Updated over 3 years ago on . Most recent reply
Methods to Determine Value of Commercial Property
I see a lot of great methods investors use to determine the value of commercial property. I wanted put them together in this post for reference and I will post this on my blog also in Bigger Pockets:
1. Gross Rent Multiplier Method (GRM)
- purchase price / gross annual rent (annual rent as if property is 100% occupied), this give you the GRM. Let's you find three sales of of properties and the GRM is between 8% - 9%. You calculate the property you are considering and the GRM comes in at 6.25%. Based on the GRM method this will confirm the property you are considering is priced on the low side.
2. Price Per Door Method
- Use three sales in the area. Sales price of property / how many units, this will give you the average price per door. Take the average price per door and multiply it by how many units the property you are considering buying. Ex. 30 units (#of units your property has) x $112,000 (average price per door)= $3,360,000. The property you are looking at is on the market at $3,129,000. Based on the price per door method the property you are considering is on the low side.
3. Cap Rate (Capitalization Rate) Valuation Method
- This is annual net operating income (NOI) / Purchase price. $150,000 NOI / $2,000,000 (purchase price of your property) = 7.5% cap rate
Now calculate the cap rate for three other properties and take the average of all four cap rates ex. 7.5% +7% + 7.3% + 7% = 28.8%, then divide the 28.8 / 4 = 7.2% (Average Cap Rate)
- Take your average cape rate of 7.2% and convert to a decimal, .072 and add a one to the front of it (1.072), then multiply that by the purchase price of your property, 1.072 x $2,000,000 = $2,144,000. In this example, based on the cap rate, your property is priced below market value.
Most Popular Reply
No Problem.
In addition to the flaw you pointed out, an even bigger flaw is the fact that the OP uses this formula to calculate market value, and I quote:
- Take your average cape rate of 7.2% and convert to a decimal, .072 and add a one to the front of it (1.072), then multiply that by the purchase price of your property, 1.072 x $2,000,000 = $2,144,000.
which is saying:
Estimated Market Value = (1 + Average Market Cap Rate) x Purchase/Asking Price of property
Given that market cap rate is always positive (I have yet to hear about a market with negative market cap rate... ), using this formula the OP will always calculate a market value that's HIGHER than purchase/asking price. In other words, the OP will always think asking price is a good deal because the market value is always higher. I don't get this all, when will the OP ever find a bad deal with this formula?
Do you read this the same way?
Cheers... Immanuel