Valuing Commercial Real Estate

valuing commercial real estate

This is “Rick’s Tips” with Rick Bean, Principle Broker at Rose City Commercial Real Estate, rosecitycre.com. This episode we’ll learn how different investors can put a value on commercial real estate when buying, selling, or leasing a property.

Why would an investor be thinking about valuing commercial real estate?

Investors will look at valuing properties primarily if they’re selling or buying properties, and the reason they want to look at the valuation is to see if they’re getting a good deal, a deal of a lifetime, or if the price is way too high. And one way to check that is to do a valuation method and check it with other valuations of similar properties in similar locations, similar qualities.

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Why would an investor be thinking about valuing commercial real estate?

Investors will look at valuing properties primarily if they’re selling or buying properties, and the reason they want to look at the valuation is to see if they’re getting a good deal, a deal of a lifetime, or if the price is way too high. And one way to check that is to do a valuation method and check it with other valuations of similar properties in similar locations, similar qualities.

What are the valuation methods that investors might use?

Well, there’s many, but the three that I see the most are the “gross rent multiplier” method, the “capilization of revenue into value” method, and then the “internal rate of return.”

What’s the “Gross Rent Multiplier” Method?

Say you have a house that’s giving you $1,500 a month of revenue, that’s $18,000 a year, and so you say “I want to get a twenty times multiplier” so you would multiply the annual $18,000 a year times twenty, the factor, and say this property is worth $360,000. That’s used for single family investors, small plex investors, and others that don’t need highly sophisticated return information.

What’s the “Capitalization Into Value” Method?

The capitalization model is a lot like putting a car motor on a dynamometer, you’re seeing what the horse power is. Now, you’re taking it away from the transmission because you just want to see what the raw output is. In the same way with a capitalization of revenue, we get rid of the debt piece. Debt is excluded from our calculation.

We want to see what kind of cash producing machine that is. So, we take the annualized revenues of operation, and subtract from that the annual expenses, and then we divide that by a capitalization rate. And that’s something a little more sophisticated investors work with. When someone sells an eight plex, often they will talk about gross rent multiplier. On an eighty-unit property, almost exclusively, they talk about the cap rate, which means capitalization of revenue into value.

What’s the “Internal Rate of Return” method?

Internal rate of return is one of the more sophisticated analysis tools and basically that says: “For however much money I invested on day one, and subsequently for additional capital calls or capital injections, what did I receive in terms of benefits?” So, some of the benefits I might get would be cash flow, some of the benefits I might get would be depreciation, which I can use to reduce taxes, and the of course there’s profit at time of sale.

When we combine all these things together that benefit an investor, and we compare that to the initial investment, that’s how we get the internal rate of return. It’s also based on the length of time it took us to do this. An investment that returns ten times the original amount in ten years, is not as good as something that returns ten times that amount in eight years. There’s not only a profitability component, there’s also a time component.

There you have it…in just about the time it takes to enjoy a cup of coffee you’ve expanded your knowledge of commercial real estate. To learn more about leasing, buying, selling or investing in commercial real estate, contact Rick Bean at 503.577.1034 or sales@rosecitycre.com.

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