February 13, 2025

Commercial Property Valuation: How to Calculate Commercial Property Value

When building your commercial real estate portfolio, you’ll want to purchase valuable properties that provide generous returns on your investment. By relying on accurate valuation methods and partnering with a leading commercial real estate firm, you ensure you invest wisely in a property. 

When calculating an investment property’s value, there are four commercial property valuation techniques to consider. Depending on the type of property you plan to invest in, different properties may require different approaches.

Why Does Commercial Property Value Matter?

Understanding the value of a commercial property allows you to make informed and reasonable investment decisions. As a commercial real estate investor, you want to pay what is required to purchase a building and don’t want to pay more than what a property is worth. The value of a commercial property matters because:

• It allows you to make a sound investment decision.
• It protects you from paying more than is necessary to purchase a building.
• It gives you an idea of what the property would be worth if you decided to sell.

The Purchase

Commercial real estate buyers need to recognize that there is sometimes a difference between the listing price of a building and its valuation. Depending on market conditions, the listing price may exceed the property value of the building, which is why it’s necessary to take the time to calculate the property’s value.

Knowing the accurate value of the building will allow you to decide if it’s a worthwhile investment to add to your portfolio. When considering a commercial property, you should keep the following factors in mind:

• The location of the building. Location is critical to the success of a commercial building, and commercial properties in prime locations often have a higher value — and a higher potential return on investment.
• The size of the building. The overall size of the space and its ability to be divided up among multiple tenants could impact the property value.
• The building’s usage. Commercial properties are typically zoned for specific uses, with some commercial buildings being more valuable than others. Retail spaces, for example, may have a higher property value than office space, depending on the area’s location and demographics.

The Sale

Commercial property owners looking to sell one of their buildings must understand the property’s value to list it for a competitive price. Sellers are in a unique position because they want the price of the building to be attractive and appealing to commercial buyers. Still, they also want to enjoy the highest possible return on their investment. You can maximize your commercial real estate investment by:

• Making minor upgrades to boost property value and marketability. For instance, updating the lighting can make a big difference when selling your commercial building.
• Increasing the curb appeal of the building. Clean up the landscaping and ensure the parking lot is free of litter and debris.
• Partnering with a commercial real estate firm that can properly position your commercial building on the market.

What Affects Commercial Property Value?

The following factors will influence the valuation of a commercial building:

Market Conditions

Like the residential real estate market, the commercial real estate market is heavily influenced by the current economic conditions. However, the market conditions for the commercial real estate market and the residential real estate market are not always the same.

Generally speaking, commercial properties are in higher demand when the economy is strong and businesses are expanding in the local area. If the economy slows, commercial property owners may find it more difficult to secure tenants, and their overall property values will decrease.

Utility

The market value of a commercial building will be heavily impacted by its utility and usability. The most common types of commercial buildings include retail buildings, office spaces, warehouses, multifamily buildings, and mixed-use commercial properties. The utility and usability of the building impact the types of tenants you can get, with larger buildings that can be rented out to high-paying tenants being more valuable than smaller, more restricted buildings.

Supply and Demand

Naturally, supply and demand also have an impact on the overall value of a building. If fewer commercial real estate buildings are available in the local area, then low supply rates can lead to higher property values. In addition, in a strong economy, there may be heightened demand for commercial real estate, which can bolster commercial property values.

How to Value Commercial Real Estate

These are the four main methods that are used to determine the value of commercial real estate:

1. Cost Approach to Valuation

The cost approach determines a property’s value when finding comparable commercial real estate listings or similar buildings in the local area is challenging. When using the cost approach, the building’s value is determined by calculating how much it would cost to rebuild the structure. It includes the value of the land itself, the materials needed to rebuild the building, and the labor costs associated with construction.

2. Income Approach

Real estate investors and property management firms commonly use the income approach, which focuses on the revenue a particular commercial building is expected to generate. Using the income approach, the projected income of an individual building may be determined by:

• Comparing similar local properties and the amount of income they generate.
• Accounting for inefficiencies that can be improved after purchasing the building.
• Considering costs that can be passed off to tenants after the purchase of the building.
• Discounting any expected future income to accurately determine the current value of the building.

This valuation approach may be best for multi-unit buildings that will be quickly rented out to available tenants.

3. Sales Comparison Approach

Sometimes referred to as the market approach, the sales comparison approach is one of the most widely used valuation methods in commercial real estate. The sales comparison approach relies on in-depth market research. Interested commercial real estate investors will evaluate the sales prices of similar commercial buildings that have sold recently in the local area. By comparing other similar properties, they can determine what the building they are considering might be worth and how much return they could generate on their initial real estate investment.

While the sales comparison approach is a relatively easy way to determine market value, relying on it in markets with fewer commercial properties available can be challenging. When using this approach, you must search for commercial properties that are similar in size, scope, and utility. If no reasonable comparison is available, it’s best to rely on a different approach.

4. GRM Approach (Gross Rent Multiplier)

The Gross Rent Multiplier method, otherwise known as the GRM approach, is often used when a building is listed for a low price, yet it could potentially offer a high return on investment. To calculate value using this approach, you would want to take the property’s listing price and divide that by its gross income. This gives you a quick calculation that you can use to compare with other nearby commercial properties, ultimately allowing you to invest in a property that will generate the most revenue.

CRE Valuation Terms to Know

• Building classification. Depending on their overall appeal, commercial buildings are classified as A, B, or C properties. The classification of a building will heavily impact its value and marketability, with Class A buildings earning the highest values and Class C buildings being the lowest-priced properties on the market.
• Capital improvements. The term refers to significant improvement projects that can impact the overall value of a building. While capital improvements often cost more, they also offer the highest investment returns.
• Capitalization rate. Known in the industry as the cap rate, this figure highlights the building’s potential investment return rate. The cap rate is calculated by dividing the net operating income of the building by its current sales price.
• Market value. This term refers to the property’s value given the current market conditions in the local area. The market value for a particular property may vary significantly based on its location and the current economic conditions.
• Return on investment. The amount of revenue an investor can expect to generate from a property. Calculating the ROI can help you determine if a property is a worthwhile investment.
• Rentable area. The size of the building that can be rented to tenants. Rentable area typically deducts common spaces used by all tenants in the building.

Contact RakowGroup

At RakowGroup, we partner with commercial real estate investors who want to build lucrative portfolios and enjoy high investment returns. Our industry expertise makes us the best commercial realty group for you. Contact us today to learn more about commercial property valuation and building an investment portfolio.