When evaluating commercial property, there are three basic approaches used to determine value: The Sales Comparison Method, the Income Approach and the Cost Approach.
The Sales Comparison Method relies upon historical market data from similar properties that are currently listed or have recently sold. Since no two properties are identical, adjustments must be made for differences in age, size, location, road frontage /traffic, condition, building/land ratio, zoning, taxes, date of sale and other characteristics that might impact a property’s market valuation. This method works best when there is an abundance of recent sales of comparable properties.
The Income Approach to Market Value, also referred to as the income capitalization approach, is used to estimate the value of a property based on the income that property generates. The property’s Net Operating Income (NOI) is divided by a market Capitalization Rate to arrive at an estimated value. The NOI is the net income from a property, for a defined period, after deducting operating expenses, but before capital expenditures, debt service and taxes.
Effective Gross Income-Operating Expenses=Net Operating Income (NOI)
The rate of capitalization, or Cap Rate, is determined by dividing a property’s Net Operating Income by the Property value, and generally represents an owner’s return on investment.
Cap Rate= Net Operating Income / Property Value
The Cost Approach to Market Value considers the current cost of rebuilding a property minus accrued depreciation (physical deterioration, functional obsolescence, and external obsolescence). This approach relies on the assumption that a property’s value is influenced by the cost to produce a comparable structure. This method is best used when sales comparison data is inadequate, when the property has not been built yet, or it’s a special use property.
There are several ways to value commercial property that is why having the right team of professionals at Colony Realty is imperative to your bottom line.