Commercial Real Estate Valuation - Best Approach to Use? Part 1 of 3 - Direct Comparison Approach
Part one of a three-part series to help you understand which appraisal approach is best when valuing commercial property, there are three primary approaches typically used by appraisers:
Direct Comparison
Cost
Income
To develop a well-supported opinion of value, an appraiser may use one or more of these approaches; which approach is applied will depend on the type of property being valued, the intended use of the appraisal, and the quality of the data available. Each approach has its strengths and weaknesses, but one or more may have greater significance in a particular assignment.
The Direct Comparison Approach
Just as the name implies, the Direct Comparison Approach (DCA) compares the property being appraised, or the subject property, with other similar properties, or comparables, that have recently sold. The DCA can be used to value improved or vacant properties of all classes as long as sufficient market sales data is available. This approach is thought to best mimic the actions of buyers and sellers in the real marketplace.
The DCA focuses on the similarities and differences between the subject and the comparables. The elements of comparison typically include:
Real property rights conveyed
Financing terms (cash equivalency)
Conditions of sale (motivation)
Expenditures made immediately after purchase
Market conditions
Location
Physical characteristics (size, access, construction quality, condition, etc.)
Economic characteristics (expense ratios, tenant mix, lease provisions, etc.)
Use, zoning and land use controls
Appraisers apply dollar or percentage adjustments to the sale price of each comparable property as it relates to the subject property. Once the adjustment process is complete, the sales prices of the most equivalent sales comparables will indicate a value range for the subject property.
Advantages:
Suitable for most property classes
Easily understood and explainable
Mimics the actions of real buyers and sellers
Disadvantages:
Not suited to special use properties
Lack of comparable sales data
Difficulty in quantifying adjustments
Sales prices are historic
Which valuation approach is best for commercial real estate?
The type of commercial property being appraised will dictate the approaches utilized; in most cases, two, if not all three approaches are applied to corroborate the value estimate produced by any one approach. The final step in any appraisal is reconciling the values generated by the various approaches into a single and final value estimate based on appropriateness, accuracy and quality of data. Ultimately, for any commercial property that produces income, the Income Approach is generally given the greatest weight.
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Malahat Valuation Group specializes in business valuation and real estate appraisals to owners of privately owned companies and their professional advisors.
When owners need to leverage, sell or reorganize their assets, we answer the age-old question "What is it worth?".
We provide our clients and their advisors peace of mind by preparing professional valuations that stand up to scrutiny from lenders, the Courts, and the Canada Revenue Agency.
Malahat Valuation Group Inc.
(250) 929-2929
