If you want to start investing in commercial property, one of the most significant things to know is how to put a value on it. Make sure you get a fair deal on your investment by knowing what to look out for in determining its value.
Here are some terms that your valuer might throw at you, so make sure you know what they’re talking about.
- Net operating income (NOI). This is all the income from the property minus the expenses. However, this doesn’t include the payment of the mortgage or loans on the property and non-recurring Capital Expenses and Reserves.
- Capitalisation rate or ‘cap rates’. This is the estimation of the value of the business, or the profitability of a property. Cap rates are also used to compare properties that you may have recently sold.
A valuation of a commercial property is a process resulting in a formal document that can help you to obtain finance to buy the property.
Features of the valuation of a commercial property:
- A valuation is a formal process carried out by a qualified valuer. The valuer takes responsibility for the information in the valuation report. It is an independent, objective and professional assessment and is not the same as an opinion on the likely sale price of a property that might be put forward by an estate agent.
- The scope of a commercial property valuation is much greater than a valuation of a residential property. Commercial properties are generally larger and built on more expensive land than houses, the sums of money involved are much greater and the responsibilities of the valuer are therefore more onerous than for valuation of a residential property.
- A lender’s criteria for valuing a commercial property are different from those for a residential property. With a commercial property the lender wants to assess how viable the commercial investment is likely to be. Cash flow is an important criterion as the lender will look at the borrower’s projected cash flow to be sure that income from rent will cover the costs of repaying the loan and managing the property as well as returning some profit. One of the major costs for the borrower is loan interest and since interest rates on commercial property loans depend on the loan to value ratio (LVR) of the lending transaction,
there are a lot of interrelated factors to be considered by the lender’s valuer.
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When should valuations be done?
Valuations should be done on prospective commercial properties as part of the due diligence process. Use this as a tool to research whether a particular property is viable for your needs. A valuation of a commercial investment property for lending purposes is a comprehensive and expensive undertaking. Therefore make sure get the right valuation at the right time to spend your money wisely;
- A formal valuation is essential when you get to the stage of applying for a loan. For the reasons explained above the lender will not advance the funds unless satisfied that the investment project is viable.
- An alternative option is a pre-purchase valuation. This is not as comprehensive or expensive as a formal valuation but can be useful in highlighting at an early stage any issues, such as council development applications, that could impact on your investment plans or your ability to get funding for a property you’re interested in.
- Ongoing checks on the value of your commercial investment property be conducted regularly. The purpose of these valuation exercises is to ensure that your investment project is progressing as planned and draw your attention to any adjustments you should be making to your investment plans.
Who will determine the value of a commercial property?
There are many ways that you can determine the value of a commercial property.
One such way is to do the calculations yourself and use the resources around you, such as online calculators. While this way is acceptable, if you’re not a professional valuer, it is recommended that you get an expert to visit the property and inspect it to determine its value. Because a professional will be able to provide a more accurate valuation. In commercial property, the value and price both help determine what income you can expect from your tenant.
Things to ask your commercial property valuer
- What assumptions are you making about this property?
- What hypothetical conditions are built into your calculations?
- Are you using actual data from my seller/tenant?
- Are you making calculations based on a perfect world?
- Can I request the property’s profit and loss statements from last year?
How will they determine the value of a commercial property?
The value of the commercial property will be determined by a variety of factors. These may include the size of the property and some of the features of the building itself. The amount of people traffic shouldn’t be the main reason as to determining the value, consider the land value as well. For example, industrial zones generally have low land value, but may be suitable for particular types of businesses like a taxi depot because it may be close to public transport.
What is commercial property?
If you’re looking to tap into this market, one of the most important things to know is how to determine the value of a commercial property. It’s crucial that you value the commercial property, because like anything you buy, you don’t want to be ripped off. If you want to make an investment you need to get a fair deal on the property you’re prepared to place an offer on. Otherwise, what you pay for may not give you a decent return. It’s important to note that residential and commercial processes are very different. A commercial property is a property that generates profits whereas a residential property is a place of residence. Different types of properties have distinct valuation processes, which means that a residential property valuer will not be a suitable candidate to value your commercial property. Most commercial properties require a specialist to value the property.
Price is what you pay. Value is what you get - Warren Buffet
You might want to keep Warren Buffet’s advice in mind, because when you are buying a commercial property, you are buying the physical property and the income stream that comes with it. Capitalisation growth and income stream are both the main selling point of the property. Capital growth plays a beneficial role in commercial property and to make a profit, you need to purchase the actual property at a reasonable price and manage the income stream effectively.
Why will the commercial property value differ from residential property values?
- Consumer traffic. One of the main advantages of having a commercial property in a busy area is that you will get more people walking into the shop from the street. As a result of this, commercial properties that have high foot traffic will often attract a higher price.
- Business assets. Many commercial properties will come with a variety of assets that will stay with the property. If the property is a restaurant for example, the property may come with a state of the art kitchen. This may raise the price of the property.
- Emotions. Supply and demand play a huge role in determining the value of a residential property, as well as the desirability of the neighbourhood. This is why buying residential property is more subjective, because it requires personal decisions. Commercial property values are more objective and much more focused on the income of the property and the numbers.
- Zoning. Zones are areas allocated to a specific type of planning provision and infrastructure. This often restricts new developments or redevelopments and often responds to demographic changes. If you rent a residential property, odds are that you won’t be able to open a restaurant because the zoning is not commercial.
Different types of commercial property
- Apartments. First you need to consider the location of the building and then see if its affordable, clean, well-maintained and close to shops and other facilities. Then you need to consider whether if it will provide you with competitive rates - if it’s not competitive and the location is perfect, then you may want to consider another commercial property.
- Retail. Technically you are buying two business; the first is your business where you try and maintain the property so that it attracts consumers, the second is the profitability of your tenant’s business. Try to look for a property that has short term leases already in place, as it increases the value of the property.
- Offices. Ensure that the business is in a well located space with up to date amenities such as onsite generators, phone and computer cabling. The value of the property also depends on the business’s strength.
- Industrial. Make sure that you meet all of the industrial requirements of your tenant and again, the value depends on strength of your tenant’s business.