Commercial real estate comps, also called comparables, are an essential part of any investment analysis. By comparing the characteristics of similar properties, you can get a better sense of what the market is willing to pay for a particular property type.
This blog post will explain how to find commercial real estate comparables and highlight some important things to consider when doing your analysis.
Who Uses Commercial Real Estate Comparables?
Property buyers, sellers, appraisers, and lenders are some examples of those who would use real estate comparables regularly.
Commercial property buyers look at comparables to ensure they get a fair price for the property.
Similar to property buyers, property sellers use comparables to get the best price for their property when selling.
Appraisers use comps to find out the value of a property, which may also include looking at the values of similar properties nearby.
Commercial real estate lenders use comparables to help determine underwriting metrics such as loan-to-value (LTV) and debt service coverage ratio (DSCR).
5 Ways To Value Commercial Real Estate
To make a profit in the real estate commercial industry, investors need to learn how to analyze real estate data, determine values, and forecast how much profit each property will produce. Accurate valuations help investors make better choices about buying or selling real estate. There are a few different ways to value commercial real estate, and you can choose as many methods as you want
1. The Capitalization Rate
One of the most important factors when doing real estate valuations is finding an appropriate capitalization (cap) rate. The cap rate is the estimated rate of return you expect to get back on a property investment. You can find the capitalization rate by dividing the yearly net operating income (NOI) by the property’s cost.
For example, if you buy property for $375,000 and expect it to generate $45,000 a year in revenue, your capitalization rate will be $45,000/$375,000, or 12%.
Now say that the property values in your market go up 5%, marking your property’s value at $393,750 the following year. Your new capitalization rate will be $45,000/$393,750, or 11.4%. This example illustrates how cap rate compression occurs when buyers are willing to pay more for the revenue stream from income-producing commercial real estate.
2. Gross Income Multiplier
The gross income multiplier (GIM), also known as the gross rent multiplier or GRM, is a rough estimate of an investment property’s value before deducting operating expenses. You can determine the GIM by dividing the property’s sale price by its gross annual rental income.
For instance, if an investor purchases a 150,000-square-foot building, they might use comparable property data to determine that the average income per square foot for similar properties in the same area is $20.
The simple calculation to determine the gross annual income is $20 x 150,000 square feet for a total gross income of $3 million per year. If the property is priced at $200 per square foot, the GIM would be $3,000,000 gross rental income divided by the $30,000,000 sale price, which equals 10.0.
By comparing the GIM to similar properties in the same market, an investor can better determine if the property is overvalued, undervalued, or reasonably priced. While this is helpful, it should not be the only valuation metric used as it does not factor in the property’s operating costs.
3. Cost Approach
The cost approach considers the price to completely rebuild the structure and the current value of the associated land, construction materials, and anything to do with replacing the structure.
The cost approach method is typically used when other comparables are hard to find. For example, when a property contains notable improvements or upgraded structures that add tangible value to the land.
4. Market Approach
Also known as the sales comparison approach, the market approach heavily depends on current sales data analysis for comparable properties. Utilizing the data from similar, recently sold properties will help investors see if they are getting a fair market value for their prospective property.
The market approach is usually used when there is a good volume of property changing hands in the marketplace. For example, if you plan to invest in a 115-unit apartment building, you would look for a similar building that recently sold in the same area. However, sometimes it can be hard to find recent comparables for like properties.
Income Capitalization Approach
The income capitalization approach is a variation of the cap rate approach and looks at the amount of income an investor expects to receive from their property. You can get this information by looking at similar properties nearby and seeing the predicted change in gross rental income and operating costs.
For example, if an office building is generating a net operating income (NOI) of $250,000 per year and the cap rates for similar properties in the same market are 6%, the property value based on the income capitalization approach would be:
- $250,000 NOI / .06 (6% cap rate) = $4,166,666 property value
What Should You Include in Commercial Real Estate Comparables?
Luckily there are several ways to find top-notch commercial real estate comps. The hard part is finding data that is current. You want to ensure that the data you receive is for active listings, as many databases have information based on expired listings.
A commercial lease comp should include:
- Tenant name
- Type of lease
- Lease term (months/years)
- Transaction Size (SQFT)
- Type of space (office, industrial, retail)
- Full address
- Lease term and expiration date
- Transaction type
- Any landlord concessions such as free rent
- Execution date or commencement date
- Starting and effective net rents
A commercial sales comp should include:
- The buyer and seller
- Complete address
- Date of transaction
- Property type
- Transaction price
- Sale price/sale price per square foot
- Gross rental income
- Operating expenses
- Net operating income (NOI)
- Cap rate
Where to Find Commercial Real Estate Comparables
You can find commercial real estate comps by searching public property records and comparing the data. In most cases, you will need to know at least the property address.
Here are other ways to find commercial real estate comparables:
- Run online searches on websites such as Crexi
- Order a formal appraisal
- Ask a commercial real estate broker for a BPO or broker opinion of value
The Bottom Line
Commercial real estate can be lucrative, but it’s essential to know how to value a property before buying. In this article, we’ve outlined five ways to value commercial real estate and where to find comparables. Use these tips to help ensure you are getting a good deal on your next investment property.