Building up a property portfolio is an enticing option for many investors, with the profit potential as just one of the many draws. Historically, the residential property market has been the main hunting ground for keen investors, but this is slowly beginning to change, with investors increasingly seeking opportunities in the commercial property sector.
UK commercial property market is currently worth about £680bn, with properties spread across sectors like retail, leisure and industrial. Other sectors of this market, including hotels and accommodation for university students, are showing particularly impressive rates of growth and as such, are becoming more and more appealing to investors.
The perks of commercial properties
There are many perks for investors willing to take a chance on commercial properties. A landlord of a commercial property renting to another business can enjoy a relatively stable source of income from rents. What’s more, purchasing a property rather than leasing one means that buyers can enjoy the prospect of capital growth over time, while their portfolio as a whole becomes more diverse and appealing. However, taking the plunge with commercial property purchases can be a daunting one without proper insights into what constitutes a good deal.
Commercial properties aren’t bought and sold openly, meaning there are no quoted prices to use as a comparison in order to discern whether or not you’re paying the right price. This may unnerve those more at home with the residential property market, but it needn’t be a derailing detail that prevents an investor from enjoying the experience and returns this thriving sector can deliver.
The Comparable Method
The comparable method simply involves considering the property in question and holding it up against similar properties elsewhere. The locations of all properties involved in the comparable method must be similar for this technique to be reliable. What you’re actually comparing is the property’s key value factors, such as its age, overall size, the interior layout, and so on.
There’s room in this method to identify any significant selling points of the property. With all this information, a valuer is then free to make a decision based on actualities, and their own experience in the market. Although the comparable method is largely used for valuation of residential property it is widely considered a straightforward method that is incredibly easy to apply in a general sense. As such, it’s a commonly used and widely popular.
However, there are a few key issues with the comparable method that means an unreliable valuation can’t be ruled out. In order for this method to be reliable, there needs to be enough detail provided about the commercial property to begin an assessment. There also needs to be enough properties to compare it to with sufficient detail included so that a more assured valuation can be reached. Insufficient data can produce a limited or skewed valuation while attempting an evaluation with next to no relevant detail is pointless.
In rare instances, the uniqueness of a commercial property may also cause problems. This individuality is an asset in one sense as distinctive features can be an enticing draw for the buyer market. However, it’s difficult to be able to hold up these more unusual properties to any kind of valuation assessment without a precedent. In situations like these, or where comparable property data isn’t sufficient or available, it’s obvious an alternative method might be a better option when acquiring a valuation.
The Profits Method
As outlined above, sometimes it’s just not possible to produce a viable valuation for a commercial property with conventional methods. In these situations, the profits method can be used.
profits method requires that the property in question have a business actively operating within it. Examples of commercial properties where this method is most suited include pubs, bars and restaurants, guest houses and hotels. Other leisure sector properties like cinemas are also examples of where this valuation of property method can be put to good use.
Although the comparable method is often seen as the go-to technique thanks to its wider field of application, the profits method tends to be a preferred option for many property investors and surveyors. This is especially true for profits-driven businesses that commence the bulk of their trade and custom on site. One significant reason for the preference towards the profits method is that, despite aesthetic similarities and superficial factors considered as part of the comparable method, there are countless more elements at work that influence the ultimate profit potential of a business premises.
How to value commercial property with the profits method
Before you begin using this method, it’s important to first ascertain the financials of the business that’s currently occupying the property. You’ll need to access that business’s financial accounts as a general rule, these need to cover at least the previous three years of operation, but more extensive financial account records are always useful. Once you have these records, you need to carefully scrutinise them. Provided these financial accounts for the occupying business are accurate and have been reliably maintained, any valuer should be able to quickly determine its financial standing, how well the business has historically performed and how well the business is performing today.
Upwards trends or sustained profits are a good sign here. Some things to watch out for when gathering financial records include any delay on the part of the occupying business in providing documents and references. If an accountant from the business side has been awkward in communications or failed to deliver on time, it might be a sign that the information provided isn’t wholly accurate. Investors looking for peace of mind are best advised to use professionals when calculating values with the profit method, not least to identify any tell-tale signs of erroneous activity and record-keeping.
Profits method calculations
Before getting too heavily involved with the profits method, be sure to be clear on gross profit and net profit calculations. Gross profit is calculated by deducting purchases from gross earnings, while net profit is derived from deducting working expenses from gross profit totals. These calculations are simple to use and provide accurate outcomes when discerning the profitability of a property. Still, need some further guidance on the financial side of things? We’ve broken it down into a little more detail below.
In short, gross earnings are the overall yearly revenues that a business has produced. However, gross earnings don’t include other costs. It’s simply the amount generated by a business before considering anything else.
Never to be confused with gross earnings, gross profit is simply the final figure arrived at after purchase costs have been subtracted from the gross earnings amount. Purchase costs refer to the essentials that are crucial for daily business operations. In relation to bars and pubs, they may include drinks and food items.
Another financial factor you need to consider, working expenses are simply the monetary expenses that refer to the daily working of a business. These working expenses can cover everything from fuel bills to telephone line rentals, broadband and business rates.
This refers to the final figure remaining after all else is deducted and is the figure that investors are most eager to discover. Once expenses and other integral outgoings have been removed from gross earnings, the net profit remains. Once you’ve got this number, you’ve got a snapshot of how much profit is realistically in the business you’re looking at. There’s room for interpretation here. Not every business runs as efficiently as others, while some business owners can look to make minor cost-saving initiatives here and there. That being said, net profit derived from the profits method should give you a reliable indication on whether a commercial property is a wise investment opportunity or not.
If you’re looking at renting a property after you’ve bought it, you’ll want to look at calculating an annual rental figure that you can use as a guide. In general, you should divide your net profit figure attained from the profits method by two. The reason for this is down to two different factors and figures.
Firstly, there are the tenants share figure. This represents tenants work, along with general day to day business operation. The second half is the resulting annual figure for rent payable. Bear in mind, when you’re looking to determine net profit figures, always remove tenants wages from the overall valuation so not to skew your result. Keep this figure for later reference.
Commercial property valuation advice
Looking to expand your portfolio to include commercial properties, but unsure on how to determine whether or not you’re getting a good deal? You’ve come to the right place. At Prideview Group, we’re experts in commercial property valuation, with extensive experience in the property market throughout London and the UK. Our dedicated team can help you identify if the dream property you’ve singled out for your business is really worth the risk, or whether an alternative option will offer you a more assured future.
Whether you need help with determining a value for a commercial property you’re interested in, want general advice about commercial properties and the market, or want to discuss one of our other services, get in touch with the team today. We’ll be happy to help.