How to estimate the value of commercial property in 30 Minutes

Introduction

Global Salone has led and facilitated countless property transactions across the country for nearly a decade, chiefly in the capital, Freetown. The company has also witnessed a number of instances in which neither the buyer nor the seller is confident that they received a good deal or offer. There have been several questions: Is the asking price actually proportional to the open market value of the property; what is the total closing cost of the property; who is supposed to pay the 10% tax; and how much rental income will the property generate? In other words, buyers and sellers are usually not sure of the choice to accept or pay a certain amount for a property.

What is the Open Market Value of the Property? The Open Market Value of the property is the price realisable if the property is put up for sale on the open market for a sufficient time to attract a buyer who buys with knowledge of all the uses to which the property could be put. That is, the property is sold in a market where there are willing sellers and buyers who are fully informed regarding the property.

Real estate is a highly professional industry with many published commercial and residential investment practice guidelines. Unfortunately, this industry hasn’t attracted the appropriate attention needed for operating policies and procedures from the government and private sector in Sierra Leone. The informal sector currently dominates the industry. Most participants in the industry do not have a clue about how important this sector is. The current operation is dominated by lawyers, businesses, and a few private individuals. Most transactions are carried outside financial institutions and are intermediated by scores of unlicensed agents. Because of this, it’s apparently vulnerable to money laundering and terrorism financing.

To be sure you are making the right choice, it is strongly recommended that before you venture out into investing in a particular transaction, you perform a specific analysis to determine the most appropriate price you should ask for your property or pay for a property.

In this article, Global Salone will discuss the most critical commercial real estate analysis you need to complete before buying commercial property in Sierra Leone using the basics of the Residual Valuation Method.

How to Determine the right price for commercial real estate property.

Determining the right price involves defining all possible uses to which you can put the property to estimate the rental value, otherwise referred to as gross operating income. After you have come up with various benefits, you can then determine how much is paid for similar property based on the square meter (size of the plot) of comparable space in the neighbourhood, zone, locality, or street.

Assuming it’s a shop or office building along Circular Road, Freetown, you may want to know how much is paid for similar shops or office spaces in the neighbouring buildings. You must also take into consideration the vacancy rate. That is, how often the property remains unrented, and you must be able to calculate the vacancy to make sure your rental estimates are as accurate as possible.

Next, you must consider how much you would pay to rent, run or maintain the property annually. These include agency service /property management fees, withholding taxes, city rate, water rate, minor repair and maintenance, and insurance. If you subtract these from the gross annual rents, you will arrive at net operating income (NOI). See table 1.0

Revenue Estimate
Rental
Description	Amount (SLL)	Amount (SLL)
Gross Rental Income		150,000,000
Operating Expenses
Property Management fee	7,500,000
Utilities	–
Insurance	1,000,000
Repair & Maintenance	10,000,000	18,500,000
		131,500,000
Taxes		10,000,000
Net Operating Income		121,500,000
Mortgage Payment		–
Annual Cash flow		121,500,000

Table 1.0

Next, divide the Net Operating income you have just calculated by the asking price of comparable property in the neighbourhood.

For example, if the asking price of a similar property is SLL1,000,000,000 and the calculated net rental income (NOI) is SLL121,500,000, Thus, the cap rate would be 12.5% (121,500,000/1,000,000,000 = 0.1215 * 100 = 12.15%).

What if other properties in the neighbourhood also sold for a similar amount but only yielded SLL100,000,000 in NOI? The cap rate for that property would be 10%. In this case, a lower cap rate could be caused by a lower NOI due to higher operating costs (which would mean less investment profit) or less property income.

By analysing the cap rate and the net operating income, you can get a sense of the potential return on the property you’re looking to buy. You can determine if the asking price is too high or not.

Now, when you divide NOI by the capitalisation rate (Cap Rate), you have the price or rough value of the property. The capitalisation rate, or cap rate, is a calculation tool used to value real estate, primarily commercial and multi-family properties.

After these calculations, you must know the property’s asking price. Is it too high or not? If it’s a good investment or you need a good negotiation. See the example below:

Table 3.0

Estimate
House
Description	Amount(SLL)	Amount (SLL)
Asking Price		1,500,000,000
Solicitors fee (10%)	100,000,000
Property Survey	5,000,000
Agent fee 5%	50,000,000	155,000,000
Site Improvement		250,000,000
Total Cost		1,905,000,000

Estimate
Bareland
Description	Amount(SLL)	Amount (SLL)
Asking Price		1,000,000,000
Solicitors fee & Reg. (10%)	100,000,000
Property  Survey (Neg)	5,000,000
Agent fee (5%)	50,000,000	155,000,000
Development Cost		800,000,000
Total Cost		1,955,000,000

Suppose a good tenant already occupies the property in question. In that case, you only need to confirm how much revenue the property is generating, the current lease with the tenant, and what you can do to improve the property’s income, like landscaping to optimise the parking, remodelling the entire structure to provide for more office or shop space, etc. 

Moreover, there is also a hidden cost in property transactions that you must be aware of. I have personally had bitter experiences with clients who aren’t conscious of these hidden costs. For better analysis, these costs must be added to the asking price. The costs you pay to the solicitor for preparing title transfer documentation and registration at the Office of the Administrator and Registrar General, Roxy Building; the land surveyor for a survey and signing by the Director, Survey and Land at the Ministry of Land, Housing and Country Planning; and agency/agent service fee (if necessary).

Finally, there is another noteworthy tax in Sierra Leone that many commercial real estate buyers aren’t acquainted with. The gains on disposal tax, or 10% NRA, as it is popularly called. Sections 57(2) (3) of the Income Tax Act of 2000 explain CGT as “the gain from the disposal of an asset is the excess of the consideration received over the adjusted cost base of the asset. And, the loss from the disposal of an asset is the excess of the adjusted cost base over the consideration received”. According to the income tax act of 2000, this tax is actually supposed to be paid by the seller (Vendor) on the gains they earned by disposing of the property.

Table 2.0

COMPUTATION FOR  25% CGT
CAPITAL GAINS TAX
Description	Amount (SLL)	Amount (SLL)
Sales Price		1,000,000,000
Less:  Cost base
Initial Cost of the property	300,000,000
Improvement/Construction	500,000,000
Legal fee	7,500,000
Wear & Tear (10%)	10,000,000
Total Cost		817,500,000
		182,500,000
Less Tax allowance		3,600,000
Taxable Gains		178,900,000
25% CGT		44,725,000

According to the Finance Act of 2022, it is 25% on taxable gains and is to be withheld by the buyer and paid to the NRA. Unfortunately, most buyers didn’t know this and ended up bearing it fully.

The problem is that it is never discussed during the negotiation. As soon as it does come up during payment, it usually leads to a dispute. Therefore, one must be wise to mention it during the negotiation as to who shall bear the CGT. It involves computation, and the final amount is what is actually paid to the National Revenue Authority (NRA). It is calculated as below:

In addition, it’s also essential to take note of the site improvement cost and any possible major refurbishment or renovation needs. If it is bare land, you must be able to come up with the demolition and development cost of the new proposed building added to the asking price, plus all other incidental expenses. See sample examples of estimates.

Finally, at this stage, you realise that buying commercial real estate is not business. Many people have defended this because of a history of buying commercial real estate. Intuitively, many have also performed this task without becoming aware of the valuation tools.

Bottom line

Suppose you wish to know the amount credited to your account yearly. In that case, you can prepare the cash flow analysis to determine the return on investment or cash on cash return. These tools reveal how long it will take for the property to reap its initial investment. They are calculated thus:

Cash on Cash Return = Cash-on-Cash Return measures the investor’s annual return on the property with the amount of mortgage paid during the same year. Before-tax Cash Flow/Total Cash Invested = Cash on Cash Return.

Based on our estimate above, the cash-on-cash return is thus = SLL121,500,000/1,818,000,000 = 6.68%. This percentage means the property rental income will recoup 6.68% of the initial capital investment yearly. It will take approximately 15 years before the investment recoups its original cash investment. We have assumed that the investment was 100% buyer funded without any mortgage.

Table 4.0

Revenue Estimate
Rental
Description	Amount(SLL)	Amount (SLL)
Gross Rental Income		150,000,000
Operating Expenses
Property Management fee	7,500,000
Utilities	–
Insurance	1,000,000
Repair & Maintenance	10,000,000	18,500,000
		131,500,000
Taxes		10,000,000
Net Operating Income		121,500,000
Mortgage Payment		–
Annual Cash flow		121,500,000

Is this example a worthwhile investment or not? Let’s start the conversation. Let us know what you think about this analysis.

Conclusions

 It would be best if you were sure you are not paying too much or missing a groundbreaking deal (by walking away) in any real estate transaction you want to enter, be it commercial, industrial, luxury or residential.

Global Salone Property and Investment Company Limited offers a complete real estate investment strategy and consulting. Our exceptional expert advice is trustworthy, conclusive, and unbiased. In Sierra Leone, we have provided these services to several businesses and individual clients.

Ismail Sheku Umarr Kebe

BSc (Hon) Applied Accounting, IPAM, USL.

Trained Real Estate Asset Manager, Valuer and Broker.

Head of Operation, Global Salone Property and Investment Company Limited with Eight years of progressive experience in Brokerages and property management in Sierra Leone

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