I am often asked how commercial brokers determine the market value of a property. In order to perform that task, a detailed analysis and report should be prepared. Here is how you do it.
Property Inspection: If you’re performing an exterior inspection and the property is open to the public (retail store, office building, etc.), then you should enter the building to gauge the condition and occupancy but please do not make contact with the property owner or tenant. In an interior inspection of a multi-tenant property, please assert your right to view individual units. Note the condition of all units, with special attention paid to items of deferred maintenance.
Photographs: Take a sufficient number of photographs to properly capture the entire subject property and important neighboring aspects. This includes, but is not limited to, front, rear, each side, parking lot, street scenes (all directions), areas of deferred maintenance and any other nearby conditions that influence the subject. Photographs may also be used to document the occupancy of the building by taking pictures of tenant’s signs or any tenant directory.
Property Identification: Research the borrower names, property address and Assessor Parcel Number (APN). Note the previous market sale and current tax values and tax assessments.
Local Market and Value Trends: Research current trends in the market and explain market conditions, direction of market values, development stage of the submarket, market activity (buyer or seller’s market), average time on market for like-kind properties, population and employment trends, and overall level of demand. Discuss area foreclosures, boarded-up properties, crime, or anything that would have effect on values in this area.
Real Estate Taxes: This should be based on the current assessment per taxing authority.
Condition / Location Ratings: Determine the appropriate rating for the property keeping in mind that these ratings are relative to how the subject property compares to the balance of the submarket. Typically the range of quality includes a simple four category scale of poor, fair, average good. When making these ratings, be sure to remember that adjustments will be needed to equalize the researched properties to the subject property.
Listed for Sale or Lease: Determine if the subject property is listed for sale or lease and obtain any MLS, Loopnet, or other listing data flyers to your CMA. Listing data of the subject should normally set the upper limit to market rent and value.
Property Comments / Description: Note the entire property characteristics including all buildings, the parking lot, ingress and egress. Also discuss external factors (positive or negative) such as vehicular or pedestrian access, visibility, zoning, neighboring property types, crime, vandalism, and stage of the market (growth, stability, decline, revitalization).
Deferred Maintenance / Vacancy Issues: Determine the specific deferred maintenance issues and the overall maintenance level of the building(s). Note all observable problems such as broken windows, roof issues, potholes in parking lot, etc. To the extent possible, determine the potential or known vacancies in the building(s). Note obvious signs of vacancies which include stark, curtain-less apartment windows, missing electric meters, broken windows, for rent signs, etc.
Comparable Sales: Research the sales of similar property types within the same or similar submarket. Comparables should be selected based on the type of real estate rather than tenancy. Retail buildings should be compared to retail buildings, office to office, industrial to industrial, and so forth. If recent comparable sales do not exist in the same submarket, extend your search further back in time and then further away in other, similar markets. Next rate the comparability of the particular sale (for age, size, condition, location, etc.) by indicating whether it is superior, inferior or similar in the appropriate field. Be cautious not to use sales that have business value, FF&E or any leased-fee component included in the sale price. In the absence of comparable sales, include comparable listings. If using listings in your analysis, then base your value conclusions (for the subject) on what you think the listed properties will sell for, not their listing prices. Document your analysis with any supporting data sheets with your CMA, including copies of the MLS or other listing.
Comparable Rentals: Comparable rentals should show support for your estimates of market rent for the various units in the building. Note in your comparable rentals findings, which party is responsible for expenses – landlord or tenant. Listing data may be used as comparables if actual comparable leases are not available. Document your analysis with data sheets (MLS listings, Loopnet, other data sources) to your CMA.
Income Approach: This is a multi-step process to estimate the value of the property based on its ability to generate income. The income approach should be based on your Comparable Rentals and knowledge of the local market. First, using estimates of market rent calculate the Potential Gross Income (PGI). PGI is the total income of the building(s) at full occupancy. Then deduct a market based estimate of Vacancy and Collection Loss (V&C). Vacancy estimate should be based on the local market, not the subject property. Add an estimate of any Other Income that the property may generate (garage rentals, parking revenue, reimbursed operating expenses, etc. PGI less V&C will generate Effective Gross Income (EGI). From EGI deduct the sum of the real estate taxes and operating expenses to calculate Net Operating Income (NOI). Divide the NOI by an estimated capitalization rate to estimate the value via the Income Approach. Make sure the capitalization rate you choose is within a range of capitalization rates as extracted from comparable sales. Your result here will be a stabilized income approach value.
Rent Loss represents an estimate of the total amount of rent not collected for a vacant unit(s) while awaiting future occupancy. For example, if six of 12 apartment units are undergoing a six-month renovation/re-leasing program and typically rent for $500 then the rent loss for these vacant units would be estimated as 6 units x $500 x 6 months or $18,000 (assuming all get rented at the end of the program). This amount may be less if units are renovated and leased over the course of the renovation project. In the case of a multi-tenant building with an estimated one-year lease-up scenario, it is fair to assume that some units will get rented before others. In other words, units would get rented as they are absorbed by the market so rent loss may be less than a full year. Estimating rent loss requires you to estimate the number of months it will take for a unit to get rented and multiply that number by the estimated monthly rental rate.
Tenant Improvement deductions represent the costs associated with making a unit rent-ready and are commonly associated with, but not limited to, office and retail properties. Costs may include new carpet, interior paint, interior alterations, etc.
Leasing Commissions account for brokerage costs for leasing vacant space. Amounts should be estimated by whatever is typical for the local market.
Deferred Maintenance represents costs associated with bringing the building back to useable condition. These costs include items such as the roof, foundation, repair/replace HVAC, interior/exterior repair/renovation, parking lot and any other item necessary to make the building rentable. If these costs are substantial, then you must get a contractor’s estimate. If minor, estimate these costs as best you can.
Properties that require extensive, lease-up, renovation, or cost to complete should be accounted for by estimating these values and subtracting it from the above Income Approach figure to determine the as-is income approach value.
The income approach is not always relevant to the valuation of the subject.
Reconciliation: This is the phase where the two market value indications are resolved into a final value estimate. Do not average the two approaches. Rate the strengths and weaknesses of the Sales and Income Approaches to value and estimate a final value by giving weight to whichever approach was more reliable. Your final value estimate should fall between the two approaches to value. If you conclude the Income Approach does not provide a valid indication of value, then you should rely solely on the indication from your Sales Comparison Approach. If the subject property is listed for sale then the list price should normally set the upper limit to value. Your reconciled value estimate should assume a 12 month marketing period.
If you were able to determine the “As Is” and “As Stabilized” value estimates (unless the subject is REO and displays significant vacancy and/or deferred maintenance), you should estimate the “As Is” value only.
