Commercial Real Estate Valuation 2
Income Approach – establishes the value of real estate as a derivative of its net operating income in relationship to the prevailing capitalization rate associated with the asset class in its submarket. The Net Operating Income (NOI) representing the amount after gross income drilled down through effective income added miscellaneous income, etc minus expenses associated with operating the property. The value calculated from this approach is deemed more indicative of the true worth of the property by some practitioners in comparison to the other two approaches below from an investment perspective.
Cost Approach – establishes the value of real estate calculating the current worth to recreate improvements at cost minus depreciation for functional and economical obsolescence; the underlying land is not depreciable. Technological advancements, procedural changes, more adaptable efficient materials, user friendly space layout plus industry changes and the desires of the end user, etc can diminish the appeal of once highly sought buildings or leasable space in relation to newer inventory. This results in a lesser market value being assigned to the property factoring its reduced appeal to a broad base market.
Comparable Sales Approach – establishes the value of real estate from the historic sales of similar properties in the submarket with adjustments for dissimilar characteristics with these properties; assigning values for these features or lack thereof and adding or subtracting dollar amounts reflective of the increase or decrease in value attributed. This process draws its data from the sales activity in the market place and the historical purchases/sales of properties of the same CRE type, e.g. multifamily, retail, industrial, etc that have sold under arms’ length transactions including financing structure which does not suppress the sale price.
The collective information obtained from each approach is analyzed with weight given to respective methods depending on the nature of the subject property, the quality of the data available for the approach and the purpose of assigning value. The nature of the subject property influences the method which is considered most applicable to determining value, e.g., is the property vacant land, stalled mixed use development, operational hotel, etc. However, from an investor’s perspective the income approach is usually given more consideration than the other two in relationship to commercial real estate income producing or potentially income producing properties. Even land’s value is tied to its use or potential use mobilized through zoning and entitlement and the income stream that can be attained from the improvements added. The final value given to the property factors all the variables applicable to the realty and the experience of the individual drawing the conclusion of property value.