How do I Calculate the Dollar Value of a Commercial Property?
Commercial real estate finds its value in the income it produces. The more rent a property produces, the more it's worth as an investment. If you're looking to invest in a commercial building, you'll have to do your background research to find out information about the companies leasing the space in the building as well as the building itself. The more knowledge you have, the better decision you'll be able to make.
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Instructions
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The most simplistic way to find the value of a commercial property is to use the following formula: Price = Net Operating Income, or NOI / Capitalization Rate.
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To find the Net Operating Income, you'll need to speak with the current owner. Find out what actual rents he receives and what his actual annual costs amount to. Subtract the costs from the rent, and you have NOI. Please note that debt service, or your mortgage payments, don't get counted in the annual costs for figuring NOI. Those payments will have to come from the income that the property produces.
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The capitalization rate, often referred to as cap rate, indicates the generally accepted return in an area. It is expressed as a percentage. In a smaller town where finding tenants may be difficult, investors expect a higher cap rate--16 percent, for example. In a desirable area in a big city, investors are willing to accept a lower cap rate because the investment will not require as much effort on their part because there is less tenant turnover, shorter vacancy periods, higher rents and faster appreciation.
You can find the cap rate by asking a commercial broker what the cap rate is in a given area, asking investors what cap rate they typically accept or by setting your own expectations--you might require a cap rate of at least 10 percent on any investment.
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Run the formula with the numbers you found. If a property produces $100,000 NOI, and you want a cap rate of 10 percent it would look like this: Price = 100,000 / .10. In this instance, the dollar value on the property is $1,000,000. If you were willing to accept a cap rate of seven percent, your numbers would look like this: $100,000 / .07 = $1,428,571.43.
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Tips & Warnings
Make sure to get actual numbers from the property owner. Owners may show you numbers that reflect potential income. But if a unit is vacant it's not producing rent, therefore it provides no value until it's filled.
If the property is newer, well-kept and in a highly-trafficked part of town you can accept a lower cap rate.
The dollar value may not represent the value you put on the property. This may be due to maintenance issues, the type of businesses operating out of the space or the location.
References
- Photo Credit building image by Andrey Rakhmatullin from Fotolia.com
