Application of Appropriate Valuation Methodology for Commercial Real Estate

In this guide, we explore the key methods used for the valuation of commercial real estate, focusing specifically on retail and office properties. Understanding and applying the right valuation techniques is essential for producing accurate, professional, and market-reflective valuations.

Selecting Primary and Secondary Valuation Methods for Commercial Properties

When valuing commercial real estate, selecting the most appropriate valuation method is critical. These methods should be applied based on thorough market data analysis relevant to the specific industry sector.

You should also be familiar with making rental determinations in line with the Retail Leases Act — either as an expert or arbitrator — by adjusting face rental values to reflect incentives and premiums for a true rental valuation.

Overview of Commercial Property Valuation

For the purpose of this discussion, commercial property includes retail and office spaces, covering both freehold and leasehold interests.

Some types of commercial properties, such as high-rise office towers or large regional shopping centers, require specialist valuers due to their complexity. Here, we focus on simpler commercial properties to illustrate core valuation methods.

Primary Valuation Methods

1. Direct Comparison Method

This method involves comparing the subject property to recent sales of similar properties in the same or surrounding areas, usually on a price per square meter ($/m²) basis. Adjustments are made for factors like location, age, and quality of improvements.

• How it works:
  Analyze sales data of comparable properties
  Determine an appropriate rate per square meter
  Apply this rate to your property’s size to estimate market value

2. Income Capitalization Approach

This approach focuses on the property’s income-generating potential.

• How it works:
  Calculate the Net Market Rental income (after deducting outgoings)
  Capitalize this income using an appropriate Capitalization Rate (cap rate)
  The formula is:

  $$\text{Market Value} = \frac{\text{Net Income}}{\text{Capitalization Rate}}$$

Market Value=Capitalization RateNet Income

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3. Cost Approach to Valuation

This method estimates the cost to replace or reproduce the improvements on the property, adjusted for depreciation, plus the land value.

• When to use:
  Particularly useful for properties not frequently sold on the market, such as specialized commercial buildings
  Often used for insurance purposes or asset valuation

• Considerations:
  Replacement cost estimation can be complex and may require specialist expertise

Hypothetical Development Valuation Approach

This approach is applied when valuing properties planned for subdivision or redevelopment, such as commercial buildings being divided into smaller lots under strata title legislation.

Steps involved:

1. a) Calculate Gross Realization:

   • Determine the highest and best use of the site

   • Estimate total gross revenue from the development or sale

2. b) Calculate Net Realization:

   • Deduct selling and legal costs related to disposal

3. c) Allow for Profit and Risk:

   • Deduct an appropriate profit and risk margin

4. d) Deduct Development Costs:

   • Include approval and construction costs

5. e) Deduct Holding Charges and Interest:

   • Account for costs incurred while holding the property during development

6. f) Determine Land Value (Before Acquisition Costs):

   • Subtract interest on land acquisition

Key Takeaways

• The goal of valuation is a technically competent and professionally sound estimate based on sound market interpretation and professional judgment.

  
  

• Each method has its appropriate use depending on the property type, market conditions, and available data.

• Commercial property valuation requires a critical and well-informed approach to data analysis and methodology selection.

If you need expert assistance or a professional valuation of your commercial property, contact our team of certified property valuers today. We provide accurate, reliable valuations tailored to your specific industry needs.