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The commercial property appraisal process

There are three available means for appraising commercial real estate:

1. The cost approach
2. The sales comparison approach
3. The income capitalization approach

Each approach has distinct advantages, depending on each situation as well as property type.

Let’s take a look at each of the three different approaches:

The cost approach

The cost approach assumes that a property’s value is equal to the cost required to construct the property, or replacement cost. This appraisal method is not commonly used, and requires a comprehensive knowledge of construction and material costs.

The cost approach usually involves four steps:

1. Estimation of a land’s value
2. Estimation of replacement cost, entrepreneur’s profit, and other development costs
3. Estimation of contributory value of improvements excluding all forms of depreciation
4. The addition of land value to the value of improvements in order to estimate market value

The sales comparison/market approach

This method is comparable to the approach used to value residential real estate.

It involves taking a look at recently sold similar properties that belong to the same market area and have the same characteristics.

Once these are identified, they are then compared to the current property in question, and a professional appraiser will than deduct or increase value accordingly. This is usually required for investors looking for conventional financing.

The income capitalization approach

This approach takes into account a property’s current market value along with its potential cash flow.

Many investors seeking a streamlined valuation method use this in order to compare a property’s value and its expected income to other similar properties.

This approach involves analyzing a property’s ability to generate an adequate net annual return on invested capital in order to estimate its value as an asset. Another factor taken into account during this approach is whether there’s a negative relationship between the market value and potential risks with regards to reaching its expected cash flow.