June 26, 2025 - Everyone should pay their fair share of property taxes, but not a penny more! Which valuation method formulates the true market value of your real estate asset? Which method captures the sole value of your real estate without including business value or other intangible value? There are multiple ways to value commercial real estate, but how will you know which one is right for your needs?

If you are valuing real estate for financial purposes, or for tax appeal purposes, are those methodologies and values the same or different?

Why would you defer to using one approach over another?

• The cost approach
• The market approach
• The income approach

We will explain these three approaches to value, how and when to use them, and what pitfalls you may encounter when comparing them.

The Cost Approach

The cost approach estimates the price a buyer should pay for a property based on the cost of building an equivalent property. It’s calculated using the cost of the land plus the cost of construction minus depreciation.

The upper limit, or the higher end of this value, represents the highest and best use for the land plus the replacement value of the improvements.

The advantage of using the cost approach is that it values only the “bricks and sticks” of a property. It does not include any business value or intangible value that is sometimes included in the other valuation approaches. However, the cost approach does not take current or future income into account. Investors typically only consider the possibility of future income when valuing a potential investment. So, a property valued using the cost approach could lose out on investment opportunities based solely on the valuation approach since no future income projections are considered.

The cost approach would also be appropriate for valuing new construction. It can be relied on to value office buildings and retail properties when adjustments need to be made due to design, construction, or primary usefulness.

The Market Approach

The market approach, also known as the sales comparison approach, estimates the property's value based on a comparison of recent sales of similar properties.

The advantage of using the market approach is that it tracks current market trends for similar properties very well. However, the market approach does not allow the specifics of each sale to be known well. For example, deeds are recorded and are public information; however, the sales price on that deed can include personal property and business value as well as the real estate value. That sale also may not be an arm’s length transaction, meaning each sale may seem comparable on the surface, but may not be once you look into the specifics of that property and that sale.

The market approach is often used for residential and multi-family housing properties, as there are many transactions in this space, and therefore, many comparable properties to use for this valuation method.

The market approach is based on the principle of substitution: a prudent buyer will not pay more for a property than the purchase price of similar properties. Some of the most important characteristics of market sales comps are date of transfer, conditions of the sale (is it arm’s length?), consideration (are there other things being conveyed?), conditions of comps at the time of sale, and type of conveyance of the property’s bundle of rights.

Some of the more important elements of comparison are:

• Location, location, location
• Asset type
• Date of sale
• Size of improvements and land (lot size)
• Zoning
• Physical condition and any deferred maintenance
• Location and site amenities (view, waterfront, etc.)
• Business considerations (gross potential income of the market, government restrictions, licenses, intangibles, etc.)
• Chattels included

Once these comparative characteristics are evaluated, it makes it much easier to compare assets on a “apples to apples” basis.

The Income Approach

The income approach converts an income stream into a market value for the property. This valuation calculation relies on market sales of comparable properties to determine the risk associated with the property, also known as the capitalization rate. It’s calculated using the gross potential income minus the vacancy and collection loss, expenses, and reserves for replacements, then divided by a capitalization rate.

The income approach (direct capitalization) is adopted by most owners and investors as the correct approach to truly measure the value of the asset. However, this approach is only a snapshot at a certain point in time. Unless the valuation is stabilized for anticipated future increases or decreases, the final value would not take future income into consideration. The discounted cash flow (DCF) analysis takes into account future cash flows and projections and is also a widely used income approach.

Income producing properties are typically valued using the income approach because it takes the income these types of properties generate into account as a basis for value and investment.

How to Choose the Best Valuation Method

In all three approaches to value, the appraiser must recognize and collect pertinent information to perform their analysis. If the appraiser does not have all relevant information, the resulting values may not be accurate.

Some examples of information that should be used in valuing the real estate include:

• Identification of subject property
• Collection of all data specific to the property
• Collection of all market data
• Environmental data with regards to the subject property
• Governmental data
• Social and population data
• Highest and best use conclusion
• Data analysis
• Estimating value utilizing all three approaches
• Reconciliation of the three approaches
• Final estimation of value or value conclusion

The art of valuation is to utilize all three approaches to value and determine which is the most appropriate for the specific property in question. In many cases, one approach may be better than another depending on the market, available information, or property asset type.

For example, the income approach is not an effective means to value a property where business value is part of the income, such as a hotel. In this case, the food and beverage income should be deducted from the overall value, and a rent applied to that square footage, in order to truly reflect the value of the real estate.

Nursing homes offer another example of business income included in the “rents” or fees. The nursing care included in the room rental is the business. This is where a cost approach would be effective in valuing just the real estate.

Another example would be marinas. Most of the time, income from the sale of gas and repairs is included in the income. This is business income and must be extracted and a rent applied to the space.

When using these approaches to formulate a value for a tax appeal, one must also take into account what types of valuations are accepted by the taxing jurisdiction. Do they value property in fee simple (unencumbered by lease or mortgage), leased fee, on a cost basis, etc.? This determination is an extremely important part of the start of a successful tax appeal.

How Citrin Cooperman Can Help

There are several important considerations for determining which approach is best to use for your situation. For a tax appeal, what does the jurisdiction allow you to use? For an investment opportunity, the future income potential should definitely be taken into consideration. Is our valuation based on a fee simple or leased fee basis? If we need to strip out the business value of a complex property, perhaps a cost approach would be the best way to value the asset. This is just a high-level review of the three approaches to value. There are so many variables that come into play in everyday applications.

We are here to assist you with your tax appeal needs and can recommend which approach to use in order to obtain a fair assessment. To learn more, contact James Vicendese, Megan Lusby, or Citrin Cooperman’s State and Local Tax Practice.