How Commercial / Industrial Property is valued

As with everything in this world - and property in particular - property is worth what someone will pay for it. It is essentially supply and demand that dictates the price - or simply , how much someone wants a property will determine how much they are prepared to pay. But in determining what price buyers are prepared to pay, they tend to look at "valuations", and valuations are determined by historical evidence of what other people have paid. Ultimately it comes down to a question of "other people are paying this, but what I am prepared to pay?"

The reasons for fluctuating demand in particular can be the subject of another treatise entirely, but we believe there are two main drivers - economic confidence, and banks lending policies and interest rates. Owner occupiers will be much more evident in the market when they are confident of the short term future of the economy and their place in it. They will also be more prepared to buy when interest rates are lower. On the other hand the higher the equity levels that banks demand will restrict owner occupier activity, and the greater the differential between property yields and bank interest rates, the more active we are likely to see investors.

Generally speaking owner occupiers are likely to pay more than investors, as they will consider:

  1. the annual cost to them of owning their premises, as compared to leasing
  2. the utility of the premises. They will look at certain buildings as having distinct advantages for their business, and therefore be prepared to pay a higher price than a valuation may put on it.

 

Investors on the other hand will generally look at a building in terms of it's "yield", which is the return it produces for the capital invested.If, say, a building is returning $90,000 a year in rental, and it can be purchased for $900,000, that is said to be a yield of 9%. In actual fact the return to the investor is less than 10%, as management costs and maintenance need to be deducted from that figure. On the other side of the ledger, ultimately most building owners would have an expectation of achieving some capital gain over time from their investment.

There will always be some agents who try to sell a vacant building based on a yield. Obviously this is a nonsense , as zero income equals a yield of 0%! Yields vary, in the current market broadly between 6% and 16% - based on factors such as the quality of the building, the quality of the tenant, the length of the lease etc.