How to Determine the Values of Commercial Real Estate

Valuing commercial property requires a great deal of calculation.

Valuing commercial real estate is an extremely challenging art --- two adjacent buildings of the same type and size built in the same year by the same builder can have completely different values. Valuation is an exact science: To correctly calculate the value of a piece of commercial real estate, you need to compile a great deal of information about the property, survey its market and then decide which valuation model to use. Ultimately, though, the true value of the property can only be found when a market price is established by a sale.

Instructions

1. Survey your property as to its quality and size. Look to see if it's a good fit for the area --- e.g., an office building surrounded by houses may be less valuable than one downtown --- and if it's easy to get in and out of. Note the physical condition of the building, in addition to the condition of the area. You can gauge an area not only by driving through it at different times of the day but also by studying past, present and projected future demographic indicators such as population, number of employers and average household income. When you measure the building's size, pay attention to how much of its space is actually inside areas that are usable by tenants, as opposed to being "common areas" that are shared among all tenants, such as hallways or common restrooms.

2. Calculate an accurate net operating income for your property. Add up all of the scheduled income from rent, reimbursements and other sources, and subtract a reasonable vacancy factor, defined as a certain percentage of the total rent. Vacancy factors vary based on product type and market, but a good rule of thumb for a multiple-tenant property in a normal market is to take the actual market vacancy or 5 percent, whichever is greater. Add up all of your recurring noncapital annual expenses, such as utilities, property taxes and normal repairs and maintenance, and subtract them from the total gross income.

3. Take a survey of comparable properties that have sold in your area or in similar areas. Look at the prevalent valuation metric in your market, such as a capitalization rate, price per square foot or unit, or other model, and figure out what the general selling range for your market is. For instance, apartments in large Midwestern markets may sell in a range from $45,000 to $70,000 per unit; retail centers in a coastal California market may sell for between a 6.5 and 8.5 percent capitalization rate; and vacant large warehouses in a mid-Atlantic suburb could sell for between $40 and $60 per square foot.

4. Apply one of the valuation models to calculate a price after adjusting your property to make it comparable to other properties on the market. If at all possible, use the income method of valuation by dividing your net operating income, or NOI, by the market's capitalization rate to find a price. For instance, if your property has an NOI of $140,000, and the appropriate "cap" rate in your market is 8.25 percent, divide 140,000 by 0.0825 to come up with a price of approximately $1,697,000.