How do you calculate the value of a property during a pandemic?

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Valuations may undergo drastic changes this next year, due in large part to the Coronavirus. That change may impact the way we calculate the value of a commercial property.
Wednesday Weekly

We’re grappling with a number of changes in the wake of the coronavirus pandemic. Most people are working and socializing remotely, steering clear of public places, and postponing nonessential travel. The shift is remarkable. It’s also affecting brokers and commercial real estate in general—specifically when it comes to assessing the value of a property.

How does commercial real estate property valuation work?

Let’s take a moment and pretend we’re not in the midst of a global health crisis. How does commercial property valuation work under normal circumstances?

The purchase or sale of commercial property generally depends on the appraised value of the building. As brokers know, commercial appraisals—which encompass everything from industrial complexes to retail centers—are usually a bit more subjective than residential ones.

The reason for this is that commercial appraisals incorporate volatile elements like:

  • The current market rate for which most spaces rent
  • Maintenance expenses
  • The number of available comparable properties

Another key factor is the amount buyers are willing to pay. But how is commercial property value calculated? Here are the main strategies brokers use to come up with an accurate figure:

The sales comparison approach

Also known as the market value approach, this strategy is a seamless method for determining the value of a commercial property. It involves comparing the property in question to similar ones that have recently sold or been put on the market in a given area.

The valuation is calculated based on this information, and adjusted for details such as square footage, the age and condition of the property, and other relevant characteristics. The resulting figure is essentially the amount the purchaser will likely pay in an open market.

The cost approach

Among the more complex strategies is the cost approach. This tactic involves factoring in the value of the land where the building is located and then combining that figure with the cost of replicating the existing building.

At this point, the depreciated value of the property is considered as well—and the valuation is the difference of that final calculation.

The income capitalization approach

This strategy—also known as the income approach—is among the most popular in commercial real estate valuations. The property value here is calculated by estimating the property’s income by way of the capitalization rate.

The capitalization rate is the net operating income of the property divided by the current market value. Say, for instance, that a shopping center has a potential income of $650,000. To complete a valuation, you would simply subtract 97,500 to reflect the current 15% vacancy rate, deduct the net operating expenses of the property ($200,000, in our example here), and divide this amount—your net operating income—by an 8% capitalization rate.

The resulting commercial property valuation would then be $4,406,250.

Do these strategies make sense? Good. Now let’s discuss commercial property valuations as they relate to the coronavirus pandemic.

How could the COVID-19 pandemic affect commercial property values?

While the public health crisis may well affect commercial real estate, our sector doesn’t move as quickly as the stock market. This means that if the crisis has a lasting impact on the economy, it will affect our industry—but not necessarily right away.

So, how could COVID-19 affect commercial property values?

Let’s explore what’s happening in Chicago. Cook County Assessor Fritz Kaegi has already made plans to reevaluate every property in the county as a result of the pandemic. (Normally, only a third of Cook County’s properties are assessed each year.)

Commercial brokers nationwide should take note of this unprecedented move—a decision that will likely have a substantial impact on local governments (who depend on property tax revenue), and on the commercial property owners themselves.

Though Kaegi claims the reassessments are crucial because of the coronavirus’s sweeping economic impact, the outcome won’t be clear until property tax bills are distributed in 2021.

Some projections: commercial landlords will likely experience a major reduction in rental income as shops, hotels, and restaurants shutter. Vacancy rates will increase. Many of the owners whose properties lose value will file appeals—and even those who don’t file could face changes in their assessments.

Are these projections set in stone, though?

No—and listing brokers would do well to sit back, be cognizant of any changes that take place, but ultimately keep from acting prematurely where commercial property valuations are concerned.

Simply take a look at prior large-scale events as a point of reference. After the 9/11 attacks in 2001, and after the SARS outbreak in 2003, the commercial real estate marked experienced a minimal impact here in the U.S.

The most substantial decline in commercial real estate sales occurred between 2007 and 2009—not as a product of the H1N1 virus, but because of the Great Recession.

The verdict is this: while the COVID-19 pandemic could cause a recession that will influence commercial property valuations, it’s still very early in the crisis to come to any sort of firm conclusion.

Proceed with caution while conducting your commercial property valuations

While navigating the pandemic, listing brokers must learn to roll with the punches, so to speak.

Signs of the coronavirus crisis have only begun to affect the U.S. commercial property market. Still, we must brace ourselves for change. Some deals are already falling through, for instance. Between 2016 and 2019, 0.4% of all commercial deals flatlined each month—but in March 2020, that figure more than tripled to 1.3%.

Right now there are also fewer players involved in the commercial real estate sector. In addition, experts claim many brokers are “isolated.” Showings have slowed, and permits have become increasingly difficult to pull.

But again, it is still very early in the process. And we must remember that price discovery takes time, sellers will continue listing their properties, and brokers will continue facilitating commercial valuations and transactions. There may well be changes in market pricing in the near future, but those shifts won’t be immediate—or concrete.

With that, brokers may anticipate the following when conducting valuations:

  • Fewer comparable properties on the market, and potentially lower market values, when conducting the sales comparison valuation approach
  • Lower commercial property incomes when turning to the income capitalization valuation approach

In closing, only time will tell what’s to come. The way governments and communities navigate the global health crisis—and the resulting economic impact—will be nothing short of significant over the next few months.

And in the meantime, commercial brokers can continue making calculations. Valuations may undergo drastic changes this next year, but if history has shown us anything, it’s that the market will bounce back. And the commercial real estate sector will survive.

Do these insights make sense? For more information, consider ordering a commercial Property Evaluation Report from biproxi here. Our team will guide you through your property valuations and answer any questions you may have.

The process is simple. Answer a few short questions at checkout, and receive a report in your inbox in just 24 hours. Our reports offer detailed valuations based on a proprietary property characteristics algorithm—and they include three of the most recent sales of comparable properties in the same geographic region as the subject.

gordon smitth

gordon smitth

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