the best approach.

But make sure you choose an appraiser with relevant industry experience, knowledge, and professional certifications.

Adding to it is the complexity of the property and the market conditions that can greatly impact the time frame required to complete the valuation. Typically, it can take anything between a few days to several weeks to complete.

Conclusion

When it comes to CRE valuation, the process can be extremely complicated. Here, you will require help from an expert to get things done right. If you are looking for any professional support, you can consider getting help from Private Capital Investors.

They have got professionals who will be there to help you with everything. No matter whether you are looking for financing or any additional help, they will make things absolutely easy for you throughout the process and guarantee you are able to make the most of the available opportunity.

So, instead of taking any risk, it will be better if you connect with the company today and get the help required to make the investment process easy.

Want to learn more? Get in touch with us today.

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