When it comes to commercial real estate in Toronto, accurate valuation is paramount for investors, developers, and property owners. Determining the value of a commercial property involves a nuanced understanding of various valuation methods. In this article, we will delve into advanced commercial real estate valuation methods in Toronto, exploring the intricacies of some basic approaches and other sophisticated methods employed by appraisers.
Valuation Methods for Commercial Properties
There are 4 popular and commonly used commercial real estate valuation methods. Let’s help you choose the best one that fits your requirements.
1. Income Approach
As an investor, your primary objective is ensuring the project provides a profitable return on investment. When evaluating the income approach, it is important to have a clear understanding of the property’s present expenditures, rental income, and market capitalization rate.
To determine the property’s potential value through this method, you need to subtract the property expenses from the rental income and then divide the result by the market capitalization rate, also known as the ‘cap rate’ for comparable buildings in the same geographical area.
2. Sales Comparison
The sales comparison approach involves evaluating recent sales of comparable properties in the same market. Calculating it involves a comparison of the commercial property in question with recently sold buildings of a similar nature. Adjustments are then made by both adding and subtracting based on specific features present in the property.
In Toronto’s diverse commercial real estate landscape, this method provides valuable insights into market trends and comparable properties, helping stakeholders make informed decisions. It is also known as a market-based approach and depends mostly on sales figures.
3. Cost Approach
The cost approach determines a property’s value by estimating the cost of replacing or reproducing the structure, considering depreciation. This evaluation guides prospective developers regarding the upper limit they can consider paying for the property. It also helps stakeholders gauge the potential return on investment and assess the property’s value from a construction and development perspective.
To determine the property’s potential value using this approach, one needs to deduct the prospective revenue from the construction expenses and the potential profit. It is also known as the residual land value.
4. Cost per Square Foot
In a deviation from the conventional cost approach, the cost per square foot method revolves around determining a property’s value based on its square footage. This technique proves particularly valuable in Toronto’s dynamic real estate landscape, where properties vary significantly in size, serve diverse purposes, and are dispersed across various locales.
To calculate a property’s potential value through this approach, you should consider the recent sales data of comparable properties to extract the average price per square foot. Subsequently, this average price is multiplied by the building’s size, yielding an approximation of the property’s worth.
Approaches Used by Appraisers
Apart from the four common approaches discussed above, appraisers also use the following two commercial real estate valuation methods:
1. Value per Door
The value-per-door approach is employed for properties with multiple units, such as apartment buildings or hotels. Appraisers assign a value to each unit or “door,” considering factors like occupancy rates, amenities, and rental income.
This approach provides a granular perspective on the property’s overall value. For instance, suppose an apartment building is valued at $1 million, and it contains 20 units. In this scenario, the value assigned to each unit, often called the “value per door,” is calculated as $50,000.
2. Value per Gross Rent Multiplier
The Gross Rent Multiplier (GRM) method serves as a swift and efficient means of calculating a property’s value based on its gross rental income. This multiplier is derived from recent comparable sales in the area.
When employing the Gross Rent Multiplier approach, appraisers calculate the property’s price by dividing it by its gross rental income. This technique helps appraisers identify properties that present a favorable return on investment, as they are reasonably priced compared to their income potential for potential investors.
Factors Affecting Property Values
Some of the factors affecting your property’s values are:
1. Functionality and Utility
The value of a property is closely tied to its ability to fulfill its intended functions efficiently. Assessing the highest and best use of the property is crucial in understanding its current and potential value.
2. Cost to Maintain Current Functionality
The process involves a thorough analysis, combining existing records and on-site inspections. The Automated Cost System (ACS) is employed to determine replacement costs, considering labor, equipment, and materials. Depreciation is then calculated, accounting for physical deterioration and additional adjustments for functional and external obsolescence.
3. Current Market Value of the Land
Evaluating the land’s market value involves using market sales data to assess it as if it is vacant. This value is then added to the depreciated replacement cost of buildings or improvements to determine the property’s assessed value.
Depreciation, the difference between the cost of new improvements and what a buyer would pay for existing ones, is a complex factor influencing property value. The three types of depreciation—physical, functional, and external—are examined to identify curable and incurable aspects.
Navigating the commercial real estate landscape in Toronto requires a comprehensive understanding of advanced valuation methods. From the income approach to the cost per square foot, these techniques empower stakeholders. For strategic insights tailored to Toronto’s market intricacies, Allen Mayer is your trusted guide. Elevate your investment journey with precision and expertise.