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Rakhi Vasavada, Financial and Legal Consultant
Category: Finance
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Experience:  Graduated in law with Emphasis on Finance and have have been working in financial sector for over 12 Years
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# how to you value an income producing commercial property that

how to you value an income producing commercial property that is generating a negative net income?
Dear Friend,

There are more than one methods of valuing your property even if it has negative returns.

Before I begin, note that here, what is important that you have returns. They are negative because your expenses are in excess of the revenue its generates. Let us examine the most commonly used three methods.

1. Cash-on-Cash Return -- Cash-on-cash return is calculated by taking your estimated, or proforma, cash flows and dividing them by the amount of cash equity you invest to purchase the property. For example, if I invested \$40,000 into a property and earned \$4,000 per year in free cash flow, that’s a 10 percent cash-on-cash return.

2. The second method concentrates on Internal rate of return and net present value. Both take into account the time value of money theory and are little complicated. Both of these calculate a rate of return based heavily on a future sale of the property and an estimated price that the property sale will generate. These rely heavily on future projections.

3. The other used method is Gross rents multiplier. There is also gross rents multiplier (GRM), which takes the property price and divides it by the gross rents the property can generate. So if the price is \$100,000 and the annual rental income is \$10,000, the GRM is 10. You would compare this to other properties in the area to see how they fare against those. While these may be a good rule of thumb, they don’t show a true picture. Different properties can have different expenses, and GRM does not account for those differences.

HAVING said this, cash on cash based returns is the most widely used method.

I hope this helps...

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Warm Regards,

Customer: replied 4 years ago.

I've discovered that they have a higher than normal salary expense and after altering this number, it results in a small positive cash flow. The trouble is there are so few transactions of similar type properties for me to derive the market cap rate, what can you do in this instance?

Dear Friend,

I understand this and I had expected this too. The most common rationale would be go for averaging of this and arrive at a conservative estimate.

You may take some say, for example, 10 such similar property valuations in your area, and average it out to arrive at your benchmark valuations.

This is the most proper thing to do, otherwise there are so many factors involved that you will never arrive at accurate price. So, averaging out and arriving at conservative estimate is the thing that one must normally do.

I hope this helps...

Rate this answer POSITIVELY IF you are done with this and if this helps and satisfies you as this is the only way we get compensated for assisting you. You may use "CONTINUE CONVERSATION" to revert with additional queries if you have or if I have missed out on any aspect of your question.

Warm Regards,

Customer: replied 4 years ago.

Someone mentioned the Elwood or Inwood method of deriving the cap rate. Can you tell me how that works and if I can use it in this instance?

Thanks

Dear Friend,

Yes... you can certainly use it. It is more professional method of arriving at valuation and this is used by professional property valuers.

This method is a financial approach to valuation and this uses DCF method.. I.e. discounted cash flow method and this method is considered as main method in line with all the methods adopted.

This is an open process valuation with feedback where the valuer delivers derailed information about the assumptions and receives benchmark information regarding the actual income, expenses and the management of the property.

The following is an excellent resource which explains this in detail.