The commercial real estate market moves fast. Technology allows us to obtain information and act on that information quicker than ever before. Property owners should be prepared.
One of the most important things owners should know is the value of their properties. They typically use this information to decide whether to hold or sell.
There are three methods to determine the value of a property: the market value approach, income approach and replacement cost approach. Each method takes a different approach to determining value, but can work together to demonstrate a correct value.
The first method is the market value approach. Compare your property to similar properties that have sold recently. This is the most effective method to understand the market for a specific area or property type.
Residential real estate relies heavily on this type of analysis. Property values are calculated based on home sales in an area and then adjusted up or down based on the characteristics of the properties.
This approach also can prove helpful for valuing such different commercial property types as industrial, office, multi-family or retail. The market for each of these property types can fluctuate independently of the others depending on the number of buyers or listings available.
The second method is the income approach. This is the best approach to determine a value for an investment property. By dividing the net operating income (NOI) by the capitalization rate (cap rate), you derive a value based on income. This value is the purchase price at which the investor would see the desired return (cap rate) if incomes remain consistent.
It’s important to remember insurance, management, maintenance or repairs, property taxes, utility costs and a vacancy factor are subtracted from the total income to calculate the NOI.
The third method is the replacement cost approach. This is the cost to rebuild the same building with today’s cost of construction. Typically, this method is used for insurance purposes, but also ensures a seller doesn’t price a property too high. Why buy an older property if building a new one would be less expensive? It’s important to include the value of the land as well as such
pre-construction costs as architectural and engineering work into the valuation.
Using these three methods, you can calculate a value range for any property. When all three methods produce a similar value, you can feel confident in your results.
Now you have the information you need to decide whether it would be best to hold or sell a property. If the answer is sell, it’s time to figure out how to best position your property on the market. But that’s a topic for another column. Stayed tuned.