How Are Commercial Real Estate Properties Valued?

 Posted on January 21, 2021 in Commercial Real Estate

The decision to buy or sell a commercial property is likely one of the most consequential financial decisions you will ever make. In order to get the best deal possible, proper valuation of the property is essential. An accurate appraisal of a property’s value is also used by lenders when determining how much debt the lender is willing to provide. There are several different approaches used to value commercial real estate properties.

Valuation Methods for Commercial Real Estate

Many people assume that the term “value” is synonymous with “price” or “cost.” Price and cost will certainly influence a property’s value, but they are not interchangeable terms. The value of a commercial property is typically determined by an appraiser. The three main methods for valuing a commercial property include the income approach, replacement cost approach, and market value approach. The valuation approach an appraiser will use depends on several factors including the type of property and how the property will be utilized.

• Income Approach: An income approach or income capitalization approach is the most popular way to value commercial properties that produce income such as retail stores, office buildings, and apartment complexes. The appraiser will first estimate the property’s potential gross income and then deduct operating expenses to determine the property’s net operating income. Next, the capitalization rate or “cap rate” is used to estimate the price that the average investor would pay for the income produced by the property. The cap rate is then applied to the net operating income to determine the value of the property.
• Replacement Cost Approach: The cost approach is much more involved than the income approach. This valuation approach considers the value of the land on which the property exists and then adds the estimated cost of constructing an exact copy of the property. Put another way, the cost approach calculates a property’s value by determining how much it would cost to completely rebuild the property and then adding this cost to the current value of the land. This approach is often used to value properties that do not generate income such as churches, schools, and hospitals.
• Market Value Approach: The market value approach or sales comparison approach is often used to value residential properties but it may also apply to commercial properties. The value of the commercial property is estimated by comparing the property to similar properties that have recently been sold or are currently for sale. If there are no similar properties in the market area, this approach may not be effective.

Contact a DuPage County Real Estate Lawyer

Proper valuation is crucial when buying or selling commercial real estate property. At Stock, Carlson & Duff LLC, we work with a trusted group of appraisers to ensure our clients receive accurate valuations. Call our office at 630-665-2500 for a confidential consultation with a skilled Wheaton real estate attorney.

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