One of the challenges you may face when purchasing commercial property is determining the actual market value of the property. Without this value, you will have no idea how much you should pay for the property, and your lender will probably hesitate in loaning money until after an appraisal is completed on the property. If you are purchasing an income-producing property, the appraiser might use the income approach when calculating value. Here are three things to know about this approach.
Why is this method used?
The income approach to valuing commercial properties is commonly used with income-producing properties because it is an accurate way to determine a property's value. This method bases the value of the property on the amount of income the property is capable of producing.
What documents are needed to calculate the value?
To calculate a property's value based on the income it produces, the appraiser will need financial information from the current owner of the building. This typically involves all the financial statements of the company for the previous year, but it may also include other types of financial documents, such as copies of receipts or bills.
How is the value calculated?
Calculating the value of a commercial building takes time, because it requires a lot of analysis and calculations. The two main elements used to calculate value with this method are:
- All the rental income collected during the previous year
- All the actual expenses the owner paid out for the property
The total income collected will help the appraiser know how much money the building is capable of collecting during a year. If there were a lot of vacant units in the building during that year, the appraiser might increase the amount of rental income to accommodate the vacancies.
The actual expenses are vital because they reflect how much money it costs to operate the building. Actual expenses include things like utilities, repair expenses, and lawn care bills. It does not include depreciation, because this is an expense that you do not actually have to pay for.
The difference between the income and expenses can help you determine the cash flow of the property and the net operating income (NOI). The appraiser will then look at other commercial properties that have recently sold and will determine a capitalization rate from those. Calculating the capitalization rate is a complicated process, but real estate appraisers fully understand how to do this.
With the building's NOI and capitalization rate, the appraiser will be able to determine the current market value of the building. Once this occurs, you will know how much to pay for the property, and this amount will help your lender determine how much money to lend for the building.
Buying commercial property can be slightly trickier than purchasing residential property, and this is often because it takes a lot of time to determine the value of a commercial building. If you are interested in purchasing commercial property, contact a real estate agent in your city.
To learn more, contact a company like Realty Executives.