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.
The value of commercial property is influenced by its income-generating potential, the current market conditions, and a range of other factors including location, tenancy agreements, and the physical state of the property.
The choice of valuation method can depend on the purpose of the valuation, the type of commercial property in question, and the data available to you. Each method has its nuances, but they all aim to provide an accurate assessment of a property’s worth, so let’s discuss how to value commercial property in Australia.
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Understanding the Basics on How to Value Commercial Property in Australia
Valuing commercial property in Australia entails a combination of methods to gauge the most accurate estimation of a property’s worth. A property’s value is pivotal in investment decisions, financing, taxation, and sales negotiations.
Key Factors That Affect Commercial Property Value
Commercial property value in Australia is influenced by a variety of factors including:
- Location and Accessibility: Properties situated in high-demand areas with robust economic activity typically hold higher values. Accessibility to major transport links such as highways, public transit, and airports also increases attractiveness to potential tenants, enhancing the property’s value.
- Property Type and Use: Commercial properties can range from retail spaces to industrial warehouses, each having unique value determinants. A commercial property’s design, facilities, and potential for property improvements plays a key role particularly in retail spaces.
A property designed for flexible use across various industries may hold greater value compared to one with a specialised use. - Lease Structure and Tenure: properties with long-term leases to creditworthy tenants are generally valued higher due to the stability and predictability of income streams.
Conversely, properties with high vacancy rates or short-term leases may face reduced valuations. Lease conditions, including rent review clauses and options for lease renewal, are also crucial.
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Methods to Value a Commercial Property
Income Capitalisation Method
This is one of the most popular valuation methods in commercial real estate that helps 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 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 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 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 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 a 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 value 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.
Comparable Sales Method
The sales comparable approach is one of the most straight-forward methods to determine a fair market value of a commercial space. It relies heavily on area sales (usually the latest estimate) or sales price 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 the commercial real estate data on certain platforms to get more insights into market trends.
Both the replacement cost and sales comparable 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 like occupancy levels.
Besides real estate fundamentals, this valuation method factors in financial elements like debt financing and senior loans for valuing 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 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 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 predetermined 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 cost of redevelopment or renovations.
Conducting a Market Analysis
Valuing commercial properties is similar to valuing residential properties, you must conduct a thorough market analysis. Market analysis involves examining the trends, prices, and factors that influence commercial real estate within a specific region or sector. Key Steps in Market Analysis:
- Collect Data: Analysts gather information on recent sales, lease prices, and the current real estate listings in the target area.
- Evaluate Comparable Sales: They focus on properties similar in size, location, and use to determine a baseline for pricing.
- Analyse Economic Indicators: Understanding the local and national economic climate, including employment rates and GDP growth, can influence demand and property values.
Interpreting Economic Indicators
When valuing commercial property in Australia, economic indicators offer crucial insight into the health of the market. Analysts regard indicators like GDP growth, interest rates, unemployment levels, and inflation as signposts of potential performance.
- GDP Growth: Reflects the overall economic health, which can impact rental demand and yields. A robust GDP suggests a thriving economy, potentially leading to higher demand for commercial spaces.
- Interest Rates: The Reserve Bank of Australia’s interest rate decisions influence borrowing costs. Lower rates can lead to increased property investment due to cheaper finance.
- Unemployment Levels: Directly correlates with consumer spending and business profits. High unemployment might reduce demand for commercial space, as fewer businesses require premises.
- Inflation: Affects the cost of construction and operational expenses. Stable inflation is preferred, as it suggests a predictable market, whereas high inflation may increase property running costs.
Determining the Right Approach
One of the best ways to identify investment opportunities, may it be residential property investment or commercial spaces, is through a reliable valuation method. Investors and brokers should always consider two different valuation approaches that complement each other, and if you still have questions enlist professional advice.
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.
Key Takeaways
- Valuing commercial property involves methods like income capitalization, replacement cost, market value, discounted cash flow, gross rent multiplier, and price per unit/square foot.
- Factors affecting valuation include return rates, capital appreciation, rental yields, location, property age, and market trends.
- Each valuation method has specific applications and advantages, requiring careful consideration of property specifics and market conditions.
- Combining different valuation approaches provides a more comprehensive property value estimation.
