Comparative Examination of Real Estate Valuation
Commercial Real Estate Investments
Comparative Examination of Real Estate Valuation
The purpose of this paper is to evaluate two ways in which Residential and Commercial real estate can be valued and finally analyze why valuation methods differ between residential and commercial real estate. Appraisals are needed for every real estate transaction to determine the estimated value of the property to be sold or purchased. “An estimate of a property’s value must take into consideration economic and social trends, as well as governmental controls or regulations and environmental conditions that may influence the four elements of value” (Folger, 2017). The appraisal is used to protect the interest of all parties apart of the transaction. Sellers use appraisals to correctly price properties they attend on selling. Lenders and Buyers use appraisals to assure they are paying a fair price for a property they are purchasing/lending on. The appraisals are also used to determine the property value to ensure you are paying the right amount of property tax. Appraisals can be both Drive By (meaning they do not go inside the property) or Standard appraisals.
Appraisal value can be determined in three ways, “cost approach,” the “sales comparison approach,” and the “income capitalization approach.” However, the cost approach and income approach is used to determine most commercial real estate properties. The sales comparison approach is the value obtained by comparing the subject property with recently sold properties that are similar and located near the subject property is the sales comparison approach. Appraisers use this type of comparison to assign a value for residential properties. The cost approach considers reproduction versus replacement and depreciation (always adjust the comparable and never the subject). The income approach is based on a value of the rights to future (rental/ lease) income properties (Eldred, 2012).
GIM (Gross income multipliers) and GRM (Gross rent multipliers) are informal substitutes for income capitalization. Near the bottom of page 3 on the appraisal form, notice a line labeled “Indicated Value by Income Approach (If Applicable).” This income approach refers to the gross rent multiplier (GRM). To calculate the market value using the GRM, find the monthly rents and sales prices of similar houses (or apartment buildings) (Eldred, 2012).
GIM is used for five or more unit properties and commercial properties. It is based on the gross annual income of recently sold comparable properties (the sales price divided by the gross annual income results in the gross income multiplier). These two approaches usually produce different values. Both should be used in estimating the final value. Reconciliation is obtaining the final value estimate by analyzing and weighing the findings from the two approaches. Depending on the type of property, one approach would be given more weight than others. In most cases, multipliers are limited to practical use (Eldred, 2012).
There are two ways to value commercial properties, the cost approach, and the income approach. Cost approached is used when appraising public buildings or properties that will not produce income like special use buildings such as schools and churches. Cost approach has several steps: estimate the value of the land as if it was vacant, find its highest and best use, estimate the current cost of constructing a building and add the estimated land value to the depreciated cost of site improvements to arrive at the total property value. (SCHUETTE, 2011)
You should also consider reproduction cost (Reproduction cost is the current cost of a duplicate of the subject property, including both the benefits and the negative features of the property) vs. replacement cost (Replacement cost is the current cost of improvements with utility or function similar to the subject property) (SCHUETTE, 2011)
Because each real estate property is different, ascertainments of value (outside of an actual sale) can be difficult. Appraisers generally estimate property values are appropriating three approaches: market data, cost, and income.
Property appraisal is an art, not a science; there are so many factors involved in estimating the value that appraisers always state that this is only their opinion of the property’s value. The bases of value include the cost that a replacement property can be obtained or rebuilt. How nearby changes affect value; how competition will affect profits; whether contemplated improvements make a net contribution to value; whether the property’s use conforms with the areas other activities; and what the highest and best use of the land might be, supply and demand.
Because of these complexities, an appraiser will normally follow not a single path toward a value conclusion but will use three approaches:
Market data/comparable sales are similar to the bargain shopping we do every day when looking for the best price for the item we are purchasing like a car or appliances. It works best when very similar properties are bought and sold on a relatively frequent basis. No property is exactly the same, of course, so differences must be identified and compensated for in adjustments made when making the comparisons.
- Market Data /comparable sales
- Cost – What it would cost to rebuild/replacement the property if destroyed
- Income – what future cash flows are the property expected to generate?
Eldred, G. W. (2012). Investing in real estate. [electronic resource]. Hoboken, N.J. : John Wiley
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Folger, J., (2017). Investopedia. . What You Should Know About Real Estate Valuation.
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Kobzeff, J., (2012). Proapod. Real Estate Valuation – How to Use the Income Approach to Value
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SCHUETTE, W. L. (2011). A Question of Values: Appraisers and the Appraisal Process.
American Journal Of Family Law, 25(1), 5-9. http://eds.a.ebscohost.com.proxy-library.ashford.edu/eds/pdfviewer/pdfviewer?vid=1&sid=9a465ca9-178f-4b44-95aa-3e9cc9f909a0%40sessionmgr4006