Valuation Analysis in Commercial Real Estate – What you need to know

Valuation Analysis in Commercial Real Estate:
What you need to know.

City Scape on rainy evening with arrows pointing in either direction and a money sign in the middle pointing in either direction to represent valuation analysis

Understanding how real estate valuation analysis works is essential in deciding whether to invest in a property. Is your investment in an identified piece of real estate of financial value to you? Will it generate a worthwhile Return on Investment? Good questions.

This is one of the biggest reasons working with a commercial real estate specialist is so important. Unlike residential real estate, commercial real estate often involves complex income and expense variables not encountered in the residential real estate space.

Why Do You Need a Commercial Real Estate Valuation?

Financial lenders will require a commercial real estate valuation report before they can decide to provide you with financial backing. To mortgage, lease, buy, sell, develop, sell, or insure the property, investors rely on property valuation reports.

Valuing Commercial Real Estate

Estimation of the value of real estate property is complex as each property has its unique characteristics. Understanding the basic concepts and valuation methods utilized by experienced real estate agents will give you more confidence and security in your investment decisions. Approach experienced professional commercial real estate surveyors and valuers to provide an accurate valuation based on unique market characteristics.

Real Estate Valuation Terms to Know

  • Income and Expenses
  • Net operating income (NOI)
  • Cash flow
  • Cash-on-cash return
  • Capitalization rate (Cap Rate)
  • Property value

Income and Expenses

Income obtained from rents, lease payments by tenants, and late fees, and other means.  Expenses are operational costs paid for property insurance, property management fees, tax fees, and others.

Net Operating Income

Net Operating Income (NOI) analyzes the profits of the total income less essential operating expenses from commercial real estate investment. A simple formula is:

Net operating income (NOI) = Total Income – Operating Expenses.

When a property's NOI rises, so does the value of the property, and vice versa.

Cash Flow

Cash flow is the property’s NOI, less debts such as mortgage payments. Calculated as:

Cash Flow = Net operating income (NOI) - Mortgage payments

Cash-on-cash Return

Cash on-cash return or equity dividend rate is the ratio (usually expressed as a percentage or yield) derived from annual cash flow (before tax) divided by the actual equity investment. It’s a simple formula:

Cash-on-cash return = Annual cash flow / Purchase Price (on actual cash invested)

Capitalization Rate (Cap Rate)

Capitalization rate or Cap Rate is an estimation of the potential return on a real estate investment. Its best understood as the measure of risk:

Cap Rate = Annual Net Operating Income (NOI) / Current Market Value (Sales Price)

The higher the Cap Rate, the higher the risk (low-demand areas), the higher potential return, and the lower the property price and vice versa. Investors are more likely to pay more for low-risk property (high-demand areas) with greater chances to continue appreciating and generating more income.

Property Value

Property value refers to the fair market valuation of a particular piece of real estate based on the price agreed upon by the buyer and seller. Calculated as:

Property value = Net operating income (NOI) /Cap Rate

The higher the property (market) value, the higher the purchase price.

How Can You Get Commercial Real Estate Valuation Reports?

Contact Pillar Real Estate Advisors to discuss the different valuation approaches. We will provide accurate real estate valuation reports that meet your needs. We are based in Chester County, PA. We are based in Chester County, PA.

We at Pillar Real Estate Advisors take the “advisors” part of our name seriously. W are happy to talk you through the valuation of your commercial real estate asset or the one you are considering purchasing.