How to Determine the Asking Price for Your

Commercial Building
It is important to ask “What does it cost?” when buying commercial real
estate, but it is even more meaningful when trying to price your own
building and coming to a valuation that a buyer would want to pay. A
commercial real estate valuation involves a mixture of science and art, we
will focus on just a few valuation approaches you can use.

Source: Real Wealth Network

Knowing the right amount to pay can be the difference between a

successful transaction and a losing one, whether you want to run a
business out of the property, generate rental income from it, or fix it and flip
it.

To sell your commercial building, processes and details need to be settled

prior to stepping into escrow. For instance, you need to be fairly certain
about its value, otherwise your property could sell under market or sit on
the market for way too long. In an active, open, and competitive market,
value is measured by the price that can be reasonably earned when both
buyers and sellers approach the sale fairly and with knowledge.

How to Value a Commercial Building:

The process of valuing commercial buildings can be complicated. A few
approaches are available to try. Assessment of commercial building value
is important since its sale and purchase depends on it. Here are the

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different approaches and the terminology you will need to estimate and
complete your commercial property valuation.

How to Value Commercial Real Estate: 4 Methods

1. Property Value = Replacement Cost – Depreciation + Land Value.
2. Property Value = Net Operating Income / Capitalization Rate.
3. Gross Rent Multiplier = Sales Price / Annual Gross Rents.

Glossary of Valuation Terms for Commercial

Real Estate
In this glossary, we provide a list of terms commonly used as part of the
value-determination process.

Cap Rate
The capitalization rate is equal to the net annual rental income divided by
the current value of a property. The analysis ignores the potential upside
associated with below-market rents and financing. Whether a property
should be sold for a profit or not is dictated by its cap rate.

Cost Per Unit

An investment property’s cost per unit can be calculated by dividing its
purchase price by the number of rented units. Income, physical condition,
or type or size of the unit are not considered in the calculation.

Debt Service
Debt service is the monthly payment of interest and the repaid principal for
a commercial real estate loan or other debt.

Gross Potential Rent

Gross potential rent, also known as gross scheduled income, is the amount
a multi-tenant property can collect after all rents have been paid in full
and all units are rented out.

Gross Rent
Taking any incentives into account, this represents the actual rent the
lessee pays. It is calculated by taking the average of the rent payments
made over the months in which the lessee is required to pay rent.

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Gross Rent Multiplier (GRM)
An estimate of the gross rent multiplier is calculated by dividing the sales
price by the property’s annual gross potential rent. This rate does not take
into account expenses, unlike the cap rate. It does not include physical
defects or rents below market.

Net Operating Income (NOI)

A property’s net operating income equals the rental income less all the
expenses associated with owning it, other than taxes and financing costs.

Here, present value is the sum of future rent payments, with each payment
discounted according to time.

Price Per Square Foot

A property’s price is split by its square footage, without regard to whether it
has one or more units, income, or is in good physical shape.

Commercial Real Estate Agents

A real estate agent’s duty is to represent buyers and sellers, lessors and
lessees, as well as lessors and lessees in property transactions, and obtain
a license from the state where they intend to practice. If you want to sell a
residential or commercial building, you need the same license. If you have
been asking, “what license is required to sell a commercial building?” In
order to obtain the license, you must:

 Take pre licensure classes approved by the state

 Take the exam and pass it

There are different licensing requirements and regulatory offices in each

state. A high school diploma, a background check, and a minimum age
are common requirements. Obtaining a license in one state could give you
access to practices in another state, too, if it has a reciprocal licensing
agreement with other states.

Return on Investment (ROI)

ROI is calculated when cash flows after debt service are divided by
investment costs.

TUMMI

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The TUMMI acronym stands for tax, utility, management, maintenance, and
insurance expenses related to real estate.

Vacancy and Collection Loss

Vacancy and collection loss refers to the loss of rental income due to
unrented units and uncollected rent.

Commercial Property Valuation Approaches

Here are the methods used most frequently to determine a commercial
property’s fair market value.

Cost Approach
Cost approach to valuing commercial buildings is equal to the land price
plus the costs of constructing the building – or the costs of constructing a
building similar – from the land price. Using a cost-approach, the value of
a tract of land worth $40,000 is $640,000 if the cost of building a six-unit
apartment house costs $600,000.

Using a cost-based approach, it is assumed that a property’s cost is

determined by its highest and best use.

When you have land in oil country or in a rural area, you should assume a
value based on the property being used to generate oil income or some
other higher and better use than being built into rental units for housing,
which there may be no demand for. Zoning laws may also affect the use of
a property and its cost approach.

When a phase of a new construction is completed, commercial real estate

lenders release funds based on the cost approach. The main advantage of
this method is that it provides a current value based on unique criteria.
However, this approach fails to take into account either the future income
or the comparable property price.

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Source: The Balance Small Business

Income Approach
According to the income approach, value is linked to rental income via the
cap rate of the property. Value of a property can be expressed as follows:

Current Value = Net Operating Income (NOI) / Cap Rate

Source: EDUCBA

If a rental property has an annual NOI of $700,000 and a cap rate of 8%, its
current value would be $8.75 million ($700,000 / 8% = $8.75 million).

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In the same neighborhood, the cap rate is calculated by extrapolating
market sales figures. If the property has unique features, such as high-
quality tenants or an aesthetically unattractive façade, the cap rate can
be adjusted accordingly. Cap rates for comparable buildings should be
within half a percentage point of the local average.

Source: Property Metrics

Advantages:

 The analysis can be adjusted to account for unique factors and

recent closings of comparable buildings.
 Commercial real estate is typically valued through income analysis,
which applies to any property that generates a consistent,
predictable income stream.

Disadvantages:

 Does not take into account vacancy and collection loss, resulting in
an overstated NOI and value.
 Additionally, it doesn’t take into account the cost of future extensive
repairs.

Sales Comparison Approach

Based on recently sold comparable buildings and the asking prices of
currently listed buildings, the sales comparison method for estimating
commercial building market value, also known as the market
methodology, relies on the prices realized from recently sold comparable
buildings. Residential buildings, such as single-family homes and multi-

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unit buildings, are commonly appraised using the sales comparison
approach.

To find recent sales or current listings of similar buildings, we will categorize

the property’s features, such as the number of bathrooms and bedrooms,
the square footage, and the lot size, and then find recent local sales. In a
market filled with energy, particularly when sales have just taken place, it is
a good idea to present recent sales.

Advantage:

 Provides a good estimate of value based on recent, relevant data.

Disadvantages:

 The relevancy of comparable buildings is affected by the unique

features of many buildings.
 In some cases, it is not possible to determine the fair market value of
commercial property by comparing sales that are too old. In other
cases, current listing prices don’t reflect current values accurately.
 This calculation does not account for vacancy and collection loss, as
well as unusual repairs and other expenses.

Commercial real estate agents are trained to account for differences

between comparable buildings so the property can be valued accurately.

Advantage:

 Provides a good estimate of value based on recent, relevant data.

Disadvantages:

 The relevancy of comparable buildings is affected by the unique

features of many buildings.
 In some cases, it is not possible to determine the fair market value of
commercial property by comparing sales that are too old. In other
cases, current listing prices don’t reflect current values accurately.
 This calculation does not account for vacancy and collection loss, as
well as unusual repairs and other expenses.

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Commercial real estate agents are trained to account for differences
between comparable buildings so the property can be valued accurately.

Other Approaches
Capital Asset Pricing Models (CAPMs) have been proposed as a means of
valuing real estate. As part of its CAPM methodology, a variable called
“beta” is assigned that indicates how risk-adjusted returns from one asset
and those from another are related.

Real estate values can be estimated by using a beta that correlates the
return on income-producing rentals to, say, the return on publicly traded
REITs. In real estate investing, CAPM can be overly simplistic because it
does not account for all the risks involved, but it is simple for investors to
use and understand. Because of this, CAPM is deemed of secondary
importance until further research is completed.

An easy way to estimate the value of an apartment building is based on

the value per door. If a comparable building with 10 apartments costs $2
million, then each apartment door would be worth $200,000. An apartment
complex with 14 units with a value of $2.8 million could be valued by
multiplying 14 by $200,000. Ideally, the apartments would be approximately
equivalent in size. CAPM requires investors to adjust for a variety of factors,
such as vacancy and collection costs, or unusual maintenance/repair
costs. This can make it overly simplistic, but it is simple to use and
understand.

Using recent sales prices and comparable buildings in your area can guide
your decision on valuation. The process of selling a building can be
simplified if you work with a broker who has experience with the type of
building you’re selling and in your market. A broker who tells you that your
property is worth $5 million might suggest that it would be worth $5.1
million or $5.3 million, and that would be a good price to list it at. It is not a
good idea to make the property available for $5.5 million or more.

Putting a price too high could lead to brokers who are searching for homes
to sell ignoring the property thinking that the seller doesn’t mean
business. Those looking for buildings to buy will say, “That deal is absurd,
either the seller isn’t serious, or his broker has no clue what they’re doing.”

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While the property is on the market, you want the price to be competitive.
Be realistic and don’t be greedy when valuing a property. Research
comparable buildings next to yours to see what they are selling for. In
addition, you should include any major repairs or issues a buyer will
encounter after purchasing the property. This cost will be taken into
account, and you should as well.

Research the Market

Commercial real estate success relies heavily on doing your research and
knowing your market, and setting an asking price is no exception.

Identify what similar buildings are selling for in your market and find out
what their price is currently. Prices need to be set based on current market
data, so due diligence is essential to achieve the best results. It wouldn’t be
wise to wait forever to drop your price. Instead, aim to set a price that
makes sense from the beginning.

Choosing an appropriate price for a building can be difficult, but

remember, you don’t have to do it by yourself. It is important to work with
an experienced commercial real estate agent to manage your
expectations and make sure that you ask for the right price. That is, not too
high so that you maximize your profits, yet not too low that you don’t miss
your deadline.

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One Seed
Words and music by Rosemary Phillips
© Rosemary Phillips 2002 SOCAN
Guitar chords: C Am F G C Am F / F C F C F C G C

There once was a seed that decided to grow

While others laughed and teased,
But that seed just wouldn’t say “No”,
In itself it truly believed.

Chorus:
It took one seed to make a diff’rence.
It took one seed to grow up tall.
It took one seed to have the courage.
One seed that’s all.

The seed took root and grew real tall

While others laughed and teased,
“You won’t last long, you’ll only fall.”
Yet the seed became a tree.

Chorus:
It took one seed to make a diff’rence.
It took one seed to grow up tall.
It took one seed to have the courage.
One seed that’s all.

Now that tree is fully grown

Now it’s making seeds
Strong enough – it won’t be long
As they grow up into trees.

Chorus:
It took one seed to make a diff’rence.
It took one seed to grow up tall.
It took one seed to have the courage.
One seed that’s all.

Next time that you’re seeking shade

You’ll find it under a tree
Remember that seed and the risk it made
How it grew for you and me.

Chorus Twice:
It took one seed to make a diff’rence
It took one seed to grow up tall
It took one seed to have the courage
One seed that’s all.

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One Seed
Words and music by Rosemary Phillips
© Rosemary Phillips 2002 SOCAN
Guitar chords: C Am F G C Am F / F C F C F C G C

There once was a seed that decided to grow

While others laughed and teased,
But that seed just wouldn’t say “No”,
In itself it truly believed.

Chorus:
It took one seed to make a diff’rence.
It took one seed to grow up tall.
It took one seed to have the courage.
One seed that’s all.

The seed took root and grew real tall

While others laughed and teased,
“You won’t last long, you’ll only fall.”
Yet the seed became a tree.

Chorus:
It took one seed to make a diff’rence.
It took one seed to grow up tall.
It took one seed to have the courage.
One seed that’s all.

Now that tree is fully grown

Now it’s making seeds
Strong enough – it won’t be long
As they grow up into trees.

Chorus:
It took one seed to make a diff’rence.
It took one seed to grow up tall.
It took one seed to have the courage.
One seed that’s all.

Next time that you’re seeking shade

You’ll find it under a tree
Remember that seed and the risk it made
How it grew for you and me.

Chorus Twice:
It took one seed to make a diff’rence
It took one seed to grow up tall
It took one seed to have the courage
One seed that’s all.

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