Professionals who work in commercial real estate—including investors, brokers, lenders, appraisers, and lawyers—need to understand the current value of assets. Although benchmark data can be useful, it isn’t always readily available or relevant to a specific market. Commercial real estate professionals need to be able to calculate valuations that don’t rely solely on historical data, especially during uncertain times. Five assumptions underlie estimations of worth:
- Certain properties are inherently difficult to analyze. In a robust market, substantial data from comparable sales can help determine benchmark numbers for cap rates, discount rates, and sale prices per square foot. But such information isn’t available in smaller markets or for properties valued below $2.5 million.
- Historical data isn’t a valid indicator of future performance. COVID-19 has made a lot of information worthless, so CRE professionals must ignore a lot of what happened before 2020. Instead, they should rely on forward-looking analytics and current market status. For example, a hotel property may look very different today than it did pre-pandemic.
- Asset types and locations are important. Geography was always key to determining a real estate asset’s worth, but COVID-19 has made asset type and location even more essential. As interest in suburban markets has ticked up, for example, recognizing this variability is crucial to predicting a property’s future value.
- Future performance affects present value. The most accurate valuations are determined by examining current and forward-looking analytics. Knowing what an asset is worth today (the acquisition cap rate) must incorporate how it will perform in the future (the discount rate). That same hotel property mentioned above will likely see its valuation rise with increasing COVID-19 vaccination rates. Estimating the performance of an income-producing property over time and applying an appropriate discount rate to those estimates will give more credence to a valuation.
- The future is uncertain. COVID-19 has required everyone to set and reset expectations. For real estate, an asset needs to be valued in a range.
These tips were drawn from the CCIM Institute course “Creating Reliable Valuations.” Learn more at ccim.com/education.