Trying to figure out how much a commercial property is worth can be difficult. It’s difficult to determine which of the many property valuation methodologies to use on your assets. Fortunately, whether you’re evaluating business personal property like equipment or real property like land and buildings, you may simplify the process by focusing on one of two major property valuation methodologies. In this post, we’ll show you how to value your commercial property, especially your business personal property, using the cost approach and the income approach, as well as when it’s appropriate to hire a valuation specialist.
Choose The Right Approach
Identifying the purpose of the appraisal is the first stage in any valuation. Are you attempting to determine the fresh value of the business personal property or the value of the property in the case of a sale? The optimum property appraisal approach will be determined by your goals.
Choose the right valuation approach: the cost approach or the income approach, once your aim is clear. The cost approach works well for the vast majority of assets. When the item in question is critical to your organization, though, the income method may be preferable (see below for more information). Let’s look at how to apply each method of commercial property valuation.
How To Value Commercial Property: The Cost Approach
The cost-benefit analysis is a three-step procedure:
1. Determine the cost of a new replacement (RCN)
First, look for price data in the market to determine the value of your asset. RCN (replacement cost new) is a method of calculating how much it would cost to recreate an asset today with the same functionality but in a new form with less depreciation. If you’re evaluating a piece of equipment, for example, there may be a sales market where you may find the cost from the maker.
If current market data is not readily available, industry data offered by experts may be available. A number of companies publish machinery and equipment price indices and data, as well as price variations over time. You can either use expert data on replacement cost per square or per unit and apply it to your assets being assessed, or you can take historical costs and trend them.
2. Calculate fair market value using a depreciation plan.
The fall in the fair value of an item over time due to physical degradation is known as depreciation. A depreciation schedule illustrates how an asset will depreciate over the course of its useful life.
The replacement cost of most assets is the asset’s purchase price less any depreciation. This reflects the asset’s worth based on where it is in its life cycle. Depreciation is often estimated based on time in use, although for some machinery, a metric such as hours online or capacity remaining, or for a vehicle, kilometer driven, may be used. A physical inspection may be required for a very large and valuable piece of equipment or a building.
3. Determine if there is any obsolescence.
It may be important to account for obsolescence when calculating an asset’s depreciation. When an asset is still in good functioning order but its value has dropped owing to technological advancements or other market factors, it is referred to as obsolescence. You might, for example, have a stock of in excellent condition landline telephones. Landline phone technology, on the other hand, has been overtaken by mobile phones, and its value has decreased beyond that of typical depreciation due to low demand for this technology. Because technology evolves at such a quick pace, this principle can be applied to a wide range of technological assets. Data must be used to support the factoring of obsolescence, which can be obtained in both free and paid sources, or delivered by a professional.
Tip: Remember to think about where the asset is located.
The location of an asset has a significant impact on its value, depending on the asset. This is most noticeable in real estate, such as a building. A building in London will be more valuable than a building in Bradford owing to market demand, regardless of land value. Consider the location, availability, and overall market circumstances, as well as the asset type’s supply and demand, when determining the value of your property.
Using The Income Approach
For supporting assets, the cost approach is typically sufficient. However, if the business personal property being valued is core to the value of your business, then this indicates it is more valuable than what market cost would indicate. In such case, the income approach may be more appropriate. For example, rail yards have a lot of train equipment which is used to help companies connect shipments to larger railways. For the company that owns this rail yard, this equipment is a core business asset, and key to the way it generates profits. Therefore, the company should use an income approach to determine the train equipment’s value.
The income approach determines the value of an asset based on the income the asset generates. This is more complicated approach since it requires assessing cash flows and overall economics of the business, and how the property fits in. If this is the case with your valuation, we recommend seeking expert guidance to navigate this approach.
Need expert help determining the value of your commercial property?
If you’re unsure about how to use these commercial property valuation techniques—or which one is right for your assets—let’s talk.
Taqeem’s world-class valuation experts work with companies in all industries to provide valuations for purposes of financial reporting, M&A, business planning, etc. For both tangible and intangible assets, we’ll provide accurate and defensible valuations as well as expert testimony if necessary. Reach out to us about your valuation needs and let us know how we can help.