Commercial Property is a classification of real estate. Types of Commercial Property include income-producing property such as office buildings, gasoline stations, restaurants, shopping centers, hotels and motels, parking lots and stores, and other similar uses.
Commercial properties in Pima County are primarily valued using the market approach. However, in some instances, the cost or income approach may also be used; or a correlation of all three approaches. For ad valorem purposes, single-property appraisal is not an efficient method due to the large number of properties, which must be valued each year. Therefore, the Assessor's office determines values using mass appraisal. Mass appraisal is the process of establishing values on groups of properties as of a given date using standardized procedures. Its purpose is the equitable and efficient appraisal of property for ad valorem purposes. The process involves data collection, market analysis, and quality control.
The Three Approaches to Value
There are three approaches used to determine property value. These approaches are based on three aspects of value:
- Replacement Cost: The cost of reproducing or replacing a property plus land value minus accrued depreciation
- Market (or Sales Comparison): The value indicated by recent sales of comparable properties in the market, with adjustments for age, condition, and other characteristics
- Income: The investment value represented by the net earning power of a property based on the capitalization of the income stream.
There are situations where only one or two approaches may be applicable. For instance, an owner-occupied residential property is not likely to produce rental income that could be capitalized into an estimate of value through use of the income approach. Therefore, the sales comparison or cost approaches might be more appropriate. Vacant land has no cost of improvements, so the cost approach would not be an appropriate method for that situation.
Specialized properties such as mortuaries, hospitals, or zoos do not typically change hands enough to generate comparative sales, so the cost or the income approach might be more appropriate in those cases.
The Replacement Cost Approach
Basic steps to this approach are:
- Estimate the Replacement Cost New of the improvements (RCN)
- Estimate the loss in value from depreciation
- Deduct the total amount of depreciation to arrive at the Replacement Cost New Less Depreciation (RCNLD)
- Estimate the value of the land as if vacant
- Add the land value estimate to the depreciated cost value to arrive at the total property value
Replacement Cost New is defined as the cost and overhead that would be incurred in constructing an improvement having the same utility as the original, without necessarily reproducing exactly the same characteristics of the property, but using today's materials, labor, and building techniques. In other words, replacement cost represents the cost to create an equally desirable substitute property
In Arizona for cost estimation, the unit-in-place method is used. The unit-in-place method is less detailed than the quantity survey method, but still reasonably accurate and complete. This is the method used in the Construction Cost Manual prescribed by the Arizona Department of Revenue, for many building components. These allow the appraiser to make adjustments for individual components for various types of structures.
This method combines direct and indirect costs into a single cost for a building component (the unit-in-place) which is then multiplied by the area of the portion of the building being valued to arrive at a total cost for that component.
The depreciation rates in Arizona's Department of Revenue Construction Cost Manual reflect only the physical factors affecting the value of structures. These tables were developed from market analysis. The rates assume that normal maintenance has been performed. The rate of physical depreciation is calculated based on the age of the structure and the quality of the construction. When the overall quality of an improvement is low, normal physical deterioration is more rapid than for fair or good construction.
Normal physical deterioration is calculated according to actual age. Other factors are computed as they arise in individual structures. If a structure has a serious physical defect, the appraiser will first estimate the RCN, and then compute the cost to cure the physical defect (if curable) and then deduct that amount from the RCN to arrive at RCNLD.
In ad valorem appraisal, deferred maintenance is not normally included in a valuation consideration. This would have the effect of punishing property owners who kept a property in good condition and rewarding those who let properties rundown. Special obsolescence factors may be noted and taken into consideration, but the aim is to achieve equity, so that owners of similar properties bear an equal share of the tax burden, regardless of whether they perform regular maintenance.
In situations where modernization has occurred during the life of a structure, the appraiser must estimate the RCN of each type of structure and compute the effective age and/or the weighted age.
The effective age is calculated by taking the percentage of the remodeling or modernization in relation to the whole.
The Market (or Comparative Sales) Approach
The Market Approach is based on comparison of the subject property to similar properties, which have been sold in the same market. Similarities and differences must be noted in detail—date of sale, location of property, physical characteristics, and conditions of the sale are a few examples. For investment properties, potential income should also be documented.
The conditions of the sale are extremely important when considering whether a property is comparable to the subject or not. If the parties are related, or special financing was obtained, or the seller was forced to sell by some condition of their life (a move, divorce, etc.) then the sale might have to be eliminated as invalid. Remember the definition of "market value": "the most probable price, in terms of cash, in a competitive and open market, assuming a willing and knowledgeable buyer and seller, allowing sufficient time for the sale, and assuming that the transaction is not affected by undue pressures." Some factors like size or shape or location may have to be accommodated by adjusting the value of the comparable up or down to reflect the difference between that property and the subject. The comparable is always adjusted, never the subject property.
The market approach indicates a range of possible values, rather than a precise figure, especially if few sales are available or many adjustments have to be made. In Arizona, the market approach is the most widely used for residential property valuation. It is ideal for types of property that is regularly sold. Furthermore, it may be the only valid approach for valuing properties that are very old or where reliable cost or income data is unavailable.
The Income Approach
The Income Approach is used to value commercial or industrial properties, or properties, which are bought and sold by investors primarily because of their income producing potential. This approach to value depends on reliable and detailed information on the income and the costs of doing business for a particular business or enterprise. This is referred to as the "income stream" of the property. The Income Approach defines value as "the present worth of future benefits of owning a property." These are composed of the annual income for an estimated number of years (called the economic life of the property) plus a capital amount representing land value or land value plus some remaining worth of the improvements. This approach emphasizes investment components rather than physical components of a property.
The steps in the income approach are:
- Estimate Potential Gross Income (PGI)
- Deduct vacancy and collection losses
- Add miscellaneous income to derive Effective Gross Income (EGI)
- Deduct operating expenses to derive Net Operating Income (NOI)
- Select appropriate capitalization rate and method
- Develop an estimated value
There are certain property types that are statutorily valued. Please return to the home page for further information regarding these property types.