Valuing an industrial property is not an easy feat. Industrial real estate and the different assets within this sector of commercial real estate require a deep understanding of the local market, the particular characteristics of the property / assets, and other important factors. This article will provide insight into what goes into the valuation process so that you can make informed decisions when it comes to investing in industrial properties.
1) What are the types of Valuations?
A commercial real estate appraisal, broker opinion of value, or valuation as some may refer to them as, is a third-party professional appraiser’s assessment of the value of a vacant or income generating properties. This is a property valuation on commercial real estate including industrial assets and land. A myriad of factors is put into consideration when appraising and determining its value.
The following is a list of six approaches that appraisers and brokers alike use to value commercial and industrial property:
This method assumes that an investor will only pay what comparable properties have sold for. Also known as the sales comparison, the market approach is based on how similar property features are and how much those features cost.
This method compares the value of a property to the cost of building a replica. The cost approach considers depreciation, assuming a fair market value for the commercial property.
Income capitalization approach
The income capitalization approach is also known as the income approach; it rationalizes the income that a property may generate over time. Commercial appraisers commonly use this method to appraise properties with high earning potential, such as industrial assets containing one or multiple tenants.
Value per door compares the number of “doors,” which is most effective in a multi-unit scenario, or in the case of industrial in cross-dock transportation facilities, for example. Because not every space, unit, or facility is created equal, this property valuation method may only provide you with an average.
Gross rent multiplier approach
This method compares the gross rents of similar properties in the area to determine the property’s appraised value.
Value-per-rentable square foot approach
This method assigns an estimated value per square foot that tenants and prospective tenants can use to value a rental property.
2) What are the methods of valuation?
The Cost Approach
The cost approach is one option. This method determines how much it would cost to reconstruct the property from the ground up. This includes the current land cost, construction materials, labor costs, and other expenses associated with replacing the existing structure on the commercial property. In a nutshell, this method assumes that the value of the commercial property is the same as the cost of re-constructing it.
Sales Comparison Approach
The sales comparison approach is one of the most widely utilized valuation approaches in commercial real estate valuations. This method uses comparable sales and recent sales data to help determine the value of the property in question.
Applying the sales comparison approach in commercial real estate can be challenging due to the difficulty in locating comparable properties especially if the property in question is highly specialized. In order to find a comparable, the appraiser or brokers may have to look well outside of the market area, which may in unreliable comparisons.
Demographics, leasing trends, access to infrastructure, and other factors can all have an impact on the market outside of the market area.
The Income Approach
When determining the value of a commercial real estate asset, the income approach is the most commonly used valuation technique. It is based on the amount of income a property is expected to garner.
To use the income approach, you need to understand two critical commercial real estate concepts, and these are capitalization rate (cap rate) and net operating income (NOI).
3) How do you calculate the value of a property?
There are several methods to calculate the value of a property, including:
- Comparable Sales Approach: This method involves a comparison of the property in question to similar properties that have recently sold in the same area. The value of the subject property is determined by analyzing the sale prices of comparable properties.
- Cost Approach: This method involves estimating the cost of constructing a similar property and subtracting the estimated depreciation.
- Income Capitalization Approach: This method is used for income-producing properties, such as rental properties. The property’s value is determined by analyzing the property’s potential income and capitalization rate.
Ultimately, the most accurate property value would be a combination of all three methods, and a professional appraiser who is certified, or a licensed broker, in the field would be the best person to assess the value of a property.
How do you work out the value of a commercial property?
The three methods below are the most used when calculating commercial property value:
The most common commercial property valuation method is to use recent comparable sales transactions as the premise for value. The standard value per square foot is calculated by analyzing recent similar property sales and then applied to the property’s value.
If the comparable valuation yields the most excellent price, the landlord should sell the property unoccupied to a company that will both own and occupy the property.
This valuation method can be summarized as follows:
Average price per square foot * Building size = Building value
In order to determine the investment value of a commercial property, a few variables must be known. These are some examples:
- The costs of the property
- The rental income from the property
- The market capitalization rate, or “cap rate,” for comparable buildings in the same geographic area.
Interested individuals should note that a professional can still perform an investment valuation even if the property is vacant. Based on comparable area lease rates, you can calculate potential rental income. Assume that the investment valuation produces the highest value. In that case, it is best to find a tenant before advertising the property to investors.
The simplified way of calculating the value of a property for an investor looks like this:
Rental income – Expenses = Net rental income/market cap rate = property value
This is also known as the “residual land value” valuation method. This method entails executing a development proforma. The proforma contains financial projections for a hypothetical development that can be constructed on the property.
This evaluation is performed to determine whether the project makes financial sense and provides the maximum amount that a developer can pay for the property. If the redevelopment valuation yields the highest value, it is recommended that the property’s redevelopment potential be advertised to builders and developers.
The development proforma is summarized as follows:
Revenue/sales – Construction costs – Development company’s profit = Residual land value
4) How is the valuation of an industrial property done?
The cost approach
The cost approach estimates how much it would cost to build the structure from the ground up (from an empty plot of land) and includes the land’s value. The logic behind the cost approach is to determine whether buying an existing property or building a new estate from the ground up is less expensive.
The cost approach has two major methods:
- Reproduction method – The cost of rebuilding an exact replica of the existing structure using the same materials, construction methods, and conditions.
- Replacement method – The cost of rebuilding the structure using new materials, construction methods, and design.
While the logic is sound, this method needs to account for the additional development and construction effort required to build a property from the ground up. It also does not take into account a property’s long-term cash flow potential.
Sales comparison approach
Comparisons to market factors are critical inputs to any valuation method. In fact, sales comparisons are frequently used to obtain information such as the cost of reproduction, current market capitalization rates, and loan-to-value ratios.
The sales comparison approach entails examining recently sold properties in the market. The following list is not exhaustive, but it does include some of the major components discovered during the comparison analysis:
- price per door
- physical state
- price per square foot
The more comparable the properties are in terms of type, location, use, and condition, the more confident an analyst can be in the statistics used to value the subject property. After comparing the subject property’s characteristics to those of comparable properties, adjustments are made to reflect any more or less favorable attributes for the subject property, and a final determination of value is made.
The sales comparison is an excellent method for determining how the market values properties similar to the subject property. Like the cost approach above, the sales comparison method does not capture the long-term cash flows that an investor can expect during the property’s hold period.
Capitalization Rate Approach
Real estate professionals frequently refer to what a property “traded at” by citing the cap rate or the price per square foot that it sold for. The cap rate is among the most widely used methods of valuing real estate in the lending industry and for preliminary analysis of an intended acquisition.
Divide the property’s net operating income (NOI) by the capitalization rate to calculate the cap rate (cap rate). The resulting figure is the approximate value of the property based on the expected cash flow during the first year of ownership, which is commonly referred to as the “1-year forward NOI.” The 1-year forward NOI is used instead of the trailing 1-year NOI because the return for the property’s buyer is based on future cashflows, not the past.
Discounted Cashflow approach
Each of the preceding valuation concepts has merit in different situations, but they all have the same disadvantage. Each approach estimates a property’s value at a specific time point.
To understand why valuations at a specific point in time are a disadvantage, we must first understand how real estate investors calculate the return they will achieve over the life of a property. If an investor holds property for ten years from purchase to sale, the total return will be a combination of the cash flow from each year of ownership plus any difference between the purchase price and the sale price at the time of sale.
5) How do I add value to an industrial real estate property?
It is common and at times considered simple for property owners to improve the value of a property by making physical and structural adjustments.
Return to the basics
Make sure you’ve completed some basic housekeeping before creating a listing for an industrial property. Maintaining an organized and well-functioning warehouse space is critical if you want to increase the value of the property. Although it may appear self-evident, an industrial space must be clean, organized, and efficient.
The first step in increasing the value of your assets is to get the warehouse in shape. If anything needs to be fixed, it is time to do it. Examine the property for obvious signs of wear and tear. Keep an eye out for chipped paint and broken elements both inside and outside the house.
Check that the basic systems, such as temperature control, air-conditioning, and water systems, are all operational. Once the housekeeping is finished, you’ll have laid a solid foundation for any future improvements.
Advanced Tech Capacity
The price of an industrial site is heavily influenced by technology. Modern buyers are looking for properties with a strong technological infrastructure and functionality. Proximity to datacenters, power, fiber,, wiring, and other Smart property technologies have the potential to transform old warehouse spaces into more functional and modern warehouses of today.
While technology can quickly become an expensive investment, it can pay dividends in the long run.
Parking is quickly becoming one of the most popular warehouse amenities. An increasing number of brands have begun to offer faster product deliveries, and industrial real estate is to blame.
Consider increasing the property’s trailer parking capacity to facilitate a seamless shipping station within your industrial space. Future tenants will be capable of increasing the number of synchronous pick-ups and deliveries in this manner. Buyers will highly seek industrial properties with a company design scheme after being on the market.
Storage centers play an important role in warehouses. Expansion of on-site storage facilities is a great and simple way to increase the value of your industrial property. Consider renovating to increase the square footage or installing racking systems to maximize the usable cubic (i.e cube).space of the facility.
Warehouses require adequate lighting. Thanks to the ever-developing world of technology, options for industrial lighting systems have improved significantly. Lighting can be utilized as advertising leverage when selling an industrial space because it helps interested buyers improve their team’s workflow and capacity.
Consider installing motion-sensored LED or high efficient fluorescent lighting in your industrial areas. These options are technologically advanced, environmentally friendly, and cost-effective. Install new LED lighting in working areas around delivery areas and packing sections. If you want to take it a step further, consider Smart Lights, which uses sensor technologies for automated activation and shutdown.
Final Thoughts About Industrial Property Valuations
It is critical to remember that owners must tailor the value-add strategy to the specific property and market conditions. To determine the best strategy for increasing the value of your industrial real estate property, consult an experienced industrial real estate company.
At Industrial Corporate Group (i.e “ICG”) we act as an extension to your company as advisors to guide your real estate staff and decision makers through the many variables faced when analyzing industrial and commercial assets that can make or break your company’s day to day operations.