How to Value Commercial Property: Income, Sales and Cost Approaches
Commercial property is valued three ways: by the income it produces (net operating income divided by a capitalization rate), by what comparable buildings have sold for, and by what it would cost to replace the building, less depreciation, plus the land. For a leased investment building the income approach usually carries the most weight. For an owner-occupied building, sales comparison often matters more, and the cost approach matters most for new or special-purpose property.
This guide explains each approach with a simple worked example, how lenders look at the same numbers, the California items that move value, and how a broker’s opinion differs from a formal appraisal. It’s written for owners thinking about a sale or refinance and for buyers checking an asking price. For the bigger picture, see our commercial real estate hub.
The three approaches at a glance
| Approach | Core question | Carries the most weight for | Main weakness |
|---|---|---|---|
| Income | What will an investor pay for this income stream? | Leased office, retail, industrial and multifamily investments | Small changes in the cap rate or NOI swing value a lot |
| Sales comparison | What have similar buildings sold for? | Owner-user buildings, small properties, land | Few truly comparable sales in small North Bay markets |
| Cost | What would it cost to build this today, less wear and obsolescence, plus land? | New construction, special-purpose buildings, insurance | Depreciation is hard to measure on older buildings |
Appraisers usually consider all three and then reconcile them, explaining which deserves the most weight for the property and the purpose of the valuation.
The income approach: NOI and cap rate
Direct capitalization divides one year of stabilized net operating income by a capitalization rate. NOI is rental and other income, less vacancy and credit loss, less operating expenses; it excludes loan payments, depreciation and income taxes. Our guide to calculating net operating income walks through each line, and our cap rate guide explains what the rate does and doesn’t tell you.
A worked example (hypothetical figures)
| Line | Amount |
|---|---|
| Potential gross rent, 12,000 sq ft at a hypothetical $1.75 per sq ft per month | $252,000 |
| Less vacancy and credit loss at 5% | -$12,600 |
| Effective gross income | $239,400 |
| Less operating expenses not reimbursed by tenants | -$47,400 |
| Net operating income | $192,000 |
| Value at a 6.5% cap rate ($192,000 / 0.065) | about $2,954,000 |
| Value at a 7.0% cap rate | about $2,743,000 |
The cap rates above are illustrations, not market figures. Half a point of cap rate moved this hypothetical value by roughly $211,000, which is why buyers and sellers argue hardest about the rate and about which NOI is real.
What makes the NOI believable
- Leases, not pro formas. Value the rent that signed leases actually support, and treat projected lease-up separately.
- Who pays expenses. A net lease shifts taxes, insurance and maintenance to the tenant; a gross lease leaves them with the owner. Our page on commercial lease types explains the differences.
- Tenant credit and term. A long lease to a strong tenant usually supports a lower cap rate than a short lease to a new business. See our guide to buying NNN leased property.
- Confirmed rent rolls. Buyers check the rent roll against tenant estoppel certificates before closing.
For buildings with uneven income, such as a lease-up or a major tenant rolling soon, appraisers may use a discounted cash flow, projecting each year’s income and a sale at the end and discounting them to today.
The sales comparison approach
This approach starts from recent sales of similar buildings and adjusts for differences: size, age and condition, location, parking, ceiling height, zoning and how much of the building was leased at sale. Results are often expressed as price per square foot, or for leased buildings, as the cap rate implied by each sale.
It is the approach owner-users relate to most, because a business buying its own building is comparing it with other buildings it could buy, not with an investor’s yield. Our guide to buying a building for your business covers that decision.
The weakness in smaller North Bay markets is the number of truly comparable sales. When the nearest comparable is in another city or a year old, the adjustments carry more of the conclusion, so ask how each one was made.
The cost approach
The cost approach adds the land’s value to the cost of building the improvements new today, then subtracts depreciation:
- Value the land as if vacant, usually from land sales.
- Estimate replacement cost new for a building of the same utility.
- Subtract depreciation: physical wear, functional problems such as a poor layout or low clear height, and external factors such as a weak location.
- Add the depreciated improvements to the land value.
It’s most useful for new buildings and for special-purpose property with few sales or rents to compare, such as wineries, schools or churches. On wine-country property, our guides to winery valuation and vineyard valuation explain how permits, vines and water change the picture.
How lenders use the same numbers
A lender cares about value, but it also cares whether the income covers the loan. The debt service coverage ratio (DSCR) is NOI divided by annual principal and interest. A DSCR of 1.25, for example, means NOI is 25% more than the loan payments.
Lenders set their own minimum DSCR and maximum loan-to-value in their terms, and a loan is sized by whichever limit is tighter. In the hypothetical above, if a lender required a 1.25 DSCR, the most annual debt service the $192,000 NOI could carry would be $153,600, whatever the appraised value.
Federal banking rules also decide when a formal appraisal is required. Under 12 CFR 34.43, the rule for national banks, a commercial real estate transaction of $500,000 or less doesn’t require an appraisal, though the lender must still obtain an appropriate evaluation. Larger commercial loans generally need an appraisal unless another exemption in the rule applies, and a lender can require one at any size.
California items that move commercial value
- Property tax reassessment. Under Proposition 13, a change in ownership triggers reassessment to fair market value as of the date of the change, according to the Board of Equalization. A buyer’s NOI should use the reassessed tax, not the seller’s bill. The creation of a lease of 35 years or more can also be a change in ownership for the leased portion. Our page on property tax for investors covers entity transfers.
- Ground leases. A building on leased land is valued on the leasehold, so the remaining term, rent resets and reversion terms matter as much as the building.
- Accessibility exposure. California requires commercial leases to state whether the premises have had a Certified Access Specialist (CASp) inspection. Known access barriers are a cost a buyer will price in; see our CASp and ADA guide.
- Environmental and hazard issues. Contamination, flood zones, fire hazard zones and seismic retrofit needs can reduce value or limit financing.
- Zoning and permits. A legal nonconforming use, or a use permit that limits operations, can make a building worth more or less to the next owner.
Broker opinion of value versus an appraisal
A broker opinion of value, or broker price opinion, is a market-based estimate that a broker prepares to help price a listing or test an offer. It draws on the same three approaches, especially comparable sales and the income approach, but it isn’t an appraisal and doesn’t substitute for one where a lender, court or tax authority requires an appraisal. Our page on broker price opinions describes how they’re prepared.
Formal appraisals are governed by the Uniform Standards of Professional Appraisal Practice (USPAP), which the Appraisal Standards Board of The Appraisal Foundation updates as needed; the Foundation lists the 2024 edition as current as of October 2026. In California, the Bureau of Real Estate Appraisers (BREA) licenses appraisers at four levels: trainee, licensed residential, certified residential and certified general. BREA’s website includes a search tool for checking an appraiser’s license.
Some commercial appraisers also hold the MAI designation from the Appraisal Institute. The Institute describes MAI members as appraising all types of real property, including commercial, industrial, agricultural, residential and vacant land, under its code of ethics and continuing education requirements. A designation is a professional credential, not a license.
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Questions people ask
What is the most common way to value commercial property?
For leased investment property, the income approach: net operating income divided by a cap rate. Appraisers usually also consider comparable sales and cost and reconcile the three.
What cap rate should I use?
There is no single right rate. It depends on property type, location, tenant credit, lease term and interest rates at the time, so it should come from recent comparable sales and current investor surveys, not a rule of thumb.
Is a commercial appraisal required for a loan?
Usually, above federal thresholds. Under 12 CFR 34.43, commercial real estate transactions of $500,000 or less are exempt from the appraisal requirement, but the lender must still obtain an evaluation. Lenders may require an appraisal anyway.
How is an owner-occupied building valued?
Mostly by sales comparison, because buyers of owner-user buildings compare them with other buildings they could buy. The income approach is used too, based on market rent for the space.
Does a sale change the property taxes a buyer should budget?
Yes. A change in ownership is generally reassessed to fair market value as of the date of the change, so a buyer’s NOI should use the new tax, not the seller’s.
What does MAI mean on an appraiser’s credentials?
It’s a designation from the Appraisal Institute for appraisers who work across property types, including commercial and industrial. It’s separate from the California license that BREA issues.
Is a broker opinion of value the same as an appraisal?
No. It’s a broker’s market estimate for pricing a listing or an offer. It isn’t prepared under USPAP as an appraisal, and lenders and courts that require an appraisal won’t accept it in its place.
Considering a sale, refinance or purchase? We can review the leases, operating statements and comparable sales with you before you set a price or make an offer. Our page on selling commercial property covers the rest of the process, or contact us to start.
This page is general information, not appraisal, legal or tax advice. Value conclusions that matter for a loan, estate, tax filing or dispute should come from a California-certified appraiser, with your tax adviser and attorney reviewing how they’re used.
Sources & notes
- Cornell LII: 12 CFR 34.43, appraisals required and transactions exempt
- The Appraisal Foundation: Uniform Standards of Professional Appraisal Practice
- California Bureau of Real Estate Appraisers
- Appraisal Institute: Our designations (MAI)
- California State Board of Equalization: Change in ownership FAQs
- California Public Law: Civil Code section 1938 (CASp statement in commercial leases)
Note: all rents, expenses, cap rates and DSCR figures on this page are hypothetical illustrations, not market data.
Last reviewed October 2026 by Matthew Martinez.
