WHEN PURCHASING A COMMERCIAL PROPERTY, the valuation is a key element in the financing process and in providing the buyer with comfort in their purchase price.
For the wise investor, it is important to have some understanding of how valuations are conducted.
Doing so will establish confidence that the valuation will not pose an issue with finance and also act as a basic tool, to verify a purchase price or estimate asset value for existing properties.
Valuing a Property
The following is a brief run down of the common approaches used by valuers when valuing commercial properties for mortgage purposes. Typically, valuers will use two methods in arriving at their valuation amount:
- Direct Sales comparison
- Net Income method
Direct sales comparisons relate to similar properties that have been sold in the area. This is the most common format for residential valuations.
Due to the differing nature of commercial properties and much smaller sales market, it is often difficult to value commercial properties using this method alone.
Where there are direct comparable sales though, these may be highly influential on the valuation that you receive on your property.
For most commercial properties, the net income approach is used.
This involves calculating the net rental amount on the property (usually as a per sqm figure), then comparing against net capitalised income for other sales in the area.
By way of example: With a commercial property with $50,000 in rental income, a valuer may determine an average return of around 8%.
For this scenario, the equation to work out the value would be: $50,000/0.08 = $625,000. Therefore, using the net income method you would get a value of $625,000.
The valuation will be calculated using net rental — so any outgoings paid by the owner will need to be deducted.
Higher rental amounts will usually reflect favourably on property valuations; although, as market comparisons on rentals will also be carried out, they can’t be too far above similar properties in the surrounding area.
Bottom Line: This is a very simple summary of how valuations are carried out. Yet, it should give you some idea of the methods used and this may provide a starting point for you doing your due diligence on any potential commercial property purchase.