Many people make a living from property investments. Commercial property investment is a great way to earn passive income. Commercial properties are not cheap but those who enter the market earn rich rewards.
Whether you’re thinking of buying commercial property or considering your property portfolio it is worth knowing the basics of commercial property valuation.
Understanding Commercial Property Valuation
Commercial real estate valuation is the process of valuing property used for business purposes. A commercial property excludes any property used primarily as a residence.
It is important that you know the difference because commercial and house valuations are quite different. The professional valuing your property should have specialist knowledge of your property sector.
How to Calculate the Value of your Commercial Property
A professional valuator will use one of five methods to value your property. These are:
- Direct comparative sales
- Cost summation
- Income capitalisation
- Residual land value
- Replacement cost
Direct Comparative Sales Valuation
As the name suggests, this valuation method uses other similar commercial properties to calculate your property value. The properties used for the comparative sales valuation must be comparable. In other words, it must completely match your commercial property.
The valuers must find at least three comparable properties for an effective market valuation. They will use the listed or recent sales prices of these properties. They convert the total price to a price per square meter and then apply that to the size of your property.
This is what the equation looks like:
- Commercial Property Value = Average square metre price x property size
Valuers use this method for valuing all property types including residential, industrial and agricultural properties.
Cost Summation Valuation Method
The cost summation method is perhaps a little more complex. It entails collecting all relevant information about the property. Having collected the data, the valuer will analyse and evaluate how it affects the property value. The valuer may inspect the commercial property and will collect outside data as part of his research.
We have listed below the information that the valuer will collect while inspecting the property:
- Property dimensions – accessed from floorplans or through direct measurements
- Age and condition – here the valuer will take account of any property improvements
- Energy use – they will examine energy saving installations
- Location – determines the availability of amenities including public transport accessibility
- Strata details – if your property partakes in a Strata Scheme
The total market value is the sum of the values of each of the above aspects of the property. Property valuers refer to individual values as the costs. Costs can either add to the eventual value or detract from it.
Income Capitalisation Valuation Method
Commercial properties are income generators. The income capitalisation method uses the income earning capacity of the property to ascertain its value. Using this method, investors will also have a clear picture of how much income they’ll earn from the property.
The valuer will need two financial figures to apply this valuation method. These are:
- Net Operating Income (NOI) – Income before interest and tax
- Capitalisation Rate (Cap Rate) – the rate of return on the investment in the property
The NOI calculation
- NOI = Property Revenue – Operating Expenses
The Cap Rate calculation
- Cap Rate = NOI ÷ Purchase Price
To value the property using this method, you divide the NOI by the capitalisation rate thus:
- Commercial Property Value = NOI
Cap Rate
If you have all the information, this is an easy way to determine the commercial property valuation.
Residual Land Valuation Method
Property developers use residual land valuation to verify that the land price supports their investment and development plans. This method evaluates the land and the planned improvements.
You will need the Gross Development Value GDV to calculate the residual land value. The GDV is the total planned development expense and includes the profit that the investor will make on the development. It takes account of interest rates and market trends.
Formula to calculate the residual land valuation:
- Residual Land Valuation = GDV – (construction cost + development profit + fees)
The residual land value gives you the negotiating leverage to ensure a fair price that will support your development plans.
Replacement Cost Valuation Method
Often used for insurance calculations the replacement cost method is also helpful for calculating rental and market property values. You can also use this method in conjunction with any of the other commercial property valuation methods.
To calculate the replacement value, the valuer will establish the cost to replace all the property structures. The figure represents the commercial value of the property. The valuer must take all costs into consideration. These include:
- The full cost of materials and labour
- All fees including engineers, consultants and architects
- Rates and government regulations
Ask a Professional
A real estate professional can help you to find the help you need. They ensure that you have included all the necessary details in your commercial property valuation.
There are loads of commercial valuers in Sydney. Still, it is essential that you find a valuer that knows your type of business. Give us a call, we’re keen to help.