Understanding Commercial Real Estate Market Values

One of the biggest differences between single-family and commercial real estate, aside from the obvious number of units, is the way properties are valued. Residential real estate, including most single-family homes, is almost always valued based on recent sales or “settlements.” Commercial real estate, by contrast, is valued based on income. The reasons for this are mainly three in number.

First of all, residential houses are usually in a lot of company. When there are many similar properties in a given area to compare, the ability to use comparable and recent sales is enhanced. It also makes residential real estate appraisal much easier because sales trends are fairly easy to track with modern technology. By contrast, commercial properties have fewer properties available to compare, making a comparable listing model much less effective.

Second, residential real estate is primarily owned by homeowners, making the income-producing property an irrelevant feature from a property value allocation standpoint. Sure, some neighborhoods have more rental homes, but there are still enough comparable sales to determine a value that way.

Less often, commercial properties are owned by someone who also lives on the property. This is most common among income properties that have 2-4 units, but they also tend to be around the same value as single-family homes. Larger commercial properties are purchased primarily as investments, so the revenue model works more effectively when evaluating them.

That brings us to the last reason for the different valuation, and that is the type of buyer that the properties most appeal to. Residential properties attract more owner occupants, who place the highest value on what other homes in their area have recently sold for. Commercial properties (especially larger ones) are almost always purchased by investors, who appreciate the importance of numbers (or at least should) and want values ​​to be based on the value of the property as an investment.

This last point is a great advantage for investors buying commercial real estate. We can often find bargains because properties that are very expensive, are rented below (value-wise), or both will be valued accordingly. Motivated homeowners who don’t manage their expenses well or make upgrades that generate higher rents are often left with undervalued properties.

A new owner who controls expenses and raises rents to market levels can often dramatically increase a property’s value in a short period of time. This ability is due to the income-based value model for commercial real estate and is something you simply need to keep in mind when looking for great deals.