It is essential that investors in the commercial property space know how to value commercial real estate (CRE) for maximum returns, since an accurate valuation can help identify overlooked deals and avoid taking positions in overpriced real estate. Here is how to determine commercial property value, and more.
Determining the fair market value of commercial property is of vital importance to investors and lenders alike, who can do so themselves or have a professional handle it.
Investors generally calculate such values to garner a purchase price, gauge prospective value-add offerings, and determine whether a property is a solid strategic fit.
As part of the underwriting process, lenders typically employ a commercial property value estimator to ultimately determine a borrower’s down payment, term length, and sometimes other provisions.
Note that a property’s cost does not equate to its value, as “value” is the relationship between the desired real estate and the promise it represents to its owner. In general, there are four primary factors that impact CRE valuation, and which must complement each other: utility, scarcity, purchasing power, and desire.
There are multiple methods for valuing commercial properties, each one providing insight into the property’s worth.
If one is using the income capitalization method, for example, say office buildings in Austin are trading at a 7.9% capital rate and a similar structure is producing an NOI of $500,000 annually. This approach would value the building at $6,329,114 ($500,000 NOI/7.9%).
Note that a property’s NOI is calculated by adding up all revenue then subtracting operating expenses. The cap rate is calculated by dividing a property’s NOI by the current market value.
The metric internal rate of return (IRR) is utilized to assess capital budgeting projects and to evaluate property over time. In other words, it is commonly used by investors to gauge profitability.
In commercial property valuations, the IRR can supplement cap rates since the tool factors in sale proceeds and NOI for multiple years. It can also permit investors to compare opportunities.
Then there is the compound annual growth rate (CAGR), which is used to gauge the rate of return for an investment over a protracted time period. It is another metric that can be used on a complimentary basis in commercial property valuation.
While a commercial real estate appraisal can be viewed as a pricing guide sans legal standing, a valuation establishes definitive value that can be used legally.
Depending on the property’s size and the information to be collected, commercial real estate appraisals can take weeks or months to finish. In general, steps include stating the appraisal report’s purpose, outlining the scope of work, collecting, and analyzing data, and calculating the property value. All the appraisal information is used to determine the property valuation.
In turn, the buyer uses the valuation to see what their property is worth in the current market.
These elements have an impact on the value of a commercial property:
How to Estimate Commercial Property Value
Methods used in estimations include:
There are a few ways to look up a commercial property’s value, but a few of the most used options include:
There are also several tools available to commercial property investors including online databases, local assessors’ offices, and real estate agents and appraisers.
The number of search options is growing along with the popularity of real estate investing in general, and commercial properties in particular, as investors seek to steer away from volatility and toward asset classes that are not directly correlated with public markets.
Intermingling such investments with the stocks and bonds in one’s portfolio also serves to mitigate overall risk, since spreading investments across varying assets means holdings are less likely to be wiped out due to a single negative event. Thus, diversification is an essential part of successful investing.
Alternative investments can be a good way to help accomplish this. Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings.
Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk.
In some cases, this risk can be greater than that of traditional investments.
This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million. These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform.
However, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments.
While it is essential that investors in commercial properties understand the importance of real estate valuation, they should also know that the exercises required are complex and require research, the application of multiple methods, and consideration of several factors.
Yieldstreet provides access to alternative investments previously reserved only for institutions and the ultra-wealthy. Our mission is to help millions of people generate $3 billion of income outside the traditional public markets by 2025. We are committed to making financial products more inclusive by creating a modern investment portfolio.