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Commercial Real Estate Valuation Methods

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Application of appropriate valuation methodology to apply for preparing the valuation :

We will look at the methods of valuation of commercial real estate.


  • select the appropriate primary and secondary methods applicable to the valuation of retail/ commercial real estate.

    • apply appropriate methods of valuation to commercial property by analysis of market data applicable to appropriate industry sector.

    . make rental determinations in conformity with the Retail Leases Act.

    • Make rental determinations as an expert or as an arbitrator.
  • Determine true rental value by adjusting face rental for incentives and premiums.

    You are encouraged to take a critical approach to study of the various techniques of data manipulation and valuation in this topic. At the outset, we stress that the various techniques that are explained are a to an end. The goal of the valuation process is the production of a technically competent and professionally sound valuation. The final valuation figure is based on a sound interpretation of the property and its market and on the valuer’s professional skill and judgment.This topic is about the valuation of commercial property. For the purposes of this topic, the term valuation includes both freehold and leasehold interests. By commercial property we mean retail and office (commercial) property.The valuation of some types of commercial property is highly specialized and is usually dealt with by specialist valuers. Examples of highly specialized commercial property are high-rise office towers and large regional shopping centres. Although this topic looks at some of the features of specialized property, we confine our valuation examples to simpler forms of commercial property.


Selecting Primary &Secondary Valuation Methods –


We’ll begin this topic with the overview of the valuation methods that are applicable to commercial property. The main valuation methods are –

Direct Comparison Method –

For commercial property Direct Comparison Approach whereby we have compared the subject property to sales of other properties sold at this and surrounding area on a $/m2, with subjective adjustments made to the rate adopted after considering relevant factors such as location, age, and quality of improvements.
This involves the analysis of the sale of similar properties to determine an appropriate Rate per square metre which is applied to the building area to determine the market value.

Income Capitalization Approach –

Analysis by Capitalization Rate and this entails determining a Net Market Rental for the property and then capitalizing this potential income stream at an appropriate Capitalization Rate.
The net rent yield is divided by the applicable percentage of returns.
Valuer use net income (Rental Income) amount actually returned after deducting of outgoings.

Cost Approach to Valuation –

The problem with this approach is that there is already some first-hand evidence relating to the value added by improvements contained in the market data. We found above that we could deduct the assessed land value of the site from the value of land and improvements to find the value of the improvements. This would infer the value of the land.

Although we found some problems with the extraction of land values and added value of improvements from the sales evidence, the sales constitute the most direct evidence that is available. In most circumstances sales would be better evidence of the value added by improvements than estimates of replacement cost.

We would use building costs in calculating the replacement cost new of the structures on the site for the purposes of building insurance. In fact, ‘replacement new’ policies really require a cost approach to the calculation of the value the improvements. We should be careful to note that the assessment of the replacement cost of many very large commercial buildings (for instance office towers and large shopping centres) is a specialized undertaking and is best left to the appropriate industry specialists.

The cost approach (replacement cost depreciated) is also applied to some asset valuations of commercial property. This is especially the case of the valuation (for asset purposes) of specially built commercial buildings that are of a type not generally exchanged in the open market. In these cases, the valuer adds the replacement cost (depreciated) to the land value to produce a value for land and improvements. Where this is done it is advisable to spell out the fact that the property is of an unusual type that is not generally exchanged and that replacement cost depreciated methods have been used. The contemporary asset valuation and professional guidance notes provide direction to the valuer on this matter.

Additionally, building costs are frequently an integral part of the hypothetical development approach to valuation.


Hypothetical development valuation approach –

The hypothetical development method is used to derive the value of a property that is to be developed in some way and sold off in more than one line. Let’s cite some examples of this. You may need to use the hypothetical development method of valuation when valuing a single parcel of land for subdivision into two or more smaller lots. You would also probably need to use this method when valuing commercial buildings that are to be subdivided into individual allotments under strata title legislation. This could apply to a variety of commercial buildings (including office and retail).

Steps in the hypothetical development approach to valuation –

1. Calculate gross realization :
– Ascertain current highest and best use for a vacant site
– Calculate the gross realisation for the development

2. Calculate net realization :
– Deduct selling and legal costs on disposal

3. Allow for profit and risk factors :
– Deduct a profit & risk factor

4. Allow for cost of development :
– Ascertain and deduct the costs of approving the development
– Ascertain and deduct the costs of doing the development

5. Allow for holding charges and interest :
– Deduct the holding charges
– Deduct interest

6 Ascertain the value of land (before acquisition costs) :
– Deduct interest on the land

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