Estimating a property’s value is critical to the purchase and sale process of commercial and residential properties. A property’s value is equally relevant to the financing terms agreed upon in a real estate development project. Real estate appraisals are used to determine the fair market value of a property and can be achieved through various techniques. Appraisals are heavily dependent on factors such as the property’s location, use, and condition. The appraisal process is typically used to determine just compensation during the Commonwealth’s taking of a property through eminent domain. Damages in the eminent domain process are based on the appraised value of the property. To obtain a higher award for damages, it is essential for a property owner to secure the highest possible appraisal for their property. The three most common valuation techniques in the appraisal process are explained in greater detail below.
(1) Sales Comparison Approach.
This approach generates fair market value of a property by comparing it to similar properties in the same area. By using recent property sale information, property owners can estimate the value of their unsold assets. For example, if a property owner owns a ten-unit property in downtown Boston, they can estimate its value by comparing it to the sale of a similar ten-unit property in the same area. The valuations of similar properties will fluctuate based on differences in quality, age, or location to transit. Overall, this approach provides property owners with a simple analysis of what their property will sell for based on similar sales.
(2) Income Approach.
The income approach generates the value of a property based on the income it derives. Property owners that actively lease properties often use this method to estimate property values. To calculate value, the property’s net operating income (“NOI”) is divided by the capitalization rate (“Cap Rate”). Calculating a property’s income can be challenging, as it requires accounting for factors such as vacancy rates, repair costs, and rental income from each unit. Still, as a commercial real estate investor, mastering the income approach is essential to future valuations.
(3) Cost Approach.
The Cost approach differs from the above approaches as it does not consider similar property values or income potential. Instead, this valuation method presumes that the price of an existing structure is equal to the cost of building the equivalent structure. This is achieved by estimating the current value of the land, calculating the current cost to construct a similar building, subtracting any depreciation from the construction costs, and then adding the land value back to arrive at the total. When comparable sales data or income metrics are not readily available, real estate investors will use this method.
Please contact D’Ambrosio LLP with any questions regarding valuation of real estate properties. Our full-service real estate team frequently guides clients through financing and development of large commercial real estate projects.
