A family home is usually valued by comparing it with similar homes that have recently sold. Commercial property, whether it is an office floor, a retail centre or a warehouse, behaves more like an investment. Buyers pay for the income stream, so valuers lean heavily on methods that convert rent into value.
Income Capitalisation
This is the workhorse method for tenanted property. The valuer estimates the net income the property would earn in the open market, after the outgoings the owner pays, and divides it by a capitalisation rate. A simple illustration: net income of $500,000 a year at a capitalisation rate of 6.25 per cent implies a value of $8 million ($500,000 ÷ 0.0625).
The capitalisation rate is the market's yield for that type of asset, so it moves with conditions. Commercial property managers describe the rate as responding to interest rates, economic growth, vacancy rates, inflation and the strength of the tenants' leases. A lower rate implies stronger demand and a higher value for the same income, and a higher rate implies more risk.
Notably, the income used is the rent the property would achieve in the open market, whether it is currently leased or vacant. If a tenant pays above or below market rent, the valuer adjusts for that gap.
Discounted Cash Flow
Discounted cash flow (DCF) forecasts the property's income and costs over a holding period, typically around ten years, then adds an assumed sale price at the end. All the future amounts are discounted back to a present value using a discount rate that reflects risk. DCF is most useful when income will not stay flat: a lease is about to expire, rents are well below or above market, or a large refurbishment is planned.
The trade-off is that DCF relies on more assumptions than capitalisation, including the discount rate, rental growth and the chance a tenant renews. Small changes in those inputs can shift the result, which is why valuers usually show how the conclusion was reached and often cross-check it against another method.
Direct Comparison
Where there are enough recent sales of similar buildings, a valuer can compare the subject property with them, usually on a rate per square metre or per unit. This works best for owner-occupied premises, smaller assets and vacant buildings, where there is little income to capitalise. It is also a common reasonableness check against an income-based figure.
Summation (Cost) Approach
For specialised assets with few comparable sales, such as a purpose-built facility, a valuer may add the value of the land to the depreciated cost of replacing the improvements. It is used less often for standard offices and shops.
What Moves a Commercial Valuation
- Lease terms. Remaining lease length, rent review provisions, options to renew and who pays outgoings.
- Tenant quality. A strong tenant with a long lease is valued differently from a short lease with a weaker one.
- Vacancy and market rent. Local vacancy rates and achievable rents for similar space.
- Location and access. Exposure, parking, public transport and surrounding uses.
- Building condition. Age, services, and capital spending the next owner will need to make.
- Zoning and planning. Permitted uses, and any scope to redevelop or extend.
- Capital markets. Interest rates and investor demand for that asset class.
What to Give Your Valuer
- The lease schedule and copies of leases and any variations.
- Recent outgoings statements and rent rolls.
- Details of incentives, arrears, vacancies and expiring leases.
- Capital expenditure plans, building reports and approvals.
The better the information, the fewer conservative assumptions the valuer needs to make. To discuss an office, retail or industrial property, see our valuation services or contact us.
