Commercial Auction Property Valuation Methods in the Current Climate

Auctions are widely considered to be a very good way of establishing the market value of a property. Of course, to decide whether you should buy or sell a property at auction it is useful to have a valuation in the first place. Here we will look specifically at how commercial property valuations are arrived at and at how the current economic climate might be affecting them.

While residential valuations are generally simpler – they can be based on what similar properties in the area have sold for and, essentially, what someone is willing and able to pay – commercial valuations are more complex. Many types of commercial property are unique and there are many more variables. There are fewer commercial transactions per year and so less market data to base valuations on.

The surveyor’s organisation RICS proposes five methods of valuing commercial property:

APC: The five valuation methods | Journals | RICS

The comparable method

This, as the name suggests, involves comparing the property being valued with the market value or market rent of similar commercial properties. It is probably the most widely used method, but it relies on a good volume of data on similar properties being available.

Valuations may need to be adjusted to take account of the cost of any work which the property requires, or any work which could lead to an uplift in value.

The investment method

This method can be used to value commercial property where it produces an income, ie. it is let to a tenant. It calls for an understanding of market rents and yields.

The profits method

The profits method is also sometimes known as the receipts and expenses or income and expenditure method. It may be used for income-producing properties but usually where these are being sold as part of a business which is being run from them. As such it is a more specialist method and more limited in use.

The contractor’s method

The contractor’s method is also known as the depreciated replacement cost or DRC method. It uses the approach that a buyer will pay no more for the commercial property than they would for buying a vacant site and constructing a similar building, allowing for appropriate adjustments. As such it is also a specialist method and generally only used where none of the other valuation methods is appropriate.

The residual method

The residual method involves taking the value of a finished, new development on the land and deducting all the construction and related costs required to develop it.

The residual method is a popular method of valuation but it can only be used to value land or property with development potential. Ideally it will be supported by comparables.

Of course, all this raises the question of which method or methods of valuation to use and how exactly to apply them. This is where the skill and knowledge of a surveyor and auctioneer prove invaluable. But, as many surveyors may tell you, this is as much (or more) of an art than a science.

Commercial valuations in the current climate

While the market has been relatively stable, pre-Covid, for the previous decade or so current market conditions are perhaps making commercial valuations for auction trickier than they have been for some time.

Right now commercial valuations involve some extra considerations: These include rising construction costs and rising finance costs. Another factor is the state of the economy and possible recession, which could potentially lead to more distressed or forced property sales than normal alongside less demand, which could impact values.

Adrian Little, Partner and Auctioneer at Mark Jenkinson & Son offers some thoughts on how valuations for commercial property are arrived at. He says: “The approach is more ‘art’ than ‘science’ as an auctioneer knows the market and the target audience in respect of location, lease terms and condition.

“As a general rule, properties in poor condition where value can be added and rental stream improved need to be adjusted to take into account capital injection.”

“It may become a matter of gambling rather than valuation. The auctioneer will rely on experience to establish a figure that he or she feels reasonably confident of selling to an investor, whose primary aim is to secure an income stream and possibly add value over a period of time.”

He agrees that the current economic climate impacts the way commercial property may be valued, but points out that setting appropriate guide prices and reserve prices are critical, as ever, saying: “Build costs are an issue so capital values have to reflect additional outgoings on any project, together with the cost of finance.”

“The auctioneer will seek to present the property to the market with an attractive guide that hopefully stimulates interest, without being misleading to potential buyers.”

“The circumstances surrounding the disposal need to be taken into account and we are back to gambling – the lower the guide and reserve, the greater the odds of a successful outcome,” he concludes.