Investing in Commercial Real Estate – Property Valuation
Valuing property in commercial real estate is quite different from doing a Competitive Market Analysis (CMA) in residential real estate. Although the market dictates property values for both residential and commercial properties, that’s where the similarity ends. 
With residential properties, an Appraiser or REALTOR® will usually locate three similar properties to compare with the subject property. Appropriate price adjustments for bedrooms, fireplaces, decks, size of lot, financing, etc. are made for the comparable properties to make them equal to the subject property. Once the adjustments are made, the Appraiser or REALTOR® will choose the property that is most like the subject property and place the appropriate value on the subject property. That is why the home down the street may have sold for more money because it had for example more bedrooms or a larger deck. Please note in Virginia, a REALTOR®, unless he or she is a licensed Appraiser is not allowed to appraise properties by law. REALTORS® however can provide sellers with comparable property data known in the industry as a CMA.
Valuing Income producing properties such as apartment buildings, shopping centers, office buildings, businesses, etc. are based on the income stream the property produces. For example, if a building had a net operating income after expenses of $10,000.00, would you pay $500,000.00 for it? Probably not; however, depending on the market, you may pay $100,000.00 for the building. As you can see, the value is based on the income the building produces and not the value of the structure. The structure will come into play when doing the due diligence. The price may be right, but if the building is falling down the cost for fixing up the building will have a bearing on the purchase.
I stated earlier that the market will dictate for how much a property will sell. This is where the CAP Rate or Capitalization Rate will play a role in property valuation. The CAP Rate is the rate of return an investor can expect in year one of the purchase. The CAP Rate is determined by looking at the market and establishing the rate of return for comparable type properties. For example, the CAP Rate for an apartment building will be different from the CAP Rate for a shopping center.
Let us look at the example above again. If you decided to pay $100,000.00 for a building that has a net operating income of $10,000.00, the CAP Rate would be 10%. What if other buildings in the area were selling with a CAP Rate of 12%? You would have over paid more than $15,000.00 for the property. However, if the CAP Rate was 8%, you would have gotten a very good deal because the comparable value would have been $125,000.00.
As you can see, knowing the market CAP Rates for various types of properties is an important aspect when purchasing a commercial investment. Do you want to over pay your next purchase?
This is just one facet for analyzing a commercial property prior to purchasing. There many other factors involved in making an informed decision when putting together that important purchase.
Note: Laws vary in different States, always seek legal counsel and work with an experienced Commercial Real Estate Broker.
Image Courtesy of David Niblack
Michael Setunsky is the Broker and owner of Michael's Commercial LLC serving the Northern Virginia commercial real estate market. His more than 23 years of experience as a commercial real estate and business broker has earned him the distinction for being one of the top commercial real estate producers in the Mid-Atlantic Region. He also serves on the Mid Atlantic Real Estate Marketing Association's (MAREMA) Board of Directors, and is a Commonwealth of Virginia licensed Instructor. He teaches Pre-licensing, Post Licensing Education, Broker's and Continuing Education courses. Visit his company web site at http://michaelscommercial.com/.
©2009 Michael’s Commercial LLC, All Rights Reserved – Investing in Commercial Real Estate – Property Valuation – August 10, 2009
