Quick answer
Lenders value commercial property mainly by what it earns. A valuer takes the net rent a property can achieve, adjusts for vacancy, outgoings and lease terms, then divides by a capitalisation rate taken from recent market sales. Direct comparison with similar sales and a cost approach act as cross-checks. The lender then lends a percentage of that figure.
Key points
- For leased property the income approach usually leads, so rent, lease length and tenant quality can matter more than the building itself
- Owner-occupied and vacant buildings are valued on the rent the market would pay, which is often less than owners hope
- A small move in the capitalisation rate shifts the value by a large amount, so the market evidence the valuer picks is critical
- Specialised buildings, such as a purpose-built factory or a childcare centre, are harder to value and attract lower lending limits
- You can help the valuation by supplying leases, outgoings, rent history and recent local sales before the inspection
Two identical-looking industrial units sit side by side. Both are the same size, same age, same street. One has a five-year lease to a national distributor. The other is empty, and the owner plans to move his own business in. A valuer, asked by a lender what each is worth, may come back with two quite different numbers. The reason is the heart of commercial valuation: lenders are not buying bricks, they are buying a stream of income, or the ability to create one.
Understanding that lets you predict the valuation before it arrives, and avoid the shock of a figure far below your expectations.
What is the valuer actually trying to estimate?
Market value: the price a property should achieve between a willing buyer and willing seller at arm’s length after proper marketing. Australian valuers work to professional standards, including the Australian Property Institute’s valuation process standard, and the lender relies on the report for its lending decision. Our general guide to how valuations work for business loans covers who orders the report and who pays. This guide goes deeper into the commercial methods.
Which methods do valuers use?
Four approaches are common, and a valuer often uses more than one to cross-check.
| Method | How it works | Where it leads |
|---|---|---|
| Income capitalisation | Net income divided by a market capitalisation rate | Leased and investment property |
| Direct comparison | Adjusts recent sales of similar property to the subject | Everything, as a check; vacant land; small units |
| Discounted cash flow | Projects income and costs over a holding period and discounts to today | Larger assets, uneven income, lease expiry cliffs |
| Cost approach | Land value plus the cost to rebuild, less depreciation | Specialised or new buildings with few comparables |
Commentary from Australian valuers and property publishers agrees that recent comparable sales carry heavy weight, and that income capitalisation is the standard approach for property that is, or could be, let.
How does income capitalisation work, step by step?
- Start with rent. The valuer takes the rent the property actually earns, and tests it against market rent for similar space.
- Add outgoings recovered from tenants and subtract those the landlord bears: rates, insurance, management, repairs.
- Allow for vacancy and letting costs, especially if leases expire soon.
- Arrive at net income.
- Choose a capitalisation rate from recent investment sales of similar property, ideally with evidence both above and below the subject so the property falls within the range.
- Divide net income by the rate to get the capitalised value.
- Adjust for rent-free incentives, deferred repairs or major upcoming costs.
A worked example, using invented numbers:
| Item | Amount |
|---|---|
| Passing rent | $120,000 |
| Outgoings not recovered | $12,000 |
| Net income | $108,000 |
| Market capitalisation rate | 7.0% |
| Capitalised value | about $1,543,000 |
| Same income at 7.75% | about $1,394,000 |
A three-quarters-of-a-point move in the rate takes roughly $150k off the value. That is why a valuer’s selection of sales evidence is so influential, and why asking for the comparable list is reasonable when a figure surprises you.
One valuation-tool vendor publishes indicative ranges, with CBD offices at the low end and regional properties at the high end, but those are guides and not market surveys. Real rates come from sales of similar property in your area in the recent past.
Why do lease terms matter so much?
Because they determine how certain the income is.
- Length of lease remaining. Long terms reduce vacancy risk. A lease ending in six months pushes the valuer to allow for downtime, incentives and agent fees.
- Tenant strength. A listed company or government agency is safer income than a start-up on a handshake.
- Rent versus market. If the rent is above market, the valuer may discount; below market, the property may have upside but you cannot count on it.
- Rent reviews. Fixed increases or CPI links support value.
- Incentives. Rent-free periods and fit-out contributions reduce effective rent.
If you are borrowing against a property you let out, put the signed leases, rent schedule and outgoings statements in front of the valuer. Missing paperwork is treated cautiously.
How are owner-occupied and vacant buildings valued?
A lender has to consider what happens if it must sell, and the buyer might not be you or your business. So a building you occupy is typically valued on the rent the market would pay and on comparable sales, not on its usefulness to your operation. Premises you have lovingly fitted out for a specific trade may have value to you far greater than to the average buyer.
Some lenders also consider a vacant-possession value. In weak markets, or for buildings with limited appeal, that figure can be notably lower. The commercial property loans page explains how lenders then set limits.
What makes a property harder to value, and so harder to borrow against?
- Specialised use: childcare centres, service stations, medical suites, cold storage.
- Remote locations, with few sales.
- Short leases or single tenants who could vacate and leave a large hole.
- Environmental concerns, such as contamination history.
- Unapproved works or non-compliant uses that raise planning risk.
- Mixed-use buildings with uncertain zoning.
Lenders respond with lower loan-to-value limits, a bigger deposit, or by declining. For a bare site, see how it differs in our guide to using vacant land as loan security.
From value to loan amount
Once the valuation is in, the lender applies its loan-to-value limit, which varies with property type, tenancy and your profile, and subtracts existing debts. See loan-to-value ratio and the LVR calculator to test scenarios. Lenders may also apply a serviceability test: even a strong valuation does not create borrowing power if the income can’t carry repayments.
If a quick sense-check of your position would help, the enquiry form takes about a minute.
How can I prepare for the valuer’s visit?
- Collect all current leases, side letters and rent reviews.
- Prepare an outgoings schedule for the last two years.
- List any capital works completed, with dates and invoices.
- Note building approvals and any compliance certificates.
- Make sure the property is accessible and presentable.
- Pass on any recent comparable sales you know about.
- Be upfront about vacancies, arrears or planned works.
Our first-timer’s guide to commercial property loans takes this further for owners buying their first premises. If the property sits inside a super fund, the SMSF commercial property loans page covers the structure.
When the number comes in lower than hoped
Stay practical. Ask which method led, which comparable sales were used, and which rate was adopted. If there are errors of fact, present evidence. If the valuation is simply more conservative than your view, then your choices are borrowing less, adding other security, contributing cash, or approaching a lender comfortable with a different type of asset or lower documentation. A bank may be the best fit for a standard, well-let property, and if a bank offers on your numbers, take it seriously. If it has said no, other lenders look at the same property differently.
Want a second opinion on your property’s borrowing power?
If you have a commercial property, or are about to buy one, and want to know what it could support, tell us about it. The enquiry takes about a minute, and asking won’t touch your credit file, so you can ask without a second thought.
We keep your details to ourselves instead of sending them to a stack of lenders. A real person reads your situation, considers the building, the lease and what you need, then phones you to talk through realistic options. Describe the property and the tenancy accurately and we can point you to the right fit first time.
Frequently asked questions
What is a capitalisation rate in simple terms?
It is the annual net income of a property as a share of its value, taken from comparable investment sales. If similar properties sell at a yield of 7 per cent, a property earning $70k net a year is worth about $1m. A lower rate means a higher value for the same rent, which is why valuers choose their evidence carefully.
Does the lender use the price I paid?
It looks at it, but the valuer's market value is what counts. A recent arm's-length purchase price is strong evidence and often close to the valuation. If you paid well above market, or the sale was between related parties, expect the valuer to disregard the price.
How does a lease affect the valuation?
A long lease to a strong tenant at a sensible rent supports a higher value because the income is reliable. A short lease, a struggling tenant or rent well above market lowers it, because the valuer allows for vacancy, incentives and re-letting costs.
Why is my own premises valued on rent when I don't pay any?
Because a lender needs to know what the building would be worth to any buyer, not just to you. The valuer assesses the rent the market would pay and values on that basis, sometimes also considering vacant possession value. This can be lower than an owner's view of the building's worth to their business.
Do lenders accept SMSF-owned commercial property?
Yes, but the structure adds rules, and lenders usually require a conservative limit and extra documents. Our page on SMSF commercial property loans covers it. Valuation methods remain the same, so everything in this guide still applies.
What if I disagree with the valuation?
Ask the lender whether the valuer will review it, and provide specific evidence: recent sales, a signed lease the valuer didn't see, or outgoings that were wrongly recorded. If the figure doesn't move, you can borrow less, add security or approach a lender with a different appetite for that property type.