Calculating the value of commercial real estate (CRE) is a critical skill for investors, brokers, and property owners alike.  In this guide, we’ll walk you through the key steps and considerations for how to calculate commercial real estate value in 2024.

Avenue’s Guide: Calculate Commercial Real Estate Value

Understanding the Basics

 Before diving into the calculations, it’s essential to grasp the fundamental concepts that drive commercial real estate valuation:

• Location: Proximity to key infrastructure, amenities, and overall neighborhood quality significantly impact property value. Prime locations typically command higher values due to demand for accessibility and convenience.
• Property Type: Different types of commercial properties (office, retail, industrial, multifamily) have varying valuation methods and market demands. For example, industrial properties might focus more on logistics and proximity to transportation hubs, while office spaces may prioritize location within business districts.
• Market Trends: Current economic conditions, interest rates, and real estate trends play a crucial role in valuation. Staying updated with market reports and forecasts can provide insights into future property values.

Key Valuation Methods

There are several methodologies to determine the value of commercial real estate. The three primary approaches are:

Income Capitalization Approach

The income capitalization approach is widely used for properties that generate rental income. It involves estimating the property’s value based on its ability to produce income. Here’s how to calculate it:

Net Operating Income (NOI): Calculate the NOI by subtracting operating expenses (excluding mortgage payments) from the gross rental income.

NOI=Gross Rental Income−Operating Expenses

Capitalization Rate (Cap Rate): The cap rate reflects the return on investment expected by investors. It is a ratio of the NOI to the property’s value and is expressed as a percentage. The cap rate varies by location, property type, and market conditions. Here’s how to determine the cap rate:

• Market Data: Analyze recent sales of similar properties in the same market to determine the prevailing cap rates. This involves dividing the NOI of these comparable properties by their sales prices.
• Risk Factors: Consider specific risk factors associated with the property, such as location risks, tenant stability, and market volatility. Properties in high-risk areas or with unstable tenants typically have higher cap rates to compensate for the additional risk.
• Economic Conditions: Adjust the cap rate based on broader economic conditions. For example, in a high-interest-rate environment, cap rates may increase to provide adequate returns to investors compared to risk-free investments like government bonds.

Example: If similar properties in the area have sold with cap rates around 6%, and your property’s NOI is $100,000, the value would be calculated as follows:

Property Value = NOI / Cap Rate 

Property Value = 100, 000 / 0.06

Property Value = $1,666,667

Sales Comparison Approach

This approach involves comparing the subject property to similar properties that have recently sold in the same market. Key steps include:

• Identify Comparables: Select recently sold properties that are similar in location, size, and type. It’s important to use sales data from the past 6-12 months to ensure relevance.
• Adjust for Differences: Make adjustments for any differences between the subject property and comparables (e.g., age, condition, amenities). Adjustments can be based on a per-square-foot basis or specific feature differences.
• Calculate the Value: Use the adjusted sales prices of comparables to estimate the value of the subject property.

Cost Approach

The cost approach is most applicable for new or unique properties where the cost to build is a significant consideration. It involves:

1. Estimating Land Value: Determine the value of the land on which the property is built. Land value can be assessed using recent land sales or land value per square foot.
2. Estimating Replacement Cost: Calculate the cost to replace or reproduce the existing structure, considering current construction costs. This can include materials, labor, and indirect costs like permits.
3. Depreciation: Subtract depreciation (physical, functional, and external) from the replacement cost. Physical depreciation accounts for wear and tear, functional depreciation for design inefficiencies, and external depreciation for economic factors.
4. Total Value: Add the depreciated value of the structure to the land value to get the total property value.

This guide from Wall Street Prep goes into more detail on calculating cost approach.

Incorporating Market Dynamics

When thinking about how to calculate real estate value in 2024, it’s important to consider real world market dynamics. Here are several tha could impact CRE valuation:

• Economic Conditions: Inflation rates, employment levels, and GDP growth can influence property values. For instance, higher inflation can increase property values due to rising replacement costs.
• Interest Rates: Higher interest rates can decrease property values as borrowing costs rise. Investors might demand higher returns to offset increased financing costs, thus lowering property values.
• Technological Advancements: Proptech innovations can affect property management efficiency and tenant experience. Properties equipped with smart technologies may have higher valuations due to their appeal and operational savings.
• Sustainability Trends: Properties with green certifications or energy-efficient features may command higher values as tenants and investors prioritize sustainability.

Calculating commercial real estate value in 2024 involves a blend of traditional methodologies and modern analytical tools. By understanding the key valuation approaches and incorporating current market dynamics, you can make more informed investment decisions. Whether you’re an investor, broker, or property owner, staying updated on valuation techniques will help you navigate the complexities of the commercial real estate market.

If you are interested in a free broker opinion of value or just learning more about investing in commercial real estate in Maryland, Virginia, or Washington DC, please contact us. Avenue Real Estate is a leading full service commercial brokerage in the Baltimore and Washington DC areas and we would love to help you explore your options and make informed decisions about commercial real estate investments.