How to value a commercial property
Before you offer on a British Columbia commercial property, work out the number the appraiser and the lender will reach. Here is how they get there.
The short answer
Income producing commercial property is valued mainly by capitalising its net operating income at a market cap rate, cross checked against comparable sales, with the cost approach used for special purpose or new buildings.
| Approach | How it works | Where it leads |
|---|---|---|
| Income approach | Net operating income divided by a market cap rate | Most income producing property |
| Comparable sales | Price per unit or per square foot from recent local sales | A cross check on every file |
| Cost approach | Land value plus depreciated replacement cost | New, special purpose or owner occupied buildings |
The income approach: NOI and cap rate
value = net operating income ÷ cap rate
Illustrative example. A building with $300,000 of net operating income, capitalised at 5.00 percent, is worth $6,000,000. The same income at 5.50 percent is worth $5,454,545. A half point on the cap rate moves the value by $545,455 without a single dollar of rent changing.
That sensitivity is why the cap rate is the most argued number in any valuation. Try your own figures in the cap rate calculator.
Build the NOI the way a lender will
The income in the formula is not the income on the listing. Lenders and appraisers use actual signed leases rather than pro forma or market rent, add a vacancy allowance and a management fee whether or not you pay one, and deduct a structural reserve for the roof, the parking and the mechanical.
A smaller income figure produces a smaller value and a smaller loan. The commercial mortgage calculator and the cap rate calculator both explain what goes in and what stays out.
Comparable sales
Comparable sales test the income approach against the market. Appraisers look at recent sales of similar buildings in the same submarket and compare them on price per unit for apartments and price per square foot for commercial space.
The same sales are where the cap rate comes from. British Columbia multifamily generally trades at tighter cap rates than most of the country, so compare against local sales, not against a benchmark you read somewhere else.
The cost approach
The cost approach adds the value of the land to the cost of replacing the building, less depreciation for its age and condition.
It carries the most weight where income or comparable sales say little: new buildings, special purpose property and owner occupied buildings that produce no third party rent.
How to evaluate a commercial property before you offer
- The rent roll and the signed leases behind it.
- Tenant quality and when each lease expires.
- Operating statements, so you can rebuild the NOI yourself.
- The physical condition, which the building condition assessment will test.
- Site history, which the Phase 1 environmental will test.
- Zoning and permitted use, set by the municipality.
- Financing: size the loan with the commercial mortgage calculator before you commit to a price.
Your value versus the appraiser's
Lenders size the loan on the lower of the price and the appraised value, and the appraisal comes from the lender's own panel. Your valuation does not replace it, but it tells you early whether the price is likely to be supported.
Read how a commercial appraisal works, and what to do if the appraisal comes in low.
Valuation questions.
Related reading
Let's fund your next deal
Send the rent roll and the price. A senior broker will tell you what lenders are likely to see, usually the same day.