What does the income approach to value rely on when valuing properties that are five or more units?
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The purchase, sale, borrowing or even leasing options for a piece of commercial property often hinge upon the appraised value of the building. Assessing that value, however, is no simple matter. Whether it’s an apartment building, an industrial complex, a retail shopping center or an owner-occupied business structure, commercial appraisals are generally more subjective than residential reviews. Show
Why? Commercial values are often dependent upon uncontrollable elements like the current market price for which spaces rent, fewer available comparables and overall maintenance costs (which can vary dramatically from industry to industry). And then, of course, there’s the tricky question of how much a buyer is willing to pay. 1. Cost approachThis valuation method considers the cost to rebuild the structure from scratch, taking into account the current value of the associated land as well as construction material and other costs that would be associated with the replacement of the existing structure. The cost approach is generally applied when appropriate comparables are difficult to locate, such as when the property contains relatively unique or specialized improvements, or when upgraded structures have added substantial value to the underlying land. 2. Sales comparison approachAlso known as the “market approach,” this method relies heavily upon recent sales data for comparable properties. By seeking recently sold buildings with similar properties from the same market area, a buyer hopes to ascertain a fair market value for the property in question. For example, a 12-unit apartment building might be compared to another that sold in the same neighborhood just a few months earlier. While this valuation method is typically used to value residential real estate, it does have one significant drawback. Depending on general and localized market conditions, it can be difficult to find recent comparables for similar properties. 3. Income capitalization approachThis valuation method is based primarily on the amount of income an investor can expect to derive from a particular property. That projected income could be derived in part from a comparison of other similar local properties, as well as from an expected decrease in maintenance costs. Say a building is purchased for $1 million, and the expected yield is 5%, based on local market research. That $50,000 per year in expected income could be enhanced by tightening inefficiencies or passing along other associated costs to the tenant, like electric or water usage. All expected future income is discounted to reflect present value. 4. Value per Gross Rent MultiplierThe Gross Rent Multiplier (GRM) valuation method measures and compares a property’s potential valuation by taking the price of the property and dividing it by its gross income. In other words, if you purchased a commercial property for $500,000 and it generates $70,000 in gross rents each year, your GRM would be about 7.14 or $500,000 / $70,000. This commercial real estate valuation formula is generally used to identify properties with a low price relative to their market-based potential income. 5. Value per doorThis commercial real estate valuation method is used primarily for apartment buildings rather than single-unit structures. This method simply determines the entire building’s worth based on the number of units. A building with 20 apartments priced at $4 million, for example, would be valued at $200,000 “per door” irrespective of each unit’s size. 6. Cost per rentable square footRentable square footage combines the usable square footage (the space tenants can occupy) with the common areas tenants benefit from, such as stairwells and elevators. Using this methodology, you can extrapolate the cost per rentable square foot, compare it to the average lease cost per square foot and make an evaluation of the building’s value. For example, if a building has 10,000 rentable square feet and the average cost to rent per square foot is $12 per square foot annually, a purchase price of $1.7 million will generate 7% gross rental yield. However, if you know you can charge rent of $14 per square foot annually, a valuation of $1.9 million will yield the same gross return. In the end, every buyer values property differently. The valuation of commercial property does have a subjective and unscientific component. The best commercial real estate investors have honed their gut instincts around finding the most attractive deals and the most effective valuation methods for each particular type of transaction. Learn more about how First Republic can help you reach your commercial real estate goals. We use one of three approaches to establish an assessed value (also known as "Current Value Assessment") for properties: The approach we used depends on your property type and how frequently similar types of
properties are bought and sold on the open market. This is the most commonly known valuation approach. We analyze recent sales of comparable properties to determine the value of your property. In considering any sales evidence, we ensure that the property sold has a similar or identical use as the property to be valued. The direct comparison approach is typically used for the following types of properties: An income-producing property’s ability to earn revenue is directly tied to its current value. When using the income approach, we carry out a detailed analysis of your property's income and expenses and then compare it to similar properties to determine how much income a property could be expected to generate. We then analyze the relationships between incomes and sale prices to calculate the capitalization rate (cap rate) for the property by dividing the income by the sale price. The income approach is typically used for the following types of properties:
Cost approachWhen a property type is unique and rarely sold on the market, we can’t rely on either the comparison or income approaches to determine its current value. In these cases, we estimate your property’s current value with a three-step process:
The cost approach is typically used for the following types of properties:
Related LinksWhat does the income approach to value rely on?The income approach is a real estate valuation method that uses the income the property generates to estimate fair value. It's calculated by dividing the net operating income by the capitalization rate.
What does the income approach to value rely on when valuing properties?The income approach to value is based on the assumption that market value is related to the market rent or income that a property can be expected to earn.
What approach to value is typically used for investment property of two to four family units?Two-, three-, or four-unit buildings are sometimes subject to confusion when it comes to arranging a loan for purchase or refinancing. Generally, appraisers use the market approach when appraising multiple-unit properties.
What types of properties are usually valued using the income approach?Barron's Dictionary of Real Estate Terms defines the Income Approach as: “One of three approaches to appraising real estate. (The others are the Cost Approach and Sales Comparison Approach.) Typically considered the most important for Apartments, Office Buildings, Hotels, and Shopping Centers.
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