Key takeaways:
- There are numerous ways to calculate the value of a commercial property, including the sales comparison method, the cost method, and the income capitalization method.
- To arrive at the most reliable estimate, it’s helpful to use several different methods—and then compare results.
- Commercial real estate appraisers, as well as commercial real estate brokers, can also provide an estimate of a property’s value.
Whether you want to buy or sell a commercial property, obtaining a reliable estimate of the property’s fair market value is an essential first step. But getting that estimate will require more than a quick search on Google—either you or someone else must do the calculation.
Professional appraisers can often provide the most accurate valuation. Yet if you decide to do your own estimate—and see how your property matches up against similar properties—there are various methods at your disposal. Learn more below about which methods can best meet your needs.
Understanding commercial property value
The value of a commercial property is determined by factors related to supply and demand. For example, prices in popular locations with restrictive building regulations—such as New York City and San Francisco—will tend to be higher than in other locales.
How a property is used will also affect its value: Will it be, say, an office, warehouse, condo, or restaurant? Properties that are occupied by highly profitable businesses will also often command higher valuations. Numerous other factors affect the value of a property, including:
- Age
- Condition
- Lot size
- Building size
- Number of units
- Square footage
- Type of construction
How to determine commercial property value
The “fair market value” of a commercial property is the price that it would command on the open market. Various methods can be used to determine the value of a property, as well as to compare the relative attractiveness of a property to similar buildings in a given area.
Determine a property’s value: sales comparison method
The sales comparison method can help you estimate a property’s value by analyzing recent sales’ prices of neighboring properties—and then adjusting for differences, such as size, age, and condition. The sales comparison method tends to be more useful in areas with high sales volumes.
Determine a property’s value: cost method
The cost method can help you estimate a property’s value by doing a hypothetical calculation of the cost to build a property from scratch. The calculation accounts for the value of the land on which the property sits, material, labor, and other construction costs, as well as depreciation of the current property. The formula is:
Property value = land value + construction costs – depreciation
The cost method tends to be more useful when there is both comparable vacant land (to provide a reliable land value for the property being analyzed) and the property itself is not too old (calculating deprecation accurately can become more difficult as buildings age).
Determine a property’s value: income capitalization method
The income capitalization method can help you estimate a property’s value by dividing its net operating income (NOI)The revenue a property earns minus operating expenses, vacancy, and uncollectible receivables. The n... by its “capitalization rate” (i.e., an estimate, expressed as a percentage, of the potential return on a property). If a property’s NOI is $1 million and its capitalization rate is 8%, the property would be valued at $12.5 million ($1 million / 8%).
A property’s NOI will help a lenderThe person or party (such as a bank or corporate entity) that loans money on a commercial real estat... determine how much they are willing to lend on that asset. Does the property generate enough income to service the debt?
When NNN (triple net) assets are appraised, the appraiser will determine the value of the asset with the tenant in place, but also what the dark value of the asset would be. Dark value is what the property would be worth with no tenant and no income. Typically, a lender will not want to lend more than the dark value of a property.
Compare a property to others: gross rent multiplier method
If you already have an estimate of a property’s value, the gross rent multiplier (GRM) method can help you determine how attractive the property is relative to similar properties. To calculate the GRM, divide the price of the property by the gross annual rent that it generates.
For instance, if the property is valued at $5 million and has gross annual rent of $500,000, the GRM would be 10 ($5 million / $500,000). All else equal, a property with a lower GRM may represent better value. Further, the GRM method (which doesn’t account for operating expensesOften referred to as “OpEx,” operating expenses refer to all costs necessary to operate and main... associated with a property) is most useful when there is plentiful data about the GRMs of neighboring properties.
Compare a property to others: cost-per-rentable-square-foot method
If you have an estimate of a property’s value, the cost-per-rentable-square-foot method can help you determine how attractive the property is relative to comparable properties. To calculate cost per rentable square foot, divide a property’s price by its rentable square footage.
For example, if a property is valued at $4 million and has 20,000 rentable square feet (out of, say, 25,000 total square feet), the property’s cost per rentable square foot would be $200 ($4 million / 20,000). All else equal, a property with a lower cost per rentable square foot may represent a more attractive investment opportunity.
Compare a property to others: cost per door method
If you have an estimate of a property’s value, the cost-per-door method is yet another way to evaluate the property’s relative attractiveness. To calculate cost per door, divide a property’s price by the number of units in the property.
If, say, a property is valued at $2 million and it has 5 units, the cost per door is $400,000 ($2 million / 5). Though the cost-per-door method doesn’t account for differences between units—such as size or number of bedrooms—properties with a lower cost per door may nevertheless offer better value to potential buyers.
Where to look for commercial property value?
If you need an expert property valuation, a commercial real estate appraiser is often the best choice. When selecting an appraiser, it’s wise to look for one that has been certified by a respected third-party, such as the Appraisal Institute.
A real estate broker can also provide a valuation. However, a broker’s desire to facilitate a sale may make their estimate less reliable.
If you want to conduct your own valuation of a property, the method you choose will depend, in part, on the data that is available. Yet whenever possible, it’s still a good idea to calculate a property’s value using multiple methods; such “triangulation” can help lead you to the most accurate estimate.
Various websites—some free, some subscription-based—allow users to search for information about commercial property, including by:
- Address
- Asset type
- Size
- Age
- Transaction history
- Debt history
- Owner’s name
Some websites (such as LoopNet and Reonomy) offer nationwide searches, while other websites offer more narrow searches; PropertyShark, for instance, focuses on Los Angeles County.
Frequently asked questions
How do I calculate the value of a commercial property?
There are different ways to calculate the value of a commercial property, including the sales comparison method, the cost method, and the income capitalization method. The type of property that is being evaluated, as well as the kind of market data that is available, can help you determine the best method for your situation.
What is the most common method for calculating the value of commercial property?
Three of the most common methods for calculating the value of commercial property are the sales comparison method, the cost method, and the income capitalization method. However, using several different methods can help you arrive at a more reliable valuation.
Who can help investors calculate the value of a commercial property?
Commercial real estate appraisers specialize in providing investors with expert valuations of commercial property. A commercial real estate broker can also estimate the value of a commercial property.
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