Exploring Common Commercial Real Estate Valuation Models

Updated May 2, 2024

When it comes to commercial real estate, accurate real estate valuation is essential for making informed investment decisions, securing financing, or analyzing the value of a property for various purposes.

Commercial real estate valuation involves analyzing the value of a property based on several factors, such as location, size, income potential, and market conditions. Let’s look at common valuation models used in commercial real estate and share some insights into these methodologies.

Cost Approach Valuation Model

The cost approach is a valuation model that estimates property value by considering the cost of replacing or reproducing it.

This approach involves analyzing the land value and square footage, estimating construction costs like materials and labor, and deducting depreciation to determine the property’s value.

Appraisers typically use the cost approach model when valuing new or in-development properties or commercial buildings that recently underwent renovations and upgrades. It’s also a common approach when limited sales data is available, such as for government, religious, or special-use buildings that don’t hit the market frequently.

Sales Comparison Approach Valuation Model

The sales comparison approach determines the value of a commercial building by comparing it to similar properties that have recently sold.

Appraisers review the sales prices of comparable properties (also called “comps” or “comparables”), adjust for differences in features and conditions, and arrive at an opinion of market value based on the comparative data.

The sales comparison approach is the most common valuation method for commercial properties because, in most cases, there are plenty of comparable properties to analyze.

You may also hear this method referred to as comparison method, market data approach, or simply market approach.

Income Capitalization Approach Valuation Model

Appraisers primarily use an income capitalization approach to evaluate revenue-generating commercial properties, including office buildings, shopping centers, or apartment complexes. This model focuses on the revenue potential and estimates property value based on the expected income generated.

Appraisers consider rental income, operating expenses, vacancy rates, and market capitalization rates to calculate the property’s net operating income (NOI). The more predictable the expenses, the more effective and accurate this method is.

This approach is valuable for investors looking to assess the property’s investment value based on its income stream and potential return on investment. We also refer to this valuation method as income approach or capitalization rate approach.

Gross Rent Multiplier (GRM) Valuation Model

The gross rent multiplier (GRM) is a simplified valuation model commonly used for smaller commercial properties, such as residential investment properties or retail spaces that produce little revenue.

It estimates the property’s value by multiplying the property’s gross rental income by the prices of the property (or recent sales of similar properties in the area). It does not look at operating costs.

Overall, this method can help you determine how much rent you will earn from the property compared to the property cost and how long it might take to make a return on your property investment.

Why You Need to Know the Market Value of Commercial Property

Understanding the value of a commercial property is crucial for various stakeholders, including investors, lenders, insurers, tax authorities, property owners, and business managers. An accurate property value helps everyone involved make informed decisions and manage their interests effectively.

Investment Decisions

Investors need to know the value of a property before purchasing it to ensure they are making a sound investment. This includes understanding potential returns, assessing risks, and comparing the property’s value to similar properties in the market.

Financing

Lenders require an accurate valuation of a commercial property to determine how much they are willing to lend against it. The property’s value often determines the loan terms, including the interest rate and loan-to-value ratio.

Insurance

Property owners need to insure their assets adequately. Knowing the property’s value helps determine the appropriate level of insurance coverage to protect against potential losses from damage or other unforeseen events.

Taxation

Property taxes are typically based on the assessed value of the property. Governments use property values to calculate tax obligations, so accurate valuations are essential for property owners to ensure they pay the correct taxes.

Leasing and Rental Income

Property value can influence rental rates. Landlords and property managers need to know the value of their properties to set competitive rental rates that attract tenants while ensuring a return on investment.

Strategic Planning

Understanding the value of commercial properties in a portfolio can help businesses make strategic decisions about buying, selling, or renovating properties to optimize their real estate assets.

What Valuation Model Is Right For Me?

Each valuation model has its strengths and use cases. The right approach depends on the property and the purpose of your valuation. Experienced valuation consultants with expertise in commercial real estate, like our team here at Akrivis, can help you find the best model to meet your needs.

Whether you want to understand the value of your commercial property or you’re a lender or legal representative, our comprehensive valuation services can provide you with accurate insights to support your decision-making process.

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