Our guide to valuing a commercial property

If you are interested in buying a commercial property with a commercial mortgage, you will need an accurate commercial property valuation.

Knowing the property value is essential for a fair transaction and to secure favourable commercial mortgage rates. The property value will serve as the foundation of your investment, ensuring that you are not overpaying or making an unprofitable investment decision.

In this guide, we highlight how to calculate a commercial property value. We also outline the different factors that impact a commercial property’s value.

Please note that this guide is for information only. We do not value commercial properties, but we can help you get a commercial mortgage.

How the value of a commercial property is calculated

Determining a property's value is not a one-size-fits-all approach. Commercial properties differ in uses, characteristics, and market conditions, requiring a tailored valuation method.

We highlight the three main commercial property valuation methods:

Income approach

If you are planning on buying commercial property that you will then lease to a business to generate an income, you can use the income approach.

The income approach, also called the income capitalisation approach, calculates the value of the property based on the potential income it will produce.

We highlight how to calculate using the income approach:

• Step 1: Calculate the net operating income (NOI): The NOI is your gross potential income minus any operating expenses. Operating expenses include costs like maintenance, utilities, property management fees, and property taxes.
• Step 2: Calculate the capitalisation rate (cap rate): The cap rate is calculated by dividing the NOI by the purchase price of the commercial property. This is expressed as a percentage.
• Step 3: Calculate the property value: Divide the NOI by the cap rate to determine the estimated value of the commercial property.

Let’s put the income approach into practice. Say you are interested in buying an office building that will generate £500,000 in rental income per annum. The annual operating expenses are £150,000. This means your NOI will be £350,000.

Based on similar properties in the area, you determine the cap rate will be 6%.

Property value = (NOI) / (cap rate)

Property value = (350000) / (0.06)

That means your estimated commercial property value will be £5,833,333.

Gross rent multiplier

The Gross Rent Multiplier (GRM) method is a useful calculation tool within the income approach method.

The GRM method allows you to calculate the profitability of a commercial property investment based on the gross annual rental income. By comparing the GRM of different commercial properties, you can make an informed purchasing decision.

Here is how to calculate the GRM:

Gross rent multiplier = (Property Selling Price) / (Annual Gross Rental Income)

For example, say a retail shop is for sale for £500,000 and the annual gross rental income is £30,000.

GRM = (500,000) / (30,000)

GRM = 16.6

The GRM tells you roughly how long it will take to pay off the property. The lower the GRM, the faster you start earning a profit from your commercial investment property. In the example above, it would take you approximately 16.6 years to pay off the £500,000 retail shop with an annual gross rental income of £30,000.

You can also use the GRM to determine the value of the property. In this instance, you would calculate the average property selling prices and annual gross rental incomes from similar properties in the area. This will allow you to calculate an average GRM.

To calculate the value of your property, use this formula:

Property value = Average GRM x Annual Gross Rental Income.

Property value = 16.6 x £30,000

The value of the property will be £500,000.

Cost approach

The cost approach method is another effective way of how to value a commercial property.

This method calculates the approximate cost of a commercial property based on what it would cost to build an equivalent building on the same land. This method is especially useful for new or unique commercial properties where there may not be comparable sales or rental data available.

Here is the cost approach formula:

Property value = Land value + (building costs – depreciation)

Imagine you are considering purchasing a warehouse on a plot of land and you want to determine the value. You evaluate the sales of similar vacant plots of land in the area and you determine the land value is £200,000. Based on current construction costs, it would cost £500,000 to build an identical warehouse. The depreciation value is £100,000.

Property value = £200,000 + (£500,000 - £100,000)

Property value = £600,000

The sales comparison approach

The sales comparison approach is a market-based valuation method. This method involves comparing the commercial property to similar properties in the area that have recently sold. By analysing recent sales prices and making necessary adjustments for any differences between the properties, you can calculate an approximate property value.

Here's how to calculate with the sales comparison approach:

• Step 1: Find comparable commercial property sales: Identify commercial properties that have recently sold that are similar in type, size, condition, location, and features.
• Step 2: Adjust for any differences: Note any differences between the sold properties and the property you are interested in buying. This can include age, amenities, or size. Attribute a cost to these differences based on research.
• Step 3: Determine the property value: Calculate the adjusted costs of the sold commercial properties. Add the adjusted costs together and divide by the number of properties to estimate the value of the property you want to buy.

Let’s say you are interested in buying an office building. Recently, three similar office buildings sold in the area for the following:

• Building A sold for £1,200,000.
• Building B sold for £1,400,000.
• Building C sold for £1,100,000.

Based on your research of the sold buildings, you determine the adjusted costs as:

• Building A: £1,200,000 - £50,000 = £1,150,000
• Building B: £1,400,000 + £100,000 = £1,500,000
• Building C: £1,100,000 + £70,000= £1,170,000

Sales comparison approach formula:

Property value = (Building A + Building B + Building C) / 3

Property value = (1,150,000 + 1,500,000 + 1,170,000) / 3

Property value = £1,273,333.

Based on the sales comparison approach, the value of the property you want to buy is £1,273,333.

Key factors affect the value of a commercial property

When discussing how to value a commercial property, it's essential to consider the different factors affecting the property value.

We highlight these key factors:

Location

Location is an essential factor that can impact the value of a commercial property.

Accessibility and visibility are two of the key elements when considering location. A location that is easily accessible and has high visibility attracts more customers or clients, making it desirable for a business. This can help boost the overall value of the property.

Other elements such as the demographics, safety, and future development plans of a location can also impact the value.

Rental income

As we have seen with the income approach method and the GRM method, the rental income potential of a property can impact its value. Commercial properties that offer a steady and high-income stream will be of more value to investors. If the commercial property is in an area with high demand, this can also increase the value as the rent will be higher based on market demand.

Property size and condition

The size of the property will play a role in its valuation. Generally, the bigger the property, the more the property will be worth.

An important consideration is the condition of a property. Commercial spaces that are in prime condition and feature contemporary amenities tend to attract more potential tenants or buyers that are willing to pay more. Properties that need significant repairs or appear dated might witness a dip in their market worth, even if they are large.

If you need help with a commercial mortgage, reach out to our team of specialist mortgage brokers today.

If you are looking to buy commercial property, Commercial Trust is ready to assist.

Commercial Trust is a specialist commercial mortgage broker in the UK. Our team of experienced mortgage brokers will find a commercial mortgage package that matches your business or investment needs. Whether you are a seasoned investor or a first-time buyer in the commercial space, our expertise can help you secure the best deal.

Chat with an expert mortgage advisor today to get started with your commercial mortgage.