As a certified appraiser and broker, I know the best practices of valuing an investment property. My go-to list boils down to three approaches related to cost, income and sales. So if you’re not so sure how to value your commercial property, keep reading.
1. The cost approach
Start by identifying the cost to replace the property. This means accounting for all costs associated with construction and property value.
If you come across comparable properties that are priced above the cost to rebuild it completely, educate your clients — the same goes if properties are priced below the cost of reproduction.
If a property is listed 30 percent below its estimated value, for example, acknowledge the edge you have over new complexes on the market that require additional cost to build. Ultimately, they’ll have to charge a higher rent and you’ll have a competitive edge.
2. The income approach
Consider the Gross Scheduled Income (GSI), or the amount of rent collected for the entire property if it was completely occupied, even if some units are vacant.
You’ll need to consider external income generated through on-site laundry, parking or whatever else is accrued through tenant property expenses.
Next, subtract the stabilized vacancy rate from the equation. Depending on your market, you’ll want to stick to about 2 to 5 percent. I always consider vacancy because it’s so unpredictable. It’s rare that an apartment will become available the same day a tenant chooses to move out. Typically, it takes about 5 to 10 days to clean, fix damages and get a new tenant in an apartment.
Once you calculate the stabilized vacancy rate, you get the Effective Gross Income (EGI), which is then subtracted by expenses including taxes, insurance, utility costs, water, sewage, garbage — you name it.
From there, you’ll be able to calculate your Net Operating Income (NOI) which clarifies the amount you’ll profit each year before debt service, tax treatment and depreciation.
Finally, divide that figure into the cap rate, which is the annual return on a property paid for in cash. Simply take the cap rate and divide into the NOI to get the final valuation of your property.
3. The sales approach
Once you’ve identified expenses, you’ll want to break it down to a per-unit basis and compare properties. Compare properties on a per-square-foot basis or even a per-bed basis, depending on your market.
Reconcile the numbers and compare a handful of properties. You’ll then want to make adjustments to your property valuation based on what you find.
Weigh each of the above approaches and determine which works best for you and what gives you most confidence. It’s different for everyone, but it works.