Calculating the value of commercial property can often be a complicated and laborious process.
Unlike other financial assets, most commercial real estate does not trade in an exchange with openly quoted prices. Valuers are instead used to estimate the likely selling price of an asset.
But how does it work?
How is property valued?
Commercial property value is primarily based on the amount of net operating income (NOI) that the property generates each year.
This method has to be used, because unlike residential property where nearby home prices will be an indicator, it can be very difficult to find similar commercial property in the same location.
The NOI is calculated by taking the actual income of the property and subtracting any operating expenses, excluding mortgage payments.
These expenses will of course depend on the type and age of the property, so for example, an older site will need more money to repair and maintain, hence a lower NOI and a lower property value.
If it is a new-build property, the value will be based on the 'expected' annual income.
The final step is to then divide the NOI by the average yield rate, the amount investors can hope to get as a return at the end of the year.
For commercial property, this can range between six and 12 per cent, depending on the property type, age and location. Similar property yields in the area, and general market trends, should give you a vague idea, but it is wise to ask an expert who is not part of the selling process.
To conclude: NOI of property (£100,000) / Yield of eight per cent (0.08) = Property value (£1.25 million)
On a side note, it is important to look at other property values or rental rates in the area so you can spot ifthe original property owner is make exaggerated claims of the property NOI.
You can verify the figures by asking for the rent roll, which details how much the site rents out to tenants for.
How can you calculate rent for your tenants?
If you have bought the property and then want to lease it out, the general view is that the higher the property's value, the higher the rental value.
This is because, as shown above, the property value takes into consideration all expenses needed by the property owner, and the rent amount must be enough to cover this.
But this is just one factor. You need to also consider the square footage, location, the overall condition of the building, and the facilities/equipment that come with the lease.
Furthermore, various rental agreements may alter rates. For example, if it is the tenant's responsibility to pay maintenance fees, you have less expenses and so you will need to lower the rent.