Knowing the value commercial real estate holds is essential; it tells you know well the asset will perform, informs pricing, enables owners to secure loans, and influences decisions for upgrades and add-ons. It enables you to make strategic decisions and maximize your portfolio.
The challenge is that valuing commercial real estate is not the same as valuing residential properties. Here, appraisers can look at comparable properties in the neighborhood, establish a baseline, and add or subtract value based on factors like number of bedrooms, square footage, etc.
CRE values are more complex: they often depend on factors that you cannot control, such as the current market price, maintenance costs which vary significantly by industry, fewer available comps, and how much buyers are willing to pay. There are three methods that address these issues and can help you determine value.
Common Commercial Real Estate Valuation Methods
The following methods are often used to value commercial properties:
Value Per Gross Rent Multiplier
The GRM is a quick calculation that values a property by dividing price by its gross income. You can use recent comparable sales or have an CRE agent or commercial appraiser do this for you. You then multiply the GRM by the gross rents of the property.
Annual Gross Rents x Gross Rent Multiplier = Property Value
This approach is somewhat limited, but it is relatively accurate and gives you a sense of a property’s value.
Here, we consider the cost of rebuilding the structure from the ground up. This calculation includes the current cost of the land, construction materials and supplies, and other expenses involved with replacing the existing structure.
We use the cost approach when there are few comparables (e.g., there are specialized upgrades or structures) and when upgrades add significant value to the land.
Sales Comparison or Market Approach
When there are many comparable properties, we use the sales comp or market approach to value commercial real estate. This is very similar to the process that residential real estate agents and investors use. But remember, it only works when you have similar properties against which to compare.
Income Capitalization Approach
This method allows you to gauge how much income you can reasonably expect a property to generate. This is based on comparisons of similar properties in the area, as well as expected decreases in maintenance. If, for example, you purchase a building for $1 million and expect a 5% yield, that $50,000 can be boosted if you take steps like passing electric or water usage to the tenant(s). This can help you ascertain current value.
Value Per Door
With apartment buildings, value per door divides a property’s worth by the number of units. For example, a building priced at $2 million with 10 units, would have a value per door of $200,000. This does not factor in differences in the individual units’ size.
There are several different commercial real estate valuation methods you can pursue; it depends on the property, location, overall market, the nature of the transaction, as well as whether you have access to comps. Value can indeed be subjective (and in the eye of the beholder), but reliable valuation gives you a key to more strategic decision-making. If you need assistance, turn to the Keller Williams Commercial Real Estate team.