Commercial real estate securities

To understand commercial real estate values, you must understand how an appraiser professionally values ​​a property. An appraiser has the responsibility to estimate or give an opinion on the value of a commercial property. You can apply your techniques to estimate value.

Comparable sales approach

The first, and probably the simplest, method of valuing commercial real estate is called the comparable sales approach. If you remember when you bought your first home, the bank had an appraiser go out and give the property a value that they hoped would at least equal the purchase price. The same applies to commercial property. The commercial appraiser goes out and compares the prices of recently sold local properties that are similar in form and function to the property he is appraising. The analysis will produce an average price and that price is where your property will be valued. In commercial properties, they not only look at price, but they also look at the selling price per square foot of the building.

Although the comparable sales approach is the easiest method of estimating the value of a commercial property, there are a couple of problems with using this approach.

• When stocks rise and fall or fail to stabilize, this may invalidate the use of the comparable sell approach.
• In some small markets, there are no or only a few comparable sales due to a lack of overall sales.

The income approach

When determining commercial real estate values, this is the most important thing to learn.

You will find that commercial properties are valued primarily for the amount of income they generate. To be more precise, it is actually net operating income that is the most important factor. When you have accurate financial and operational information on the property, the income approach can be used.

This approach is based on the capitalization rate that is calculated for a property. To calculate the capitalization rate, you must first know the property’s sales price and its net operating income.

After calculating the property cap rate, compare the cap rate to similar property cap rates that were sold in the area. The appraiser goes out and finds the cap rates on the other properties and averages them. Then use that average capitalization rate to calculate the property’s value knowing the net operating income.

The cost approach

The final approach to calculating the value of a property is the cost approach. This approach is the least frequently used as you are trying to calculate the value of the property based on what it might cost to build in today’s market, in addition to adding the value of the land. The cost approach is more accurate for newer buildings because when determining the value of older buildings, you must take into account depreciation, which can be difficult to determine.

The calculation you perform for this approach is the value of the land plus the cost of construction less depreciation equals the estimated value of the property.

Understanding these approaches to commercial real estate values ​​will help you get started with the valuation process.