Commercial and industrial buildings are often large and complex, and thus, there are many variables affecting their value.
Variables relate primarily to the building itself, its location, condition, demand, use class (as per the Use Class Order), the local, regional, national and world economy, property market and the potential for development.
There are also numerous methods used to calculate commercial building value, guidelines are published in the RICS Red Book, which is distributed both in the UK and globally with the aim to unify valuation methods to gain consistency across the market.
With many value factors and valuation methods in the mix, it’s perhaps unsurprising that the commercial property valuation process is often complex and demanding!
Commercial valuations do share many of the same characteristics as residential valuations, but the primary point of differentiation is that they have to take the income of the building into account.
The value of a commercial building varies greatly with how much money can be generated from its use, either immediately or in the future after redevelopment or renovation.
This is what makes the commercial property valuation process more complex.
By comparison, residential properties have just one primary use – residential use.
For example, even a terribly run-down warehouse could have significant value because, with a small investment, it could be converted into an extremely high-grossing industrial building, or could even be converted to a totally different use, perhaps even without planning permission using Permitted Development Rights.
On the flip side of the coin, it might be hard to even give away an empty commercial office space in a poorly connected area with a weak, depreciating local economy, even despite its material value still being relatively high.
There are two main ‘types’ of valuation that you come across in the UK commercial property market.
The first is a market appraisal, which is carried out prior to placing a property on the market to give the seller a guide of what the property could fetch. This is an informal (and often inflated) figure and cannot be relied upon for lending purposes.
The second valuation is a true valuation, a formal valuation. Formal property valuations are carried out by an RICS Chartered Surveyor and obtain the true market value of a property for lending purposes.
The (colloquially named) Red Book is a long-established RICS documentation on how to value property.
The Red Book doesn’t enforce any one particular valuation method and these will vary on the project.
The main valuation methods for a formal commercial property valuation include:
The cost approach is simple and makes a simple calculation of the costs and material value of the property, or how much it’d be worth to construct and buy a property of equal use capacity.
This is a useful foundation for most valuations, but it’s inadequate for commercial buildings because it doesn’t take potential income into account. A more nuanced approach is favoured in the vast majority of valuations.
The income/profit approach will use the financial statements of the businesses currently operating the building to discover its value as informed by the profit it generates. For example, a hotel, shop, pub, cinema or gym will be able to show how much profit they’re making, thus guiding the valuation.
The income approach can tie in with investment metrics such as the cap rate (net yearly operating income divided by current value) to compare a commercial investment opportunity to other commercial properties/investment opportunities within the local/wider area.
Given the volume of market information available during a valuation, the preferred method (and method most frequently used in a Red Book valuation) is the comparative valuation method.
Commercial properties will be compared against a vast wealth of historical and current price data for similar comparable properties. By looking up the data for near-identical assets, you can price up your own according to the current market. As long as the data is recent and the assets thoroughly comparable, this method is reliable.
The comparative approach will set a solid benchmark at which to rank the importance of other valuation factors, e.g. future development potential. There is usually more nuance than simply chalking up value based on similar assets and other factors will be taken into account to provide a more complete valuation.
So what does a normal commercial property valuation procedure look like?
It does depend on the type of property, the relationship between vendors and buyers and the motive for selling/acquiring the asset, but the general procedure is as follows:
Confirming valuation instructions and unique requirements – Prior to valuation, the client and surveyor conducting the valuation will agree on the terms of engagement, which set out the ‘scope of work’. This keeps the client and surveyor on the same page for what will be included in the formal valuation (there are minimum requirements).
Confirm there is no conflict of interest – The valuation must officially confirm its objectivity from conflicts of interest.
Inspection – The main inspection of the property, analysis of its physical features and characteristics. May occur in parallel to a number of other surveys.
Further analysis – Discovering planning permissions and potential, transport, intersecting local developments, environmental factors, land designations (e.g. is the building in a National Park or site of specific scientific interest?), rights of way, etc.
Comparable data analysis – Comparing property characteristics to current and historical market data.
Final Report generation – Finalisation of the formal valuation.
Now we understand the typical valuation process, let’s look at specific valuation factors.
Valuation factors primarily relate to the physical characteristics of the building itself and its features and qualities, its location and position within the local economy, use class and operating income and scope for the future.
The economy matters on a macro level, e.g. the global and national economy, and on a micro-level, e.g. the regional and local economy. According to the Property Industry Alliance and Savills, commercial property yields are typically stable but sensitive to industry trends and demand.
Industrial investment has increased the most of any commercial property investment sector since 2016.
Valuations will take demand into account, especially when it comes to highly purposed ‘turn key’ commercial buildings that are fit-out for specific uses.
Location is the greatest environmental factor involved in the valuation of almost any property worldwide. National and regional price differences differ dramatically. Currently, according to Statista, parts of London have the highest average commercial and office building value in the whole of Europe. Warehouse rental costs in London are double pretty much anywhere else in the country and as much as treble that of the Scottish, Welsh and Northern Irish average.
The following figure is from a study entitled ‘Factors Affecting Industrial Property Value’, showing a breakdown of valuation factors taken from international valuation data and literature.
Location takes the number 1 spot, comprising 24% of the market value for an industrial property.
For sure the most arduous component of a valuation is a thorough building inspection. Building surveys may occur parallel to a formal valuation, or separately, or at the same time. Surveys aim to take all physical factors into account, from the foundations and roof of the building to its energy efficiency, maintenance costs, fit-out works required for use (e.g. adding better electricity or plumbing).
Ground rents may also be payable to the landowner (e.g. the Crown Estate) which is another cost to take into account.
Contamination reports and other environmental surveys are particularly important for industrial buildings, and these may affect the future use potential of the building (e.g. preventing it from being converted from industrial use to residential use).
Buildings equipped with future-proof technology, e.g. advanced networking systems, built-in or integrated technologies, advanced fire safety technology, etc, will obviously be worth more, perhaps significantly more if this suits them to a range of cutting edge commercial uses (e.g. laboratories and R&D).
Comparable market data is one of the key valuation factors used for a Red Book valuation. There is nearly always some level of historical or comparable data to look into, especially concerning multi-unit commercial buildings with stable, long-term tenants.
Of course, the performance of the commercial building itself can only be assessed if it is currently or recently occupied. If not, then similar buildings nearby (that share the same intended use) can be used to assess value.
Location ties to the local economy. The local economy undergoes a rigorous assessment when any new commercial development is proposed.
For example, in the proposal for the relatively new Chesterford Research Park Building, the proposal detailed the economic assets of the locale, including the proximity of Stansted Airport and proximity to Cambridge, signalling a provision of skilled labour.
Studies into the local economy assess employment and wages, supporting infrastructure and historical labour market data. Governmental schemes and incentives can also boost the value of properties, e.g. buildings designed for R&D purposes can yield R&D tax incentives.
Many commercial properties are purchased with planning permission granted or in processing. This changes the future scope of the building or plot.
A building that can be cheaply converted into something with high operating income is worth more than a building that cannot be changed due to a lack of planning and development scope.
Permitted development rights (PDRs) can also be taken into account to assess how much value can be added to the property immediately or in the near future. Some plots may be very easy to develop at a low cost, despite having relatively low material value.
Tied closely to the above are other commercial benefits, both current and future. For example, shops may benefit from increased or decreased footfall following the construction of other nearby developments, high-street closure, new roads, etc.
Similarly, nearby transport services may change in the near future, altering the potential value of the building. Small nuances can also affect value, e.g. proximity to a particularly secure, well-policed, high-end district.
It could go the other way too, proximity to a number of strong, growing competitors could reduce the value of a commercial property. For example, a restaurant set amongst a district of very successful, established restaurants will be valued differently compared to one set amongst a low-competition but low footfall area.
Commercial and industrial buildings take many forms ranging from the grandeur of the Ritz Hotel to the semi-dilapidated, unoccupied light industrial warehouses that characterise many industrial inner-city areas.
Commercial property valuations are complex and sensitive to a huge variety of micro and macro-level factors that tie to the economy. In all instances, a RICS valuation by a Chartered Surveyor is an absolute requirement.
High profile, high-value commercial property investments should be consulted to the Nth degree – you can leave no stone unturned when it comes to negotiating price and value.