This comprehensive guide to commercial real estate property valuation teaches you everything you need to know, including popular real estate valuation methods.

Property valuation plays an essential role in commercial real estate. Both an art and a science, property valuation helps real estate investors, operators, lenders, brokers and other real estate stakeholders to assess the value of a given real estate property. 

This comprehensive guide explains property valuation in detail, including key concepts, methodologies and its significance in commercial real estate. 

In this guide to property valuation, you will learn:

• Why property valuation is important
• Key terms in property valuation
• Property valuation methods
• Why investors need property valuations
• What is an appraiser?

Why property valuation is important 

Property valuation is important for multiple reasons, including:

• How much buyers are willing to pay for a property
• How much sellers may be willing to sell a given property
• How much banks are willing to lend
• How much property taxes an owner will pay

Therefore, a property’s valuation plays a critical role in commercial real estate. Investors, operators, asset managers, lenders and other stakeholders all depend on a property valuation for an independent analysis of a property’s worth. Armed with this knowledge, these real estate actors can make more informed decisions.

Property valuation: key terms

When it comes to property valuation, it’s important to understand several key terms. For example:

Market Value

Market value is the highest price that a potential buyer would pay for a commercial real estate property and the minimum price that a potential seller would accept. Consider market value to be a measure of financial value that buyers and sellers use to transact on a property, with both buyer and seller entering into the transaction fully-informed and without undue pressure. Rather than basing valuation on historical value or original purchase price, the market value is based on recent comparable transactions, condition of the property and other factors.

Use Value

The use value of a commercial property is based on the designated purpose of the asset. For example, a commercial property with a residential use would be valued differently than an industrial property or a senior housing facility. 

Demand

Demand is high when there is increased interest and popularity for a particular property or market. When demand is high, prices rise. With high demand, buyers may be more willing to pay higher prices to acquire a desirable property, which can benefit sellers. In contrast, low demand can indicate lower prices and a buyer’s less willingness to pay a premium for a real estate asset. 

Supply

Supply is the amount of available commercial real estate properties in a particular market that are comparable to the target property. Investors look at inventory to assess the amount of readily-available property in a particular market. If there is high demand and low supply in a market, prices can be expensive to acquire a target property.

Utility

The utility, or use, of a commercial real estate property refers to the property’s ability to meet the needs and goals of a particular buyer or owner.

Transferability

Transferability refers to the ease with which ownership right of a particular commercial real estate property can be transferred from a seller to a buyer. On a relative basis, commercial real estate properties that are unencumbered and can be transferred more easily generally have higher valuations.

Property valuation methods

There are multiple types of property valuation methods that investors, asset managers, lenders and other stakeholders use to determine the value of a commercial real estate property. Here is a snapshot of some popular valuation methods:

Comparable Sales Method

The comparable sales method uses recent transaction data of similar properties in the same neighborhood or market to arrive at a value for the target property. So, this valuation method determines the value based on precedent sales transactions. 

Income Capitalization Method

The income capitalization method is based primarily on the amount of income an investor can expect to generate from a particular property. Rather than focus on transaction data, this method focuses on income generation. To leverage this method, calculate net present value of of a future stream of income the property is expected to produce. 

Cost Approach

If there is a lack of comparable sales data or if the property is a new construction, the cost approach can be an effective valuation method. The cost approach focuses on the cost of land plus the depreciated cost of the building. 

Value per door

The value per door method is most relevant for apartment buildings and determines the value of a building based on each individual unit. For example, if a building is valued at $10 million and has 100 units, then the
value per door is $100,000.

Why investors need valuations

Valuation are important for various real estate stakeholders. For example, investors and asset managers use valuations to help them make more informed decisions. When they know the independent value of a property, they can use this data to make a reasonable offer or use the valuation as a comparable to build a new project or buy a similar asset. 

Lenders use valuations to determine the safety of their commercial real estate loans. Lenders need to understand how capital is at risk for a given property, and a valuation helps them gauge both the risk of the loan and the underlying asset. 

What is an appraiser?

An appraiser is a real estate professional who values a commercial real estate property. Through both art and science, appraisers use their expertise to deliver an appraisal, which is a comprehensive analysis of a property, which could include location, the property’s condition, comparable assets and precedent transactions, and other factors which drive value. 

Conclusion

Whether you’re an investor, asset manager, buyer, seller or lender, a commercial property valuation is an essential tool that sets the foundation for any real estate transaction. By understanding the key principles and terms for real estate valuation, you can make a more informed decision about a given property and investment decision.