To value commercial real estate, rebuild the property's net operating income from its leases and capitalize it at a rate taken from recent sales. Then check that figure against comparable sales and replacement cost, and deduct what it will cost to fill any empty space. Work in that order, because each step catches an error the next one would carry forward.
- Define the assignment. Write down what you are valuing: the building with its leases, or as if free of them. Note the date and the purpose, such as a purchase, a loan or a tax appeal.
- Collect the file. The rent roll lists every tenant, its space, its rent and its lease dates. Ask for it with the documents in the table below.
- Test highest and best use. Decide whether the current building is the most valuable use of the site, with the four tests in the next section.
- Rebuild net operating income. Net operating income (NOI) is rent and other income minus the costs of running the property, before mortgage payments and income tax. Use market vacancy, a management fee and a reserve for replacements, even where the seller's pro forma NOI leaves them out.
- Run each approach that applies. Divide NOI by a capitalization rate drawn from closed sales. Compare the result with adjusted sales of similar buildings, and with land value plus the depreciated cost of rebuilding.
- Reconcile and deduct. Weigh each approach by how reliable it is for this building, then subtract lease-up costs, below-market leases and deferred repairs.
The three approaches applied to one industrial building show step 5 in full. US banking regulators ask for step 3 too. An appraisal "should reflect an analysis of the property's sales history and an opinion as to the highest and best use of the property" (Interagency Appraisal and Evaluation Guidelines).
| Document | What it tells you |
|---|---|
| Rent roll | Who pays what, for how much space, until when |
| Leases | Rent steps, renewal options and which costs tenants pay back |
| Operating statements for two to three years | Actual expenses and how they trend |
| Tax and insurance bills | Two large costs that can change after a sale |
| Record of capital spending | The age of the roof, the heating plant and other big items |
| Estoppel certificates | Each tenant's own statement of its rent and lease terms |
Highest and best use is the reasonable and probable use of a property that supports the highest present value on the appraisal date. The California State Board of Equalization teaches assessors four tests, and a use must pass all of them (California State Board of Equalization, appraisal lesson):
- Legally permissible: zoning and other rules allow it.
- Physically possible: the site's size, shape, topography and utilities can carry it.
- Financially feasible: demand for the use covers its costs and returns the investment.
- Maximally productive: of the feasible uses, it gives the highest land value.
The test matters most for old, low buildings on valuable land. A one-storey retail strip on a corner zoned for six storeys can be worth more as a development site than as a building. Its value then starts from the land, less the cost of demolition, and the current rents only carry the owner until construction.
A building with empty space or rents below market is worth its stabilized value minus the cost and the lost income of getting it there. US appraisal rules require it for "partially leased buildings" and "non-market lease terms". The deductions "should include items such as leasing commission, rent losses, tenant improvements, and entrepreneurial profit" (Interagency Guidelines, deductions and discounts).
Take a 50,000 square foot multi-tenant industrial building where similar space leases at $14 per square foot on triple net terms. 12,000 square feet sit empty, and one tenant pays $11 on 20,000 square feet with three years left on its lease.
- Stabilized: fully leased at market rent, the building would bring in $700,000 a year. Less a 5% vacancy allowance and $35,000 of costs the leases do not pass through, its NOI is $630,000. At a 7% cap rate, its as-stabilized value is $9,000,000.
- Today: it earns $389,000, which is $472,000 of rent minus the same $35,000 and $48,000 of property costs the owner carries on the empty space.
The appraiser starts from the stabilized figure and subtracts what the lease-up will cost, assuming the empty space takes 12 months to fill:
| Step | Amount |
|---|---|
| As-stabilized value: $630,000 of NOI at a 7% cap rate | $9,000,000 |
| Rent lost on 12,000 sq ft for 12 months at $14 | −$168,000 |
| Property costs on the empty space for 12 months at $4 per sq ft | −$48,000 |
| Tenant improvements at $15 per sq ft | −$180,000 |
| Leasing commissions: 6% of a five-year lease's rent | −$50,400 |
| Entrepreneurial profit: 10% of the four costs above | −$44,640 |
| Loss to lease: $3 per sq ft on 20,000 sq ft for three years, discounted at 8% | −$154,626 |
| As-is value | $8,354,334 |
The as-is value lands 7.2% below the stabilized figure. Capitalizing today's $389,000 at the same 7% gives $5,557,143, about a third lower again, because it treats the empty space as empty forever. A seller who quotes the stabilized value counts rent nobody pays yet. A buyer who quotes the in-place value counts a vacancy the market will fill. The deduction table prices the lease-up once.
Loss to lease is the gap between the rent a tenant pays under its lease and the market rent for the same space. In the example, the tenant paying $11 against a $14 market creates $60,000 a year of loss to lease until its lease ends. A buyer takes the building subject to that lease, an ownership appraisers call the leased fee. US guidance covers a long lease to a highly rated tenant at a rent below market. There, "the market value of the leased fee interest would be less than the market value of the unencumbered fee simple interest" (Interagency Guidelines, non-market lease terms).
As-is value is the property's market value in its current condition, use and zoning on the appraisal date. As-stabilized value is its market value at the time it should reach stabilized occupancy. Lenders ask for both on a building in transition. For construction or renovation, a lender "would generally request" the as-is value plus, as applicable, a prospective value on completion or stabilization (Interagency Guidelines, market value). The gap between the two is the deduction table above. Both figures feed how lenders underwrite a commercial real estate loan.
Replacement cost is what it would cost today to build a building of equal use. Since 2019 it has risen far faster than the prices buyers pay for existing commercial property. The Bureau of Labor Statistics producer price index for new office building construction averaged 142.6 in 2019. It reached 224.6 in September 2026, a 57% rise (FRED, office construction prices). The Federal Reserve's commercial real estate price index rose 9.5% from its 2019 average to the second quarter of 2026 (FRED, commercial property prices).
Source: U.S. Bureau of Labor Statistics, producer price index for new office building construction (PCU236223236223, monthly), and Board of Governors of the Federal Reserve System, Financial Accounts of the United States, commercial real estate price index (BOGZ1FL075035503Q, quarterly), via FRED. Each series rebased to its 2019 average = 100.
The gap changes how the cost approach reads in both directions:
- A cost estimate from 2019 is stale. Priced at 2019 construction costs, the replacement cost of an office building comes out more than a third below today's figure.
- A current cost estimate runs high. Land plus today's building cost can land well above what buyers pay for an existing building. The appraiser has to deduct external obsolescence, the loss of value caused by conditions outside the property, such as weak demand or higher interest rates.
- "Below replacement cost" says little on its own. When building costs outrun prices this far, many sales can carry that label. The test is whether market rents would justify building new; if they would not, the building's value rests on its income.
A commercial appraisal follows the same steps as any valuation. A credentialed appraiser carries them out and signs an opinion of market value as of a stated date. US rules set the bar for lenders. Federally related commercial real estate deals above $500,000 "shall require an appraisal prepared by a State certified appraiser" (12 CFR 34.43).
The appraiser's work runs in five stages:
- Scope of work: the client, the intended use, the interest valued (with or without its leases) and the effective date.
- Inspection: the building, its systems and its surroundings.
- Market research: sales, leases, vacancy and new supply in the submarket.
- Analysis: highest and best use, then each approach that applies.
- Reconciliation and report: one value, with the reasoning and the limiting conditions behind it.
An owner can estimate what a commercial property is worth by capitalizing a realistic NOI at a market cap rate. Check the answer against recent sales per square foot. Start from the rent roll, apply the stabilized and as-is logic above, and compare the result with a broker's opinion of value. These estimates cost little and help set an asking price. A lender will still order its own appraisal.
Assessed value is the figure a tax authority uses to bill property tax. It often differs from market value because of the date it measures or the rules behind it. In Ontario, assessments for 2026 property taxes still reflect what a property would have sold for on January 1, 2016 (MPAC, assessment notices). In California, Proposition 13 reassesses property to market value on a change in ownership or new construction and generally limits annual increases to 2%. The Board of Equalization says it "converted the market value-based property tax system to an acquisition value-based system" (California State Board of Equalization, Publication 29).
Lenders test an assessment before they lean on it. A lender may base an evaluation on a tax assessment when "a valid correlation exists between the tax assessment data and the market value" (Interagency Guidelines, tax assessments).