How is commercial real estate valued?
Commercial real estate is valued mainly on the income it produces, not comparable sales. The dominant method is the income approach — divide a property’s net operating income by a market cap rate to estimate value. Appraisers also use the sales-comparison and cost approaches, but for income property, income leads.
Income leads, because you’re buying cash flow
A home is priced against comparable homes. An income property is priced against the money it generates — a buyer is really purchasing a stream of cash flow, so value follows the income and the return the market requires. That’s why the income approach dominates.
| Net operating income | $140,000 |
| Market cap rate | 7.0% |
| Estimated value ( $140,000 ÷ 0.07 ) | $2,000,000 |
The three approaches to value
- Income approach. The primary method for income property — direct capitalization (NOI ÷ cap rate) for stabilized assets, or discounted cash flow (DCF) for complex or value-add deals.
- Sales-comparison approach. Recent comparable sales, usually on a per-square-foot or per-unit basis. Most useful for owner-user buildings, land, or where income data is thin.
- Cost approach. Land value plus the cost to rebuild, minus depreciation. Reserved for new construction or special-purpose properties with few comparables.
Discounted cash flow, briefly
For deals with changing income — lease-up, renovations, rolling rents — a DCF projects each year’s cash flow plus a sale (“reversion”) at the end, then discounts them back to today’s dollars. It’s more work than direct capitalization, but it captures a story that a single year’s NOI can’t.
How you actually raise a property’s value
Two levers, both visible in the formula: increase NOI (raise rents, cut expenses, lease up vacancy) or lower the cap rate the market applies (better tenants, longer leases, a stronger asset). Forcing NOI upward is the heart of nearly every value-add strategy.