The market value of a commercial property is determined by comparing it to recent sales of similar properties (sales comparison approach), by capitalizing its net operating income (income approach), and by estimating what it would cost to rebuild minus depreciation (cost approach). Income-producing properties lean most heavily on the income approach. A broker opinion of value gives a practical estimate, while a licensed appraisal provides a formal one.
What "market value" means
Market value is the most probable price a property would bring in a fair sale between a willing buyer and a willing seller, with both acting knowingly and neither under pressure. It is different from the following figures, which owners often confuse with it:
- Asking price. What the seller hopes to get.
- Assessed value. The value a local government assigns for property taxes, which may lag the market.
- Replacement cost. What it would cost to build the structure new.
- Insured value. The amount of coverage, which may differ from market value.
- Book value. An accounting figure based on the owner's cost and depreciation.
The three approaches to value
| Approach | How it works | Best for |
|---|---|---|
| Sales comparison | Adjusts the prices of recently sold, similar properties to account for differences | Owner-user buildings, land, small properties |
| Income | Divides NOI by a market cap rate, or discounts projected cash flow | Apartments, retail, office and industrial buildings with tenants |
| Cost | Land value plus replacement cost minus depreciation | New or special-purpose buildings with few comparables |
Appraisers often use more than one and reconcile the results.
1. Sales comparison approach
Start with recent sales of similar properties in the same submarket: same property type, comparable size, age, condition, location and tenancy. Then adjust for differences. A building with higher clear height, newer roof or better access may justify a premium over a comparable. One with deferred maintenance may justify a discount. Price per square foot is a handy unit but only meaningful when the comparisons are truly similar. Comparable sales data comes from sources such as CoStar, public records and broker knowledge. Our firm has access to CoStar.
2. Income approach
For an investment property, value follows income. The most common method is direct capitalization:
Value = Net operating income (NOI) divided by the cap rate
For example, a hypothetical building with $500,000 gross income and $150,000 operating expenses has NOI of $350,000. If similar buildings were selling at a 7 percent cap rate, the indicated value would be $5,000,000 ($350,000 divided by 0.07). If the market cap rate were 8 percent, the value would be $4,375,000. These numbers are examples only, not current market data. Notice how sensitive the result is to the cap rate. That is why finding true comparable sales and the right cap rate matters. See how to calculate NOI and what is a good cap rate.
Larger or more complex properties may use a discounted cash flow analysis, which projects income over several years and discounts it back to today's value.
3. Cost approach
This approach estimates the land's value, adds the cost to construct a similar building today, and subtracts depreciation for age and obsolescence. It is most useful for newer buildings, special-purpose properties and insurance purposes, and less useful for older buildings where depreciation is hard to measure.
What affects a property's value
- Income quality. Lease terms, tenant creditworthiness, rent compared with market rent, and the lease structure (NNN versus gross). A rent roll analysis shows the strengths and risks.
- Vacancy and rollover. Leases expiring soon create uncertainty.
- Location. Access to I-95, I-66, Route 28, the Dulles corridor, Metro and employment centers.
- Physical condition and functionality. Roof, systems, parking, clear height, floor plan.
- Zoning and development potential. Unused density or a higher-and-better-use opportunity may add value, particularly for land.
- Capital markets. Interest rates and lender appetite affect what buyers can pay.
Practical ways to estimate value
- Gather your documents. Rent roll, leases, 2 to 3 years of income and expense statements, tax bills, survey and recent capital improvements.
- Calculate NOI. Use actual figures and normalize one-time items.
- Collect comparables. A broker can pull recent sales and lease comps from CoStar.
- Request a broker opinion of value. A broker analysis estimates likely pricing and marketing strategy. It is not a certified appraisal.
- Order an appraisal when needed. Lenders, estates, partnership disputes and tax or legal matters often call for a licensed appraiser.
- Test the price in the market. The market is the ultimate judge. Listing at a reasonable price and tracking inquiries and tours reveals whether it is right.
Common mistakes owners make
- Relying on assessed value or a tax bill as the market price.
- Using the asking prices of listings rather than the closed sales.
- Overlooking deferred maintenance or lease rollover risk.
- Using a cap rate from a different property type or submarket.
- Presenting inflated income that buyers cannot verify.
- Assuming an owner-user buyer will pay the same as an investor, or vice versa. The buyer pool changes the price.
Improving value before you sell or refinance
Owners can sometimes increase value by renewing key tenants, filling vacancies, bringing below-market rents toward market when leases allow, correcting expense recoveries, and addressing deferred maintenance. If you plan to sell, a clean data package and an effective marketing plan help. Read our guide on choosing a broker to sell your property, and if you hold a building with vacancy, see how to market a commercial building for lease. Our landlord representation services can help with leasing, and you can list a property with us when you are ready.
Valuation, tax and legal questions vary by situation. Consult an appraiser, attorney and CPA for advice specific to your property.
A worked example of the sales comparison approach
For example, imagine an owner of a 12,000 square foot flex building wants a value estimate. A broker finds three recent sales of comparable flex buildings. Suppose the first sold for a hypothetical $190 per square foot but had a newer roof, the second sold for $170 per square foot with similar condition, and the third sold for $160 per square foot but was in a weaker location. The broker adjusts each sale for those differences, reviews how long each took to sell and what concessions were made, and arrives at a range rather than a single number. The owner's building might then be positioned inside that range depending on its roof, tenancy and access. These figures are hypothetical and only illustrate the reasoning. Real comparables vary by submarket and timing, which is why current data is essential.
Next step
If you want to understand what your property might be worth, call us at 703-505-3501 or use our contact page. We can discuss your property and the comparable data available.
Frequently asked questions
How do you value a commercial property?
Appraisers and brokers use sales comparison, income and cost approaches. For income-producing properties, the income approach, dividing NOI by a cap rate, usually carries the most weight.
What is the difference between a broker opinion of value and an appraisal?
A broker opinion of value is an informal estimate based on market knowledge and comparables. An appraisal is a formal report prepared by a licensed appraiser, often required by lenders and in legal matters.
Is assessed value the same as market value?
No. Assessed value is set by the local government for property taxes and may differ from what a buyer would pay.
How does the cap rate affect value?
Value equals NOI divided by the cap rate, so a lower cap rate means a higher value for the same income, and a higher cap rate means a lower value.
How much does a commercial appraisal cost?
Fees vary with property type, size and complexity. Ask appraisers for a quote and timeline.
Can vacancy change the value of my building?
Yes. Vacancy reduces income and increases risk for buyers, and a building with long-term tenants in place is generally valued differently from a vacant one.
