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What Factors into Your Building Valuations? Understanding the Three Methodologies

Posted: November 27, 2017 by Anna Jotham

There are many reasons you might want to estimate the value of the commercial real estate you own. Maybe you’re conducting an investment analysis, looking for real estate financing, obtaining property insurance or preparing to sell the commercial property. Or maybe you just want to consider your next steps with the property—whether to hold on to it, buy it or sell it. Whatever the reason, a number of considerations factor into your building valuations. And although it may seem as easy as pulling out your smartphone to find the estimate value of any property these days, knowing how the experts arrive at those numbers is important.

There are three methodologies at work when determining a commercial property value, according to, “Valuation Methods to Calculate Commercial Property Value.

#1 The property–sales comparison methodology, which compares a property to a similar property sold in the same market, weighing such factors as the size, condition, location and age of the property. In “Determining the Value of Commercial Real Estate” by Dean Willmore, he asserts that the location of property is a key factor in determining valuation. Under this methodology, properties which are located within city limits, with great access to public transportation, will likely be worth more than those in rural, hard-to-get-to locations.


Under the sales comparison approach, a valid comparison is dependent on three factors: the comparison properties must be as similar as possible to the subject property, must have been sold within the past year in what they call an open and competitive market, and must have been sold under standard market conditions.


#2 The income–capitalization methodology, most often used when a property has one or more tenants. The value of the property is determined by the income the property generates. Of course, the more income a property generates, the higher the number at which it will be valued. The accuracy of the income and expenses generated by the property are essential to determining the value of a property based on this methodology, which is then used to determine the net operating income of the real estate. The value of the property, according to the Riverdale Funding article, is then determined through this formula:


Value = net operating income (NOI) / capitalization rate (or cap rate). To find the value of a commercial property, an appraiser or investor would find an average cap rate of market properties similar to the one in question, essentially employing the sales approach methodology.


#3 The replacement cost approach methodology, where the expense of replacement of parts of the property determines its value. This is especially beneficial for properties that are one of a kind, or special use, or when data from other similar market properties is limited. This methodology is based on the assumption that a buyer would not pay more for a property than it would cost them to buy a similar lot and build a structure of similar functionality, according to, “What You Should Know About Real Estate Valuation.” This method may be used for appraisals of properties that are not commonly sold and do not generally product an income, like churches, hospitals and schools.


Having an Accurate Commercial Building Valuation is Important

Accurate valuation of your building may be important to any number of people, including lenders, investors, buyers and insurers, and of course you as a property owner. Gaining a basic understanding of these three valuation methodologies may be helpful to you as your business needs and your interest in your commercial properties grows and changes over time. 

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