As a commercial property landlord, it can be difficult to decide whether it’s better to sell or lease out your property without knowing how much it’s worth.
If you want to know how to value a commercial property, here’s an overview of the most common methods you can use to gauge what your property is likely to be worth.
How to Value a Commercial Property Five Ways
There are several ways you can calculate the value of a commercial property including:
- Income Capitalisation (Cap) Rate
- Comparable Sales
- Hypothetical Development
- Replacement Cost
While the most suitable method of calculation will largely depend on what the valuation will be used for, the most common valuation methods include the Income Capitalisation (Cap) Rate and Comparable Sales methods.
Income Capitalisation (Cap) Rate Method
Income Capitalisation is the most common method of valuing commercial property as it’s relatively simple to calculate, buyers can quickly estimate the likely return on their investment and it makes it easy to compare the property against other similar properties.
To use this method, you’ll need:
- the net operating income of the property (i.e. the annual rental income minus expenses), and
- the cap rate of other recent sales of other similar properties in the area (calculated by dividing the net operating income by the sale price).
With this data, you can calculate the value of a commercial property using the following formula:
Net Operating Income / Cap Rate = Market Value
Here’s an example:
Imagine a commercial property that can generate $50,000 in gross rental income. You anticipate costs of $5,000 (for things like loss of rent due to vacancy or capital expenditure), leaving you with a net operating income of $45,000.
You’ve calculated a cap rate of 7% based on other similar recent sales.
By dividing the net operating income of $45,000 by the cap rate of 7%, you’re left with a property value of around $640,000.
Comparable Sales Method
Another popular and simple way to value commercial property is to use the Comparable Sales method.
This method relies on drawing a comparison between the property you’re valuing and recent sales of other similar properties, and considers factors such as:
- when the property was sold
- where the property is located
- the size of the land and any buildings
- the property zoning
- the physical characteristics of the property, including its age and condition
- its proximity to amenities and services
While the calculations may not be as specific as using a method like the Income Capitalisation Rate, it doesn’t take the return on investment into consideration as it’s based on actual recent sales data. It will still provide a good representation of what price the property could achieve in an open and fair market.