Evaluating Commercial Real Estate Today

Evaluating Commercial Real Estate

So you are new to the world of Commercial Real Estate Investing? Not a problem! The first thing you will understand is the different methods used to evaluate a potential Commercial Real Estate acquisition. It doesn't matter if you are wholesaling or buying to hold, it all starts with the evaluation.

There are three different ways to evaluate Commercial Real Estate. Three Methods to Evaluate Commercial Real Estate

1. Sales Comparison method
Comparisons and adjustments are made for like and non like features and amenities.

2. Cost of Replacement Method
a. This method is used for non-income producing properties like churches where they value the property based on what it would cost to rebuild today.

3. Income Capitalization Method
a. This method is the standard for the industry. The future cash flows dictate what the present value should be and what an investor is willing to pay for the property.



Commercial Real Estate Income Capitalization Method

There are three variables that are needed to accurately evaluate a Commercial Property Acquisition using this approach.

1. CAP Rate: Measure of the income produced by a property divided by the cost of the property
3. Value of Property: NOI divided by the CAP Rate

With any two of these variables you can obtain the third with some simple multiplication or division.

Net Operating Income: $100,000.00
Purchase Price: $1,000,000.00
So in the scenario above, let's say that I am interested in facilities that need a little work (Class C) in the inner cities. The market CAP in those areas is 12% and that is what I want to buy at. I will take the NOI on the property and divide it by the CAP rate to determine my max buy price.


CAP Rate: 12%
Maximum purchase price: $833,333.00

That's it! My maximum purchase price would be $833,333.00.