In Real Estate we have 4 ways to “give value” to property:

1. Sales Comparison Market Analysis. Also known as the “market approach,” this method relies heavily upon recent sales data for comparable properties. By seeking recently sold buildings with similar properties from the same market area, a buyer hopes to ascertain fair market value for the property in question. For example, a 12-unit apartment building might be compared to another that sold in the same neighborhood just a few months earlier. While this valuation method is typically used to value residential real estate, it does have one significant drawback. Depending on general and localized market conditions, it can be difficult to find recent comps that have similar properties. This is the easiest and most common method Realtors(R) use to evaluate a property. More information about this method can be found in REAZ.app under Working with Sellers Training Module.

2. Income Capitalization Approach. This valuation method is based primarily on the amount of income an investor can expect to derive from a particular property. That projected income could be derived in part from a comparison of other similar local properties, as well as from an expected decrease in maintenance costs. Say a building is purchased for $1 million, and the expected yield is 5 percent, based on local market research. That $50,000 per year in expected income could be enhanced by tightening inefficiencies or bypassing along with other associated costs to the tenant, like electric or water usage. All expected future income is discounted to reflect the present value. This is the second method used by Realtors to Valuate Property. More information about this method can be found in REAZ.app under the Flips and Investments training module.

3. Cost Approach. This valuation method considers the cost to rebuild the structure from scratch, taking into account the current cost of associated land, construction materials, and other costs that would be associated with the replacement of the existing structure. The cost approach is generally applied when appropriate comparables are difficult to locate, such as when the property contains relatively unique or specialized improvements, or when upgraded structures have added substantial value to the underlying land. This is the method appraisers would use to appraise the property, this method is not used by Realtors.

4. Valuation Per Gross Rent Multiplier. The Gross Rent Multiplier (GRM) is a back-of-the-envelope calculation used to measure and compare a property’s potential valuation by taking the price of the property and dividing it by its gross income. This method is generally used to identify properties with a low price relative to their market-based potential income. In the end, every buyer values property differently. The valuation of commercial property does have a subjective and unscientific component. The best commercial real estate investors have honed their gut instincts around finding the most attractive deals, and the most effective valuation methods for each particular type of transaction. At the end of the day, no matter how much analysis has been conducted, the value of a commercial real estate is always in the eye of the beholder. This is the method used by most Commercial Realtors and Commercial Appraisers, not very much used by Residential Real Estate Agents.