In theory, commercial real estate comps are simple: find a few recently sold properties similar to yours and use their sale prices to set your own.
The rub is actually finding CRE comps that are fundamentally similar to your asset. A potential comp two blocks away may be the same size and asset type of the building you want to sell, but a difference in tenants, age, or tax rate makes it a less valuable investment—and will warrant a lower price.
Setting your property’s price based on irrelevant comps will cost you—either by scaring away buyers with a high price or leaving money on the closing table with a low price. To set a price that attracts buyers and maximizes profit, you’ll need to answer some questions about each potential comp to weed out the ones that aren’t good matches.
The commercial real estate market is neither static nor linear. Comp transaction data more than a year old shouldn’t be considered a reliable benchmark of value for your commercial property.
The pandemic has been a stark example of the market’s unpredictability; it quickly disrupted the value of most CRE asset types. While some (tech centers, warehouses) saw a boon, others (retail, hospitality) declined sharply. Few remained unchanged.
Because of these fluctuations, comps pulled from transactions more than a year old are largely irrelevant. If you can’t find newer comps in your geography, look for recent comps from similar markets in other locations. Those will be more relevant than a stale comp.
Distressed properties often sell for less than market value. If you compare your property to a distressed comp, it’ll lead you to a falsely low sales price.
A distressed property is one where the owner can no longer maintain the mortgage payments or expenses of an asset. In those cases, owners are often motivated to sell the asset quickly, even if it’s at less than market value.
The last sales price of a distressed property isn’t a reliable benchmark of the current market value for your full-priced asset. Unless your property is also under distress, find comp transactions that were sold under normal conditions.
Most popular valuation methods don’t consider the upgrades needed to older buildings, but those costs will certainly affect the cashflow and, in turn, the property value of a CRE asset. A good comp for your property should be of the same approximate age and condition.
Net operating income (NOI), gross rent multiplier (GRM), and cap rate are all common methods to compare CRE assets. But none of them consider capital expenditures to repair older, outdated buildings.
High cap-ex costs will typically drive the sale price of a commercial property down (higher cost of ownership > less profit > lower sales price). Transactions of assets significantly older than yours may not lead to a fair market value. Where possible, find buildings of the same relative age or level of upkeep as yours.
Higher taxes will reduce the cashflow (and value) of a CRE asset. When finding comps, make sure you’re comparing properties with the same tax burden. Or, at least, ensure you’re accounting for any differences.
Total tax rate delta can be large, even for properties just a short distance away. For example, the property tax rate in Aurora, Illinois, is 3.16%, but, at 2.1%, it’s a full point less in neighboring Cook county. That’s a significant cost delta on a $2 million asset.
When you’re pulling sales comps, compare tax rates since a large delta will mean a weighty difference in profit potential and pricing.
A CRE property may have sold for less simply because it never reached full occupancy. Use that under-utilized asset as the benchmark for your building and your pricing will come up short.
Low occupancy rate might not have anything to do with the property or location. Poor management or marketing can leave an office building or hotel performing poorly.
Low occupancy makes the property less profitable and leads to a lower sale price. A poorly performing asset isn’t comparable to your building, which may have full occupancy.
FAR tells you how many square feet of building you can construct on a given size lot. For example, a four-story building that covers the entire lot is a FAR: 4.
The greater the FAR, the more valuable the land is likely to be, and your comps should reflect that.
FAR is typically determined by zoning or other local ordinances and is important to consider when assessing a comp. A similar lot with half the allowable FAR can’t be considered a 1:1 comparison, so verify the comp you’ve chosen has the same buildable space as your commercial property.
In CRE, some owners only own the physical structure and pay for a lease on the land while others own the land and building outright.
You may see a recent sale of a similar property, but it was only the building. That transaction isn’t a direct comparison for you if your property is fee simple—you own both the building and the land.
Verify that the sales comps you choose fall into the same ownership bucket as your property.
It’s better to find comps in distant-but-similar sub-markets—urban vs. suburban vs. rural—than to use comps from the same geographic area located in different sub-markets.
If you’re selling a class B [future link] office building in Plano, Texas, you’d be better off comparing to another large suburb in Pennsylvania or New Jersey than a similar property in the heart of Dallas’ downtown—where CRE pricing is much higher even though it’s only 20 miles away.
It’s not just the building and location that determine the value of an investment. The companies leasing the space in an asset also affect income and, therefore, market value.
High-value tenants make an asset more valuable. A building leased by an institutional brand or a company with a AA credit rating will sell for higher than a similar property rented by a mom-and-pop shop with less attractive credit.
Choose comparable properties with similar types of tenants as yours to get a clear picture of your building’s market price.
Owners want to make their properties look as valuable as possible, so they typically post gross rents—the highest rent a tenant would pay without any discounts. Effective rent, that’s rent net discounts, is a better measure of income, value, and asset price.
Tenants leasing space can negotiate rent concessions like a few free months of rent or a reduced rent if another high-volume tenant leaves. Those concessions reduce the effective rent, and NOI, of the asset. It may have also caused the property to sell for less and throw off your pricing comparison.
When comparing and choosing comps, verify you’re using effective rent or you may overprice your property.
Some lease types make certain CRE assets more valuable to real estate investors. To make a fair comparison, the comps you choose should have tenants with similar terms as your own.
Triple net (NNN) leases, for example, are often more attractive to investors. They put most of the operational cost and work on the tenant making the investment more passive.
Appraisers may value a property similar to yours with an NNN lease tenant higher because of this. So it’s not a great comparable property for your building whose tenants have a gross lease and pay for nothing but rent.
Compared to residential, where recent sales of similar properties abound, finding comps for CRE can be difficult to impossible at times. Two things will help.
First, use the best possible options instead of completely ruling out everything that’s not a perfect match. Ideally, you’re using other valuation methods to price a property, so if comps aren’t perfect (they rarely are), you have some failsafe in your valuation method.
More importantly, leverage available technology to quickly sift through thousands of potential comparables. Proptech companies like biproxi are solving the dilemma of disparate data by coalescing property details and sales transaction history in easy-to-search online platforms.