Three Methods of Appraising Commercial Real Estate
Appraising commercial real estate may seem like simple process from most business owners’ perspectives. The appraiser comes to the property, looks around, takes a few notes, and comes up with a value for the piece of real estate. But that’s not really the case. The appraisal process is actually a lot more complex. There are typically three different methods for appraising a commercial property – the income capitalization approach, the sales comparison approach, and cost approach – that go far beyond just taking a look around.
Income Capitalization
This approach is based on the expected cash flow. It values property based on the amount of income it’s likely to produce. Business owners seeking income-producing property in order to generate a regular income should focus on the value produced by this method. Real properties, such as office buildings, apartments, and shopping malls, are prime candidates for the income capitalization approach. To arrive at a property’s value using income capitalization, an appraiser uses the gross annual income, the effective gross income, the net operating income, and the capitalization rate.
Market rental studies determine potential annual gross income through the use of comparable properties that are leased. In calculating effective gross income, factors such as vacancy rates and collection loss are estimated and subtracted. The appraiser arrives at the net operating income by subtracting annual operating expenses from effective gross income.
The subject property’s annual net operating income is divided by a capitalization rate to determine the value of the property. Capitalization rates can be estimated by dividing the net operating income of comparable properties that have recently sold by their sale price. The capitalization rate is the same as the investment’s rate of return; therefore properties having higher capitalization rates will be more attractive to investors.
Sales Comparison
The sales comparison approach uses several comparable properties that have recently sold in the area to determine the value. Each of their sales prices is used as a baseline; then differences in the features are used to adjust the unit prices up or down accordingly. Sometimes properties are sold for less than market value due to the owner’s financial difficulties, so these comps may be excluded from the sales comparison approach analysis.
Cost Approach
The cost approach method is based on the actual value of the site and the cost of constructing a building with the same features. Because this approach takes the property’s depreciation into consideration, it is most valid when dealing with relatively new structures, since estimating depreciation for older structures can be difficult.
The depreciated replacement cost of the improvements is added to the estimated land value for a final value estimate. To estimate the land value, comparable sites with similar utilities, zoning and use contribute to determining the site’s value.
All of these appraisal methods are very different and can be challenging to the appraiser, since market data is relied on in all three approaches. Let Commercial Investment Appraisers help you choose the right option for your property and provide you with a thorough appraisal. Contact us at 407-929-8080 or info@commercial-appraisers.com.
