When you’re dealing with the commercial real estate market in Australia, it’s important to determine a fair market value, regardless of whether you’re looking to sell, buy, or lease out a commercial space.

Determining a commercial property’s value is key to a successful investment, keeping all necessary information at hand. There are several methods you can consider whilst calculating commercial property value.

Depending on your investment goals, financial baseline, and development strategy, most property investors can explore many approaches for evaluating a commercial property’s worth.

Let’s discuss these in detail.

Contents

Residential vs Commercial Real Estate

  • Commercial properties usually yield between 5 and 12 percent returns, which is a higher amount when compared to the rental yields you obtain from a residential property.
  • The capital appreciation rate for a commercial space amounts to anywhere between 5 to 10 percent while residential units only offer a 1 to 3 percent minimum threshold.
  • Rental yields amount to 3 to 5 percent with a residential property investment (after property taxes and maintenance costs) while 6 to 10 percent for commercial spaces.

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Methods to Value a Commercial Property

Income Capitalisation Method

This is one of the most popular commercial property valuation methods that help determine a property’s monetary worth in relation to the profits it can generate. The evaluation is always based on current market conditions.

The method determines a property’s net operating income by factoring in certain expenses like maintenance, staff, and utilities. Additionally, you also need to consider the gross income generated under market conditions or occupancy rates.

The NOI value (net operating income value) is divided by the current capital rate, resulting in a fair estimate of the commercial property. But in some cases, the NOI cannot be evaluated, like when a property remains vacant for months or hasn’t been maintained over time.

In this case, consider the NOIs of similar properties for an approximate rate to use in projections. If a buyer wants to upgrade the property or has the resources to reduce operating expenses, you can consider these factors as well in the income approach.

The capitalisation rate is mostly determined by dividing the sales price by the NOI. Keep in mind that in some cases you cannot determine the cap rate but as an alternative, you can consider comparable properties in the area to determine the market cap rate.

Replacement Cost Method

The replacement cost method factors in the current land value of a commercial property, including the cost of rebuilding an entire property. You have to deduct the depreciated value of the existing structure in this approach.

Additionally, the replacement cost method considers the most profitable and efficient means to use commercial property. But there are certain commercial properties in places where the zoning laws don’t align with this approach.

The biggest advantage of such an approach is that it uses current values and conditions during the estimation. It’s also used by lenders and tax assessors to establish a commercial property’s value accurately for insurance purposes.

The only disadvantage of the cost replacement approach is that it doesn’t factor in the profits for an income-producing asset. For this reason, investors avoid projects that cost too much in terms of improvement since it surpasses market value.

Market Value Method

The sales comparables approach is one of the most straightforward methods to determine the fair market value of commercial space. It relies heavily on area sales (usually the latest estimate) or sales prices of similar commercial properties.

Such a method always establishes a value range first before determining an accurate figure for an existing commercial property. Variables that you take into account are a property’s age and structural condition, upgrades or additions, location and area tax rates, and more.

All these variables including the size of the land the commercial property is built on are considered in relation to current market trends. But a huge disadvantage here is that it doesn’t consider maintenance costs, occupancy rates, or building expenses.

Such a method is sensitive to market activity and economic factors, often technology-driven to simplify calculations and ensure accuracy in projections. You can study commercial real estate data on certain platforms to get more insights into market trends.

Both the replacement cost and sales comparables methods are used in tandem as they complement capital growth. Such a combination helps buyers determine whether it’s better to invest in an existing property or renovate one from scratch.

Buildings that remain empty for most times of the year or have a really low tenant footprint are excellent options to consider. Both methods are independent of existing or potential income, having little to no influence on the market value.

Discounted Cash Flow Method

While the income, replacement, and sales approach help determine a fair market rent at a particular time frame, all three options don’t consider the equity that results from a property sale once the holding period is over for any commercial asset.

In contrast, the discounted cash flow method addresses changing values of a commercial property by considering projected differences between the estimated sales price and the potential owner’s purchase price at the end of the holding cycle.

Variables taken into account during the discounted cash flow method are net operating income and value, reinvestment potential, internal rate of return, profit and risk margins, and more. In this method, rental trends are also taken into account for occupancy levels.

Besides real estate fundamentals, this valuation method factors in financial elements like debt financing and senior loans for valuing the commercial property. Any change in the economy also affects commercial property prices, changing valuation rates as a result.

Gross Rent Multiplier Approach

Similar to the income approach, this method determines commercial property values using gross rental income instead of a property’s NOI. As a result, it discounts major property expenses like property taxes, maintenance costs, staff wages, and so on.

Because the gross rent multiplier (GRM) approach disregards operating costs, it must be used in conjunction with other valuation methods. The base difference between the income and GRM approach is that it replaces the traditional cap rate.

When you can’t determine the GRM for a given property, then you have to take into account the GRM of comparable properties in the same area. One of the best advantages of this method is that it projects the potential income capitalisation in relation to its value.

Price Per Unit/Price Per Square Foot Method

While such an approach isn’t often used to determine the market value of the commercial real estate, it’s often used in conjunction with other methods. It’s a quick way to consider or discard a potential investment opportunity before investing any resources.

The price per square foot approach is categorised into three subtypes:

  • Price per square foot approach: Ideal for retail and industrial properties, and offices, this approach helps determine a commercial property’s value by multiplying the square footage with a pre-decided cost per square foot.
  • Price per unit approach: Ideal for condominiums and apartments, this approach determines the value of a commercial property by multiplying the cost per unit by the total number of units within a building or larger infrastructure.
  • Price per key approach: Ideal for hotels, resorts, and other hospitality structures, this approach determines the market price of commercial spaces by multiplying the price per key by the number of guest rooms in the building.

If you’re unable to figure out the price per square foot, you can always determine a range based on comparable properties within the same location. You can always adjust the property values so they’re comparable to a specific asset.

Such a method is also useful for properties in the renovation phase or development phase of a commercial property, giving you an overview of overall costs, upgrades, downgrades, and the cost of redevelopment or renovations.

Key Takeaways

How Much is My Property Worth?

One of the best ways to identify investment opportunities, may it be residential properties or commercial spaces, is through a reliable valuation tool. Investors and brokers should always consider two different valuation approaches that complement each other.

Leah Jay deals with commercial property management and procurement for small to large-scale businesses and companies in Australia. We can help you figure out which evaluation method best fits your business needs.

Our expert team has experience with the commercial real estate landscape and would be happy to assist you by answering all your queries. We can also provide you with a comparative market analysis report to simplify your investment experience. 

For commercial property management services, call us today.

Disclaimer: This information is general in nature and does not take into account your personal situation. You should consider whether the information is appropriate to your situation, and for professional advice, seek out a financial adviser.