Investing in commercial property is always challenging for investors or businessmen. The demand for a fair deal on properties to generate profit is a basic concern of any business or investment community.

Understanding the commercial property values can be helpful for any investors in negotiating and initiating a fair deal. Here, we describe the detailed concept of property value calculation and critical ideas for understanding the valuation methodologies.

How To Value a Commercial Property?

There are different methods to calculate commercial property values, which consider various factors unique to the commercial real estate sector. All these methods come with both pros and cons.

To estimate the value of any commercial property, you need a commercial property value calculator. Here is an overview of the most common methods for determining the value of commercial properties.

Income Approach

The income approach is best suited for properties with income-generating potential, such as office buildings, retail spaces, and apartment complexes. The potential investors can generate an idea of the estimated value of the property they could earn.

Property Value = Net Operating Income (NOI) / Capitalization Rate

In this method, the net operating income (NOI) of a property is considered. The NOI is the total income generated by the property, which excludes operating expenses such as – taxes, insurance, etc.

NOI = Gross Rental Income – Operating Expenses

The capitalization rate, or cap rate, is determined by dividing the NOI by the purchase rate or current market value of the property. It is the return rate expected by an investor from the property.

Cap Rate = NOI / Current Property Value or Purchase Rate

The capitalization rate can be adjusted to reflect particular property features—tenants, for instance. Without a basic estimation of the cap rate, the true income-generating potential will be unmeasurable.

Cost Approach method

The cost approach estimates the value of commercial property by considering both current land value and construction cost based on market rates. The ideology behind this concept is that the value of any property shouldn’t exceed the cost of building a similar one.

Commercial property value = Land value + replacement cost – depreciation 

In this method, the replacement cost estimates the cost of building a similar building, either with similar utilities or building a duplicate. The land value depicts the value of the land where the property is located.

The depreciation of the property, which indicates its age or other maintenance, would be taken into consideration. This would decrease the value of the property due to wear and tear over time.

However, estimating the deprecation or land value is only sometimes accurate based on the age and development of the building and area, respectively.

Sales Comparison Approach 

The sales comparison approach is commonly used in residential real estate deals. This method evaluates the commercial property value by comparing similar properties sold recently in that area.

Property Value = Comparable Sales Price ± Adjustments

The sales data provides a rough estimate of the property’s value and details age, size, location and essential features.

Generally, more than 3 properties are the ideal choices to determine the subject property’s fair market value. Less than the mentioned amount would be insufficient to determine the property’s accurate commercial value.

Discounted Cash Flow (DCF) Analysis

The discounted cash flow analysis considers fast market trend change over a specified period. This approach estimates the property’s future income and expenses, taking into account factors such as vacancy rates, rental growth, and operating costs.

Property Value = Sum of (Cash Flow / (1 + Discount Rate)^time period)

The cash flow represents a property’s annual net income. The discount rate indicates the rate at which future cash flows are discounted to their present value. The period indicates the future year for each cash flow.

Price Per Square Foot Approach

This method helps to evaluate the rental value of commercial real estate property.

Cost per Rentable Square Foot = Total Annual Rent / Total Rentable Square Footage

Here the total annual rent indicates the rent amount received by a landlord from his/her tenants over the course of a year. This includes base rent and additional charges.

This method is commonly used by landlords/ tenants, and real estate agents and professionals to compare rental rates across different properties. This allows them to assess the competitiveness of a rental rate in the market.

What Factors Affect the Commercial Property Value?

There are multiple factors that affect the commercial property values. These factors essentially determine the estimate of any property value in the current time period. This, thus, affects the overall investment value and output.

Here, we discuss the prime factors that affect commercial property values.

Location

Location is a key factor in estimating a property’s value since the price varies depending on proximity to key amenities. Also, properties near transportation hubs such as airports, bus stands, and major highways tend to be of higher value due to their convenience and accessibility for businesses and other such works.

Market Demand 

The demand for commercial properties fluctuates based on economic growth, business expectations, and industry trends. Areas with high economic development and continuous business growth have higher property values.

Lease Terms

The duration, terms, and quality of lease agreements impact property value. Long-term leases with reliable tenants provide stability and thus elevate property value.

Economy

The economic trends of any country impact commercial property values. An exceptional economic growth increases the need for commercial space, thus impacting the commercial value positively.

Technological Advancements

Value of a commercial property also depends on the technological advancements of a property. Properties with modern technology and energy-efficient features are appreciated by tenants and investors, which increases property value.

Conclusion

Commercial property values are essential for investors or business personnel to make beneficial deals. Different valuation techniques allow people to estimate the worth of property and choose their desired ones without any hassle. Some key factors also affect the actual property value, which needs to be considered.

By understanding the prime aspects of commercial property values, investors can ensure sustainable growth and profitability in this vital sector.