Knowing how much your commercial property is worth is more complicated than knowing the value of residential real estate. The value of commercial depends greatly on the what the property is worth and the income it can generate. Also, the property’s location, type, and potential of future income will also affect its value.
Commercial real estate investors who specialize in retail leasing, investment, and land assembly calculate how much real estate is worth one of using 3 different ways.
- Direct comparison approach
- Income approach
- Cost approach
Let’s look at these ways of valuing commercial property in more detail.
Direct comparison approach to knowing how much commercial property is worth
Comparing the selling prices of similar commercial properties in the nearby area is the easiest way to know how much a property is worth.
A commercial real estate (CRE) investor calculates the average selling price of these properties. They then adjust the figure based on the square footage of their property. It’s also necessary to take into account any building upgrades.
Income approach and commercial property value
The income approach to finding out how much a commercial property is worth is one of the most common methods.
CRE investors usually calculate the capitalization rate, or cap rate. This is basically net operating income divided into the price of the property. For example, if the annual income from the property (after expenses) is $150,000 and the cap rate is 6%, the commercial property would be worth $900,000.
The cost approach determines what it would cost to replace the property. This is rarely used by commercial real estate investors.
Basically, the cost approach method starts by estimating the land value of the property without any building on it. Then, the investor needs to calculate how much it would cost to build the exact same building on the site. Then, depreciation is taken into account depending on the age of the property.
The cost approach is more reliable when calculating how much newer commercial properties are worth.