How To Value A Commercial Property
Posted on: February 7, 2020
Determining the value of your commercial property can be complicated. With a variety of property valuation methods, it can be difficult to know which to apply to your current assets. Luckily, whether you’re valuing business personal property, such as equipment, or real property, such as land and buildings, you can narrow the process down to two primary property valuation techniques that can guide you to your goal.
In this article, we explain how to value your commercial property, particularly your business personal property, with these two main valuation methods, the cost approach and the income approach, as well as how to know when it’s time to enlist the help of a valuation expert.
Choose The Right Approach
The first step in any valuation is to identify the purpose of the appraisal. Are you trying to capture what the business personal property would be worth new, or what it would be worth in the event of a sale? Your purpose will inform the best property valuation method to use.
Once your purpose is clear, choose the appropriate valuation approach: the cost approach or the income approach. For the majority of assets, the cost approach works well. However, when the asset in question is core to your business, the income approach may be more appropriate (see below for more information). Let’s take a look at how to use each commercial property valuation method.
How To Value Commercial Property: The Cost Approach
The cost approach is essentially a three-step process:
1. Find the replacement cost new (RCN).
First, look to the market for price data that indicates the value of your asset. Replacement cost new (RCN) is a form of valuation meant to determine what it would cost today to recreate an asset with the same functionality, but in a new form and less depreciation. For example, if you are assessing a piece of equipment, there may be a sales market where you can find the cost for the equipment from the manufacturer.
If current market data is not easily accessible, there may be expert-provided industry data available. A number of companies put out price indices and data for machinery and equipment, including price changes over time. You can either take historical costs and trend them, or use the expert data on replacement cost per square or per unit; then, apply that to your assets being valued.
2. Apply a depreciation schedule to arrive at fair market value.
Depreciation is the decline in the fair value of an asset over time due to physical deterioration. A depreciation schedule shows how a particular asset will be depreciated over the number of years of its useful life.
For most assets, the replacement cost is the price of the asset minus any depreciation. This shows the value of the asset given where it is in its usage life cycle. Depreciation is usually calculated by time in use, but for some machinery, it may be measured by a metric such as hours online or capacity remaining, or for a vehicle, miles driven. For a particularly large and valuable piece of equipment or a building, a physical inspection may be needed.
3. Calculate obsolescence if applicable.
When calculating the depreciation of an asset, it may be necessary to factor in obsolescence. Obsolescence occurs when an asset is still in good working order yet its value has declined due to technical advances or other market factors. For example, you may have an inventory of landline telephones that are in perfect condition. However, as landline phone technology has been superseded by mobile phones, its value has declined beyond that of normal depreciation, as demand for this technology is low. Because technology changes so rapidly, this concept can apply to many technological assets. Factoring obsolescence must be supported by appropriate data, which can be found in public and paid sources, or provided by an expert.
Tip: Remember to consider the asset’s location.
Depending on the asset, location has a big impact on value. This is most apparent in real property such as a building. Land value aside, a building in San Francisco will be more valuable than the same exact building located in Kansas City due to market demand. When valuing your property, consider the geography, availability, and overall market conditions, as well as the supply and demand of the asset type.
Using The Income Approach
For supporting assets, the cost approach is typically sufficient. However, if the business personal property being valued is core to the value of your business, then this indicates it is more valuable than what market cost would indicate. In a case like this, the income approach may be more appropriate. For example, rail yards have a lot of train equipment which is used to help companies connect shipments to larger railways. For the company that owns this rail yard, this equipment is a core business asset, and key to the way it generates profits. Therefore, the company should use an income approach to determine the train equipment’s value.
The income approach determines the value of an asset based on the income the asset generates. (Tweet this!) This is a more complicated approach that requires looking at cash flows and overall economics of the business, and how the property fits into that picture. It typically requires an expert to ensure you’re including the right things while excluding other assets that contribute to the income. If this is the case with your valuation, we recommend seeking expert guidance to navigate this approach.
Need expert help determining the value of your commercial property?
If you’re unsure about how to use these commercial property valuation techniques—or which one is right for your assets—let’s talk.
Valentiam’s world-class valuation experts work with companies in all industries to provide valuations for purposes of financial reporting, M&A, business planning, or tax appeals. For both tangible and intangible assets, we’ll provide accurate and defensible valuations as well as expert testimony if necessary. Reach out to us about your valuation needs and let us know how we can help.
Topics: Property valuation