Property valuation can be defined as the art of estimating the value of a property for a particular purpose for a particular interest at a particular point of time after considering all the features of the property and taking into account all the economic factors of the market. Valuation of the property involves determining all types of value like investment value, assessed value, market value, insurable value and salvage value. However, this report shall highlight on the process and the problems involved on the determination of market value of a commercial property.
Market value can be said to be the price at which an asset will be traded in a competitive auction setting. Precisely, Market value of a property can be defined as the an amount that is estimated for which a property should be exchanged between a willing buyer and a willing seller in an arm’s length transaction on the date of valuation assuming that the parties to the transaction have acted in a knowledgeable and prudent manner and without any compulsion (Almy 2014).
Commercial Property is also known as commercial real estate. Commercial property includes those properties which generate income either in the form of rental income or capital gain or any other form. These properties are used to make money (Baum, Mackmin and Nunnington 2012). Commercial properties include industrial property, office building, malls, hotels or any other property that is capable of generating income.
There are mainly three methods of valuing a commercial real estate. These methods include sales comparison approach, cost approach and income capitalization approach. Each method has a separate value that depends on the type real estate that is involved and the situation of the real estate that is involved (Blackledge 2016.).
This method is a real estate valuation method. As per this method, a buyer is required to pay a price for the property that is equivalent to the cost that has being incurred to built the property (Bokhari and Geltner 2016). Under this method, the market price of the property is equivalent to the cost of the property as increased by cost of constructing the property less the depreciation of the property. This method is considered more applicable when the property is new property (Diewert and Shimizu 2013). This method is considered less reliable when in case of valuing older constructions. In case cost approach, an estimate is made regarding the value of vacant property, the current cost of adding the structures to the vacant land (Enever, Isaac, and Daley 2014). The value of the land the value of the structure is totaled and the depreciation is reduced from the sum of the two. The depreciation can be calculated by applying written down value method or straight-line method (Halbert, Henneberry and Mouzakis 2014). Therefore, the value of the commercial property can be determined by the formula given below:
Present day value of the property= Value of the land+ Value of the building+ Value of the amenities and services- Depreciation
Under this method, a comparison is made between the recently sold properties that are similar to the subject property and the price of the subject property fixed accordingly. Adjustments in price of the property are made for the differences that have been identified between the comparable property and the subject property (Havard 2013). There are two major types of adjustments. These adjustments are dollar adjustment and percentage adjustments. Percentage adjustment means the difference between the subject and comparable properties is expressed as a percentage of the sale price. This adjustment mainly captures major differences which cannot be denoted in numerical terms. On the other hand, Dollar adjustments refer to those adjustments which can be expressed in monetary terms. In other words, this method determines the market value of a property based on the recent sales of identical properties in the same area (Hayward 2014). The market value shall be the price at which similar properties have been sold at or about the same time in the same area.
Under this method, the value of the property is determined using the income generated by the property as a basis to determine the value of the property. This is done by taking into account the net operating income generated by the property and dividing the same by the capitalization rate (Isaac and O’Leary 2013). Rent capitalization method, Income capitalization method and discounted cash flow method are covered under this approach valuing commercial property. These methods have been discussed in detail as given below.
Under this method of valuation, the net annual rental income is capitalized at a rate of interest that is considered as most appropriate. Net annual rental income means Gross Annual Rental income as deducted by the amount of repairs, property tax, service charges, rent collection and management charges, maintenance charges and other similar charges associated with the commercial property (Ling and Archer 2012). The rent capitalization formula used to value the property is given below:
Value of the property=( Gross annual Rental Income- Charges associated with the property)/Capitalization rate
Under this method, the rental income that is received annually or that is expected to be received over a period of time if the property is leased is estimated. From this estimated amount, the expenses incidental to the ownership of the property is deducted to arrive at the net annual rental value (Millington 2013). This net annual rental is then capitalized at a capitalization rate that is considered most appropriate in order to arrive at present capital value of the property. The capitalization rate is selected based on the investment rate of return expected for the property. This rate is selected after taking into account factors such as capital appreciation, security of income, risk management of the property and other similar factors (Parkinson and Cooke 2012).
This method presents the net present value of the (NPV) of the projected cash flows that are available to all the providers of capital which is net of the cash needed to be invested in order to generate the projected growth (Wyatt 2013). This method of valuation is mainly based on the principle that the value of an asset depends on its capability to generate cash flows the providers of capital. A theoretical approach relies on a number of assumptions.
The valuation of a commercial property is done using any of the above mentioned methods depending upon the circumstances of each case. The method that is considered most suitable for valuation of the property is selected depending on the nature of the property.
Valuation of a commercial property is not an easy task. This is because the property might be a unique property with no similar sales. Many a times an income that is to be expected to be derived from a property has to be estimated to determine the value of the property. Many factors have to be considered while estimating the probable income. More this estimation also might not be accurate. Further commercial real estate is subjected to aggressive negotiations. Some of these problems are highlighted below:
No similar transaction
In sales comparison approach, many a times, the person doing the valuation of the property faces difficulty in valuation of the property as there is no sale of similar property at or about the same during which the property in question is being valued. The non availability of similar transaction causes a lot of difficulty in valuing the commercial property (Wirtz 2012).
Issues relating to adjustments
As already mentioned above, in order to make the comparable property at par with the subject property, certain adjustments are made. Sometimes it becomes quite difficult to estimate the degree of adjustments that is required to be made. The difficulty in making the adjustment increases even more when the adjustment to be cannot be quantified in numerical terms (Warren-Myers 2012).
Estimation of Income
In case of income capitalization approach, while valuing the property, an estimate has to be made regarding the income generating capacity of the property. The person valuing the property often faces challenges while estimating the income generating capacity of the property.
Estimation of expenses
As mentioned above, in case of income capitalization approach, the person valuing the property has to estimate the annual expenses relating to the property. After the estimation of these expenses it is deducted from the estimated income to arrive at the net income of the property. Then this net income is capitalized using an appropriate capitalization rate. The amount arrived at after capitalization is the value of the property. It is often seen that while valuating the property, valuing the expenses associated with the property becomes quite difficult. Further, it is has also been observed that despite considering the various factors while estimating the expenses, the estimated expenses are not accurate (Parkinson and Cooke 2012).
Capitalization rate
The net income of the property’s capitalized using an appropriate capitalization rate. The valuation officer face problems regarding the section of the most appropriate capitalization rate. Selection of the correct rate is very essential to correctly value the commercial property.
Before valuation of the property adequate data relating to the property needs to collected and arranged in a systematic manner in so that the valuation process is carried out properly. This data mainly includes data relating to the property like when the property was built what was the cost of the property when it was built what major repairs have been carried out on the property since the time it was built. This data influences the valuation process. Sometimes this data is not easily available. In such circumstances, the valuation officer has to put in extra efforts to obtain such data in order to value the commercial property (Ling and Archer 2012).
In case of cost approach, the value of the land is obtained. The value of structures constructed on this land is then added to the value of the land. From this amount, the depreciation is reduced in order to arrive at the value of the property. Under this method, the valuation officer often face with the problem of choosing the right rate of depreciation. Further the selection of right method of depreciation also needs to be considered. The valuation officer needs to decide whether, whether straight line method of depreciation should be used or written down value method. The decision regarding the choice of the method of depreciation is done on case to case basis depending on the facts and circumstances of the case.
Conclusion
Therefore it can be concluded from the above discussion that the commercial property can be valued using the methods mentioned above. However every method has its own advantages and disadvantages. In some cases the valuation officer face the problem of making the correct and the most appropriate estimations while in some other case the valuation officer might face the problem of non availability of relevant data that is required for valuation purposes relating to the property to be valued. The valuation officers need to analyze the circumstances prevailing each case and determine what information is available and make a choice of technique to be used for valuation of the property accordingly. Hence, the valuation officer needs to careful while making a choice of the method to be used in valuing a commercial property. The valuation officer also needs to exercise precaution and take into account all the relevant factors while making estimates for valuation purposes. The assumption made in valuing the commercial property also needs to be clearly disclosed.
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Blackledge, M., 2016. Introducing property valuation. Taylor & Francis.
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