How commercial real estate values are set
Commercial real estate values are set mostly by income: a buyer pays for the net operating income a building produces, priced at the return the market expects on that income. For apartment buildings of five units or more, that usually means dividing NOI by a market cap rate.
Houses are priced mainly by comparing them with similar homes nearby. Income property is different because the buyer is buying a stream of rent. Two identical buildings on the same street can sell for very different prices if one collects 20% more rent or spends far less on operations.
The cap rate carries the market’s view of risk. It reflects the location, the age and condition of the building, the tenant base and how much work the buyer sees ahead. A lower cap rate means buyers will pay more for each dollar of income; a higher cap rate means they want a bigger return for the risk.
How to determine commercial real estate value: the three approaches
There are three accepted ways to value a commercial property: the income approach, the sales comparison approach and the cost approach. Appraisers usually work through all three and then explain which one they lean on most and why.
For apartment buildings, the income approach almost always carries the most weight, with comparable sales used as a check. The cost approach matters most for newer buildings, special-use properties and insurance.
| Approach | Core question | Main inputs | Best for |
|---|---|---|---|
| Income | What is the income worth? | Rent roll, expenses, NOI, cap rate or discount rate | Stabilized apartment and commercial buildings |
| Sales comparison | What have similar buildings sold for? | Recent sales, price per unit, price per square foot, GRM | Checking the income result; smaller buildings |
| Cost | What would it cost to replace? | Land value, construction cost, depreciation | New construction, unusual properties, insurance |
Valuation of a commercial property vs an apartment building
The valuation of a commercial property uses the same three approaches whether it is an office, a shopping center, a warehouse or an apartment building; what changes is which inputs carry the most risk. Fannie Mae defines multifamily housing as rental housing with five or more units, and lenders finance and appraise those buildings as commercial property, valued on income rather than on house comparables.
The biggest difference is the lease. An apartment building has many tenants on short residential leases, so income resets often and one move-out barely shows up in NOI. An office, retail or industrial building may have a few business tenants on multi-year leases. There, the appraiser reads each lease: how many years remain, what the rent steps are, whether the tenant can leave early, and how strong the tenant’s credit is. A building with one tenant and a lease ending next year can be worth far less than its current NOI suggests.
Expenses work differently too. Many retail and industrial leases are net leases, where the tenant pays some or all of the property taxes, insurance and maintenance. Apartment owners usually pay those costs themselves, which is why apartment NOI is a smaller share of gross rent and why expense figures deserve a close look on a multifamily valuation.
Finally, the unit of comparison changes. Apartment sales are compared per unit and by gross rent multiplier. Office and retail sales are usually compared per square foot of leasable space, and warehouses per square foot of building area. Use the measure buyers in that property type use, or your comparable sales won’t line up.
| Factor | Apartment building (5+ units) | Office, retail or industrial |
|---|---|---|
| Main valuation method | Income approach, checked by sales per unit | Income approach, often with a DCF built on each lease |
| Tenants | Many households | Often one to a handful of businesses |
| Lease length | Short, renewed often | Often several years, with rent steps |
| Who pays operating costs | Mostly the owner | Often the tenant, under a net lease |
| Biggest income risk | Vacancy, collections, expense growth | A key tenant leaving and the cost to re-lease |
| Comparison unit | Price per unit, gross rent multiplier | Price per square foot |
The income approach, step by step
The income approach turns one year of net income into a price. The calculator on this page uses this method, called direct capitalization, and works through the same steps an underwriter would.
- Start with gross annual rent: the rent roll for all units over twelve months.
- Subtract the vacancy allowance: gross rent multiplied by your vacancy percentage.
- Add other income such as laundry, parking, storage or pet fees. The result is effective gross income.
- Subtract operating expenses, entered as a dollar amount or as a percentage of effective gross income. What remains is net operating income (NOI).
- Divide NOI by the market cap rate, written as a decimal. That is the estimated value.
- The calculator repeats the division at your cap rate minus 0.5% and plus 0.5% to show a range, and divides value by your unit count if you enter one.
A worked example: a 20-unit building
Take a 20-unit building with $300,000 in gross annual rent. A 5% vacancy allowance removes $15,000. Laundry and parking add $15,000 back, so effective gross income is $300,000. Operating expenses run 40% of that, or $120,000, which leaves NOI of $180,000.
At a 6% cap rate, $180,000 ÷ 0.06 gives an estimated value of $3,000,000, or $150,000 per unit. At 5.5% the same income supports about $3,272,700. At 6.5% it supports about $2,769,200. Half a point of cap rate moves this building’s value by roughly $250,000 in each direction, which is why the range matters as much as the single number.
Now cross-check. Say three similar buildings nearby sold in the past year for $140,000, $155,000 and $162,000 per unit. After adjusting for age and condition, a range of $145,000 to $158,000 per unit points to about $2.9 million to $3.16 million, which brackets the income result. The gross rent multiplier is $3,000,000 ÷ $300,000 = 10.0, which you can compare with the GRMs of those same sales.
A cost check might look like this: land worth $450,000, plus 18,000 square feet at a replacement cost of $220 per square foot ($3,960,000), less 35% for age and wear ($1,386,000). That gives about $3,024,000. When all three methods land near each other, you can trust the estimate more.
| Method | Calculation | Indicated value |
|---|---|---|
| Income (6% cap) | $180,000 NOI ÷ 0.06 | $3,000,000 |
| Income range | 5.5% to 6.5% cap | $2,769,200 to $3,272,700 |
| Sales comparison | 20 units × $145,000 to $158,000 | $2,900,000 to $3,160,000 |
| Cost | $450,000 land + $3,960,000 cost − $1,386,000 depreciation | $3,024,000 |
A second example: valuing an 8-unit building
Smaller buildings use the same math, but the cap rate and the expense ratio are often higher, and there are fewer sales to compare against. Here is an 8-unit building with average rents of $1,050 a month.
Gross potential rent is $100,800 a year. A 6% vacancy allowance removes $6,048, and $1,200 of laundry income brings effective gross income to $95,952. Expenses run 45% of that, or about $43,178, leaving NOI of about $52,774. At a 7% cap rate, the building is worth about $753,900, or roughly $94,200 per unit. At 6.5%, about $811,900. At 7.5%, about $703,600.
The gross rent multiplier is about $753,900 ÷ $100,800 = 7.5. If two similar buildings in town sold at GRMs of 7.2 and 7.8, the income result sits between them and you can be fairly confident in it. If the only recent sale was a renovated building at a GRM of 9, don’t raise your number to match; that building likely had lower expenses or newer systems.
| Cap rate | Value | Per unit |
|---|---|---|
| 6.5% | $811,900 | $101,488 |
| 7.0% | $753,900 | $94,238 |
| 7.5% | $703,600 | $87,950 |
Discounted cash flow: the second income method
A discounted cash flow (DCF) values a building by forecasting several years of NOI plus a sale price at the end, then discounting all of it back to today at the buyer’s required return. It is the method larger buyers and appraisers use when income is expected to change, such as a building with below-market rents or a planned renovation.
Direct capitalization assumes this year’s income is a fair picture of the future. A DCF lets you model a lease-up, rent increases as leases roll, or a big roof replacement in year three. The tradeoff is that it depends on more assumptions, especially the exit cap rate, so small changes can swing the result.
The sales comparison approach
The sales comparison approach values a building by what similar buildings in the same market sold for recently. For apartments, the comparison is usually made per unit, per square foot or by gross rent multiplier.
No two buildings are the same, so appraisers adjust each sale. A comparable with newer roofs and in-unit laundry gets adjusted down to match an older building; one in a weaker block gets adjusted up. Date matters too. A sale from 18 months ago may need a market adjustment if interest rates or cap rates have moved since.
This approach is weakest when there are few recent sales of similar buildings, which is common for 5 to 20 unit properties in smaller markets. In that case, the income approach does most of the work.
The cost approach
The cost approach values a building at the land value plus what it would cost to build the same improvements today, minus depreciation for age, wear and outdated design. The logic is that a buyer would not pay more for an existing building than the cost of building a new one.
For older apartment buildings, depreciation is hard to measure, so the cost approach is rarely the main method. It is still useful as a ceiling, for newer construction, and for setting insurance replacement values.
How to evaluate a commercial property before you price it
To evaluate a commercial property, a buyer checks whether the income is real, whether it will last and what it will cost to keep the building running. The value estimate is only as good as the numbers behind it.
These are the items a serious buyer or appraiser will ask for:
- A current rent roll with lease dates, deposits and any concessions.
- A trailing twelve-month (T12) operating statement and the last two years of profit and loss.
- Property tax bills, insurance declarations and utility bills.
- A list of capital work done in the last five to ten years: roof, boilers, plumbing, electrical, parking lot.
- Any open code violations, permits or insurance claims.
- Market rents for similar units nearby, to see whether current rents are below, at or above market.
How to price a commercial property for sale
To price a commercial property, start with the income approach using actual collected rents and realistic expenses, then test the result against recent comparable sales per unit. Price near where both methods overlap.
Pricing on pro forma rents or a cap rate from a stronger market is the most common reason buildings sit unsold. Buyers will underwrite the building themselves, so an asking price built on numbers they can verify gets to a signed offer faster than one built on hope. If you have below-market rents, show the gap with real comparables and let the buyer price the upside.
Commercial real estate appraisal cost
A commercial real estate appraisal for an apartment building commonly costs a few thousand dollars, with industry sources often citing about $2,000 at the low end, around $4,000 as typical and more than $10,000 for large or complex properties. Turnaround is usually measured in weeks, not days.
The fee depends on the size of the building, the number of units, how many comparable sales the appraiser must research, whether a full narrative report is needed, and the lender’s requirements. For most commercial loans, the lender orders the appraisal from a state-certified general appraiser who follows the Uniform Standards of Professional Appraisal Practice (USPAP), and the borrower pays for it.
Federal banking rules set a $500,000 threshold for commercial real estate loans. At or below that amount, a federally regulated bank may use a simpler evaluation instead of a full appraisal, according to the 2018 rule from the Federal Reserve, FDIC and OCC. Above it, an appraisal is generally required.
| Valuation type | Who usually orders it | Typical use |
|---|---|---|
| Broker opinion of value | Seller | Setting an asking price; usually free |
| Evaluation | Lender | Commercial loans at or below $500,000 |
| Full appraisal (USPAP) | Lender or owner | Larger loans, estates, tax appeals, partnerships |
Reading your results
Treat the estimate as a starting point for conversations, not a final price. The cap rate you enter carries most of the weight, so use one drawn from recent sales of similar buildings in your area, or ask a broker what comparable properties are trading at.
Price per unit is a quick cross-check. If your result lands far above or below what similar buildings have sold for per unit, revisit your expense figure and your cap rate before relying on the number.
Mistakes that inflate or deflate the estimate
Most gaps between an owner’s estimate and a buyer’s offer trace back to a handful of inputs.
- Using asking rents or pro forma rents instead of rents actually being collected.
- Entering zero vacancy. Buyers apply a vacancy allowance even to a full building.
- Leaving out expenses the owner handles personally, such as management or routine repairs. A buyer will budget for them.
- Using last year’s property tax bill when a sale will trigger a reassessment in your state.
- Subtracting mortgage payments. Debt service is not an operating expense and does not belong in NOI.
- Picking a cap rate from a different market or a different class of building.
Selling to Skyline Capital
Skyline Capital Investments buys apartment buildings of five units or more nationwide, in any condition. We buy directly, close on your timeline, and can work inside 1031 deadlines. Send your rent roll and T12 through the form on this page and we will review the building on its actual numbers.
