Commercial real estate valuations are more detailed than residential real estate, but both are equally crucial. Investors and appraisers use these approaches to establish the commercial property's value, which is essential in determining if a property is worth the investment. There are three main approaches to evaluating commercial real estate value -- the income approach, the sale comparison approach, and the cost approach.

1. The Income Approach

This approach divides the capitalization rate with the income that the property generates. An appraiser would need to compile the expense statements, the income of the property, and similar properties in the area. There are four steps in estimating the net operating income:

Step 1: Gross Potential Income Estimation

Estimate the gross potential income of the property at 100% occupancy.

Step 2: Effective Gross Income Estimation

Estimate the effective gross income based on the probable vacancy costs of like-properties in the area.

Step 3: Property Expenses Estimation

Estimate the property expenses, which fall into two sections—fixed, fixed, and variable expenses, including management fees and utilities.

Step 4: Net Operating Income Calculation

The NOI or net operating income is calculated by subtracting the estimated expenses from the effective gross income. This is computed after deciding on an appropriate cap rate, which is determined by using the market sales of similar properties in the market.

Step 5: CAP Rate Application

Once you have the NOI for the property, you can apply the going capitalization rate (CAP Rate) for the market, and product type, by dividing the NOI by the CAP Rate, this will then give you an estimate of value.

2. The Sales Comparison Approach

The sales comparison approach is also referred to as the market approach -- this is commonly used in residential real estate but is also often used in evaluating the value of commercial real estate and other rental properties. To do that, appraisers would need to compare the property sale prices with those recently sold and similar properties outside the market area.

These properties are also referred to as comps or comparables. These will also include looking at leasing trends, other infrastructures, and demographics that can also profoundly impact the property's value. The physical features such as the condition, number of rooms, the age of the infrastructure, and its square footage are also essential factors. This approach is mainly used for single-family homes since there are many comps available to analyze.

3. The Cost Approach

On the other hand, the cost approach evaluates by calculating the costs of the property had it been rebuilt. It considers the property value and land cost, including construction cost minus its functional and physical depreciation. This approach allows the buyer a better understanding of the evaluation of the property. It is beneficial for buyers hesitant about purchasing a property they feel might cost them less had they started from scratch.

The cost approach allows them to study in detail the possibilities that they may be spending less by purchasing a property that already has been built. The cost approach is common in properties that are not quickly sold, such as government buildings, hospitals, and schools. Investors and appraisers can use all these approaches on one property to get a more accurate property value.

For more information, you may reach us at info@cbicommercial.com