The value of a commercial or retail property heavily influences its operational performance, the tenants’ leasing options and the investment yield. Investors and appraisers utilize several different methods to determine the value of a property, often depending on the type of real estate, the availability of information or the goal of the investment. Gain insight into four of the most common methods below to accurately assess the value of single and multi-tenant commercial properties and maximize your profits from retail real estate leasing.
The Income Approach
The income approach is a frequently used method for evaluating a commercial property. In this situation, the value of a retail investment property relies on the interpretation of the net operating income (NOI) and the capitalization rate (cap rate). The NOI of a retail property is determined by subtracting operating expenses and vacancies from the overall potential rental income. The cap rate predicts the annual rate of return by dividing the NOI by the most recent value of the property.
By evaluating these factors, the investor focuses on recent sales and operational figures. The income approach also allows for simple adjustments to account for unique scenarios, such as likely tenant additions or scheduled maintenance.
The Cost Approach
The cost approach method considers the cost of the land plus the cost of constructing the “highest and best use” building from scratch. For example, if the piece of land is worth $100,000, and constructing a multi-tenant retail property would cost $1.2 million, the cost approach would value this commercial real estate at $1.3 million.
This approach is commonly used for new construction and vacant lots. The simplicity of the cost approach is appealing to investors and appraisers. Additionally, the cost approach accommodates for unique factors such as zoning laws to yield an accurate and current valuation.
The Capital Asset Pricing Model
The capital asset pricing model (CAPM) is a comprehensive approach to assess a commercial or retail investment property that includes risk and opportunity cost. The CAPM considers the return on investment (ROI) on a risk-free investment, and labels it as a control, which is referred to as “beta.” Frequently-used betas include US Treasury bonds or real estate investment trusts (REITs). This valuation method is based on the comparison of expected returns between a guaranteed investment and the property in question. If the potential returns on a bond exceed those of a retail investment property, the investment isn’t financially advisable.
The CAPM assumes inherent risk and natural economic behavior that doesn’t always meet expectations. Accordingly, net lease investors find the CAPM useful for estimating the value of a property investment, understanding the approximate risks and establishing optimal tenant leasing structures.
The Sales Comparison Approach
The sales comparison approach (SCA), sometimes referred to as the market approach, utilizes prices from similar and nearby commercial or retail investment properties. This method takes the property’s general attributes into consideration and is best applied over a significant period of time. Investors and appraisers rely on the uniform metrics in this approach, such as price per square foot and recent sale price, to determine the value of the commercial real estate in question.
The SCA has the advantage of simplicity and accessibility, but often neglects the uniqueness and distinctive characteristics of a commercial property. Investors and appraisers find the SCA useful to gain insight on neighborhood pricing trends or for quick property valuations.
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