Comparable Sales

With all types of real estate, as with most other asset classes, the first step to valuing a property is to look at the most recent comparable sales (“comps”). However, this is more difficult in commercial real estate than in residential real estate because each property tends to be unique and there are so many factors to consider. Again, price per square foot is the common metric and is used more than overall purchase price because most commercial buildings have very different square footage. When looking at comps, the most accurate ones will be the ones that are most similar in location, age, size and building class. Look at as many recent sales and try to understand the differences between the properties and between the locations that account for the difference in value.

Potential Cash Flow

In evaluating commercial properties, figuring out potential cash flow is the key to valuation. It is imperative to get the current rents and leases and when possible, verified copies of current expenses. Most people evaluate properties using the capitalization rate (“cap rate”), which is calculated by taking the net operating income (“NOI”), which is the rental income minus all expenses (taxes, utilities, maintenance, etc.), divided by the purchase price. If the NOI for a property is $100,000 and the price is $2,000,000, the cap rate would be 5%. The higher the cap rate, the better for investors. Cap rate is a useful tool to compare properties but is not a be-all end-all. It is important to know that cap rates will differ between cities and between neighborhoods, with more stable areas tending to have lower cap rates as investors are willing to take a lower return in exchange for lower risk. Properties that advertise higher cap rates are more likely to come with more risk, whether that is because of the tenants or the neighborhood.

Cash-on-cash, which measures the cash return versus the amount invested, is also a useful metric, as it represents the rate of potential distributions for investors in crowdfunded projects. In projects with no financing, the cap rate and cash-on-cash are identical, but they can differ considerably in projects with financing.

Conclusion

Always do your own research into the property to see how accurate the seller's projections are and whether they have included accurate comps. The biggest factor for whether you will make money on a real estate investment is the acquisition price - make sure to consider worst case scenarios for both cash flow and appreciation to see if a property is still worth it. There are no shortcuts here and no real way to try and evaluate properties on a larger scale - you have to be willing to do the work on each individual property.

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