Ways To Valuate Commercial Real Estate
The prime question you would ask while making plans to buy a property is 'What would be the actual worth of this land? The next question that jumps up instantly is: What can I afford to pay? And the clinching question at the end is: What price can I actually buy the property for? And all these questions need us to find a satisfactory answer before you can consider throwing your weight behind buying the property you wish.
An investor will in all probability first gauge the value of the property according to its size or on the financial credibility of the purchaser. It would be best to also depend on simple methodologies because being relatively new at investing commercially and also we are targeting rather smaller properties. However, this thinking will not make the valuations unreliable or inaccurate.
Fundamentally, there exist three ways in which a commercial property can be evaluated effectively:
- The Direct Comparison Method
- The Cost Method
- The Income Method
Approaches like the direct comparison method utilizes the most recent details of sale of like properties, i.e. similarity in size, location of the property and even tenants, as facts for comparison of prices. This method is commonly adopted and often combined with the Income Method for best results.
The cost method, is also known as the replacement cost method, is not very common. It is all about finding out what would be the value to actually replace the whole property.
The third, the income approach, is the most widespread method in valuation of commercial real estate. This method has two ways valuation can be approached. The easier method has been the capitalization rate technique. It is also known as the "Cap Rate", ad is the ratio, normally expressed as a percentage, calculated with dividing Net Operating Income by actual property price. This method of valuation determines a justifiable cap rate that the property values by taking a cue from sales of other properties, then that rate is divided by Net Operating Income of the property. Eventually, The figure arrived at would be income less vacancy less operating expense. Or you can calculate the cap rate of asking price and dividing by Net Operating Income of the price demanded.
Another method that is used infrequently is Discounted Cash Flow approach. This is used in valuating larger properties. Valuation by this method is rather difficult and also very subjective. Computer programs are now available to assist in this valuation since it involves innumerable variables and calculations aplenty.
For small investors, utilizing a thorough combination for the small time investors, utilizing a combination of sale of similar properties and income valuation by making use of the cap rate approach will bring about the most reliable valuation that could be calculated. The idea of purchasing properties today is done with the intention of getting higher returns for ourselves each month that it could take away from our pockets and the property must fall within the precints of our investment targets.