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By far the majority of commercial and industrial property are leased from the owner who holds the
property as a long term investment. Most owners have three main objectives: (1) maximize income; (2)
maintain income security; (3) capital gains.
General valuation techniques used are as follows:
1. Direct Comparison
This approach involves comparison of the property to be valued to completed sales of similar
properties.
Comparisons can be made in many forms including straight comparison, or analysis on a rate per
area basis (i.e. so much per square metre). Adjustments are made to account for differences in
quality, location, age of the building, etc.
Direct comparison is the usual means of valuing residential property, but it is generally used only as a
secondary or check valuation method for Commercial properties.
2. Investment Approach
This is the primary approach used for Commercial & Industrial investment properties.
The two mathematical models used are either, (i) Income Capitalisation and/or (ii) Discounted Cash
Flow analysis (DCF).
(i) Capitalisation - The market rental (this can differ from the contract rental) of the property is
capitalised in perpetuity to arrive at the market value of the property.
The capitalisation rate (also known as Yield or Return) is derived from analysis of completed sales of
other investment properties. The central concept for selection of the Capitalisation rate is consideration
of the Risk premium. Simply stated, the higher the risk the higher the return demanded.
The resultant capitalised value may be adjusted to reflect immediate capital maintenance expenditure
required to sustain the current income, ‘letting up’ allowances to fully lease the property, or the value of
the difference between the passing (contract) rental and the market rental. Sometimes the current rent
may be above or below market (refer to the two free VCNZ calculators – Shortfall & Excess income).
(ii) Discounted Cash Flow (DCF) – the previous capitalisation method has some limitations. It
has an inherent assumption that the income and expenses are frozen in time.
The DCF method involves forecasting future cash flows over a specified period (this usually ranges
between 5-10 years), estimating the market value of the property at the end of the term of projection,
and discounting these amounts back to arrive at the Net Present Value (NPV).
It allows the model to take into consideration ‘one-off’ expenses (e.g. replace a structural element such
as a roof, or a mechanical element such as a lift) at some future time over the holding period. This is
not easily done using simple capitalisation.
The NPV is calculated using a discount rate which is assessed in comparison to returns indicated by
the analysis of other completed sales using similar methodology.
Discounted cash flow analysis is most frequently used for the valuation of substantial commercial
premises which are subject to long term lease arrangements. It is also used for valuation some
special purpose properties such as Self-Storage facilities and Forestry.
3. Depreciated Replacement Cost (DRC)
This involves the assessment of the value of the underlying land.
The replacement costs of the buildings are then assessed having regard to current construction costs.
The result is discounted back to account for depreciation and/or obsolescence. The latter takes into
account the remaining economic life of the building, which is a combination of the functional, economic
and physical obsolence of the structure.
The value of the land plus the deprecated replacement cost of the building are then added together.
The DRC method is either used as a secondary ‘check’ method for investment property or as a primary
method for valuations of specialised assets for financial reporting.
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There are three broad categories of these types of properties, each which have their own set of
valuation complexities.
These are (a) Owner occupied properties; (b) Investment properties; (c) Special Purpose properties.
This article deals with the first two.
valuation complexities.
These are (a) Owner occupied properties; (b) Investment properties; (c) Special Purpose properties.
This article deals with the first two.
| (a) Owner Occupied |
These types of properties are sometimes distinguished by specific layout and design which might only
suit the specific requirements of a particular occupier. They include ‘monumental’ type properties used
as headquarters by large corporations. The investment return for these are often low compared to their
exceptionally high replacement cost.
Other Industrial examples may include freezing works, food processing plants, breweries, etc.
When assessing these category of properties, the Valuer needs to consider whether the property has:
suit the specific requirements of a particular occupier. They include ‘monumental’ type properties used
as headquarters by large corporations. The investment return for these are often low compared to their
exceptionally high replacement cost.
Other Industrial examples may include freezing works, food processing plants, breweries, etc.
When assessing these category of properties, the Valuer needs to consider whether the property has:
- Alternative uses – if the answer is "yes" then normal valuation methods apply. Sometimes
the cost of conversion to an alternative use needs to be deducted, if this is appropriate.
- Existing Use only – certain types of highly specialized commercial properties have few other
uses beyond their present function. Some of the examples given above, are dependent upon
their continued existing use and the economic soundness of the occupier. The replacement
cost approach less a discount for obsolescence is the favored approach.
| (b) Investment Rental Properties |
| Commercial & Industrial Valuation Reports |
| PO BOX 9018, Wellington 6141 | phone: (04) 240-0124 | fax: (04) 232-4414 | email: valuer@ vcnz.co.nz Innovation + Experience |
Innovation + Experience |