It’s a common misconception that you only want to buy real estate in “good” market. The truth is, if you’re investing in the right property at the right price, you’ll be able to make a solid investment no matter what the economy looks like.

Even if you’re not ready to put an offer in tomorrow, these tips on how to value commercial real estate can help when you are ready to purchase.

Start with Research

Once you’ve identified your key criteria like size, location and price, you’ll want to begin with some initial research. If you’re working with a broker, this part is easy.

As brokers, we have access to databases and tools not available to the general public. We’re able to view on and off market properties around the world that meet your criteria. We’re then able to evaluate these options and present you with only the most profitable or best suggestions.

If you don’t have a broker, you can still do your own research, it’ll just take some more time and you won’t have access to all the tools. You can sift through public records or take a drive through your neighborhood to hunt for commercial sales. To peruse online on-market properties, you can start with a quick Google search. Many commercial real estate firms publish their own listings online, and there are a few free resources you can use to start your search, like LoopNet or Craigslist.

Cost Approach to Valuation

Once you’ve identified one or more properties that you’re interested in, you’ll want to start by digging into the details to assess the value. You can do this using the cost approach or the income approach to asset valuation.

The cost approach calculates the total cost to rebuild the property from the ground up. This method takes into account, the cost of the land, construction and any labor associated with rebuilding the current structure.

It is calculated using this formula: property value = land value + cost to build new + accumulated depreciated.

We talked about this method more in our How to Value Commercial Real Estate as a Seller blog, since this method is much easier for owners to use. Buyers are unlikely to know material, land and depreciation costs. While it’s much less popular than the income approach, it’s still worth mentioning.

Income Approach to Valuation

If the property you’re eyeing is represented by a broker, there’s a good chance they’re using the income approach. This approach looks at the property in relation to the income it is expected to generate.

To calculate the value of the property, start by looking at the net operating income (NOI) and capitalization rate (cap rate.) For context, NOI is calculated by taking the effective gross income less the operating expenses. It does not include tax or the mortgage payment. Cap rate is a ratio of NOI to the property’s price or value. It’s calculated by taking the NOI and dividing it by the asking price.

A brief note about cap rates: In short, a higher cap rate represents more risk and greater return while a lower cap rate represents less risk, and of course, less return. Now, what’s high for one market, may not be high for another. Cap rates vary greatly based on location. It’s more important to compare cap rates across the properties you’re looking at so that you can determine the amount of risk you’re willing to take, and reward you’re hoping to achieve.

Now that we’ve covered some of the nitty gritty, back to the income approach. Property financials can get a little tricky. Typically, sellers have a “sale package” or “offering memorandum” that breaks down the property’s financials. Commercial properties can either present actual or pro-forma financials in their sale packages. Both are beneficial to examine, but it’s important to know which one you’re looking at. A seasoned commercial real estate broker, can help you break down a property’s financials and help you understand the upside potential.

Other Questions to Consider

While the above methods will help you determine the property’s actual value, as an owner, you’ll want to consider other items outside of price. We like to keep these questions in mind when helping buyers:

  • Does the property need upgrades and when? If you’re looking to snag a shopping center for a deal, you may want to consider an older center. However, these centers typically will come with necessary upgrades such as resurfacing the parking lot.
  • Does the property have parking? If you’re looking to own a retail center or an industrial building, this can be especially important.
  • Are you looking to occupy the space or rent it out? Location always matters, but it may differ depending on whether you’re personally looking to be near your target market, or if you’re trying to attract tenants

A commercial real estate professional can ask these questions and more. They’re there to help with the heavy lifting so that you can easily find the perfect property for your investment. Plus, working with a broker for purchase is free to you; the seller pays commission which means there’s no reason not to hire one.

Start your search with a quick call, or by taking a look through our extensive property database.