In commercial real estate, during the appraisal process there are several methods used to evaluate a property’s value. The appraisal may include a cost approach to value, a sales comparison approach to value, an income approach to value, or all three.
The income approach is used for the widest range of commercial properties and looks at both the specifics of the property in question as well as the information gathered from comparable properties located within a specified area. There are several items which the income approach will factor into its overall value analysis including:
- Market occupancy and market trends.
- Industry expense information. Some industries generate more expenses than others, which may affect their profitability.
- Location, age of building, number of established or potential tenants and other factors are also included in this approach.
How Potential Income Is Estimated
The potential for income is always possible in real estate, but not always certain. There are some questions about whether or not the potential will be reached- for instance, a big retail building in the center of an economically distressed city may remain largely vacant for large periods of time. The longer a building remains empty the more likely damage or maintenance issues may occur, especially in an area with a lot of crime (vandalism, theft) or extreme climates (sun, wind, water damage). All of these factors may impact the expenses it would take to get the building ready for tenants again and will reduce the possible profit. An appraiser will determine or at least estimate the possible income by looking at all of these factors:
- Gross potential income vs. the operating expenses. If the property is already in play, that is tenants are already in the building, then established income numbers are available. If the building is new or it has been a long time since it has been utilized, the numbers will all be raw estimates based on the income figures of comparable properties in the area.
- The gross potential income minus the expenses (such as operating and upkeep) will equal the net potential income for the property. The net income is basically what will determine the property’s actual market value.
The appraiser may also use the discounted cash flow analysis during their assessment. In this method, the revenue and expenses are either retrieved from previous years or estimated for a set period and then used as an annual cash flow report. That figure is then discounted or adjusted to the current market values and the potential, current income plus value of the property is given.
The key for any commercial appraiser regardless of the methods used is having the most accurate data possible in order to complete the most accurate valuation possible.
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Integra Realty Resources specializes in both commercial and residential appraisals for divorce, bankruptcy, estate, date of death, tax appeals, pre-listings, and more throughout the greater San Diego area. For more info contact us at (858) 259-4900, visit our website at IRRSanDiego.com, or email us @ firstname.lastname@example.org.