There are three primary types of valuation approaches utilized to determine the property value of commercial properties. Each approach has merit for specific situations with the pros and cons outlined below.

1. Income Approach:
   • Pros:
     • Utilizes the income generated by the property as the primary factor in determining its value, making it especially relevant for income-producing properties such as office buildings, retail centers, and apartment complexes.
     • Considers future income potential, which can be particularly useful for properties with varying lease terms or development opportunities.
     • Takes into account market trends and investor expectations regarding returns on investment or cap rates.
   • Cons:
     • Requires accurate and reliable data on rental incomes, operating expenses, and market capitalization rates.
     • Sensitivity to changes in market conditions and rent levels, which can impact valuation significantly.
     • Valuation may be subjective, as it heavily relies on assumptions about future income streams and market conditions.

2. Sales Comparison Approach:
   • Pros:
     • Utilizes comparable sales data of similar properties in the market to determine the subject property’s value, making it straightforward and intuitive.
     • Provides a benchmark by which potential buyers and sellers can gauge the property’s market value.
     • Suitable for properties with a significant number of comparable transactions in the market.
     • Tends to represent the most common approach for valuation and often used for owner-occupant properties.
   • Cons:
     • Relies heavily on the availability of accurate and recent comparable sales data, which may not always be readily available depending on the geographic market or property type.
     • Requires adjustments to be made for differences between the subject property and the comparable properties, which can be subjective and may vary between appraisers.
     • Less suitable for unique or specialized properties that lack comparable sales data.

3. Cost Approach:
   • Pros:
     • Values the property based on the cost of reproducing or replacing it, adjusted for depreciation, making it particularly useful for new or relatively new properties.
     • Provides a baseline value for the property, especially when market conditions are volatile or when there are limited comparable sales data.
     • Offers insights into the cost of land and improvements, which can be beneficial for insurance purposes.
   • Cons:
     • Does not directly consider the income generated by the property or prevailing market conditions, which may result in inaccuracies, particularly for income-producing properties.
     • Relies on accurate estimates of construction costs, depreciation, and land values, which can vary over time and across regions.
     • May undervalue properties with unique or specialized features that cannot be easily replicated.

Realizing each approach has its strengths and weaknesses, the choice of valuation method often depends on factors such as the property type, market conditions, and the availability of relevant data. In practice, appraisers may use a combination of these approaches to arrive at a comprehensive and reliable valuation while a broker primarily uses the Sales Comp Approach and may rely more heavily on properties in closer proximity to the subject property.

Also, it must be noted appraisals are required when bank financing is involved and appraisers tend to have knowledge of the contracted sales price, which provides a safeguard for the bank. A Broker Opinion of Value utilizing a market driven Sales Comp Approach removes any bias tied to a contracted sales price or a past appraisal.

To learn more about the Commercial Property Valuation process and our firsthand experience of the pros and cons feel free to contact Reliant Partners.