One thing business owners need to know are the complexities of a commercial real estate appraisal. While residential appraisals cost less time and money to complete, commercial appraisals are a much more complex and lengthy process, which, in turn, costs more money. A lot of the value of commercial property is rooted in rental rates received relative to the expenses that are paid out. The actual asset weighs less heavily in commercial appraisals than residential ones. These are the basics you need to know about commercial real estate appraisals.
What is a commercial appraisal?
Essentially, a commercial appraisal is an assessment performed to determine the perceived value of commercial property. Some examples of commercial property might be an apartment building, an office building, a brick-and-mortar storefront, a restaurant, a mall, or even a vacant piece of land.
Commercial property needs to go through the appraisal process during buying and selling. Commercial real estate appraisals are based on an unbiased opinion made by an independent third party appraiser about the current market value of your commercial property. Having a proper appraisal is important for everyone involved in a real estate transaction. The seller, lenders, and buyers all require an accurate assessment of the value so that they are comfortable moving forward in the process. Appraisals are especially important for underwriting to determine the amount of risk involved in making a loan for commercial real estate.
Why would I need a commercial appraisal?
There are many reasons a person would need a commercial appraisal. Here are some of the most common:
- Help prospective sellers determine an acceptable asking price
- Help prospective buyers decide on an offer price and aid with negotiations or support lease negotiations
- Aid an underwriter in establishing the value of security for a mortgage
- Determine tax assessments or appeals of said tax assessment
- Help with business dissolutions or corporate mergers
- Assess gift or inheritance tax
- Determine damages created by weather conditions
- Deciding on the feasibility of construction or renovation
Is an appraisal just an inspection of my property?
No, it is much more than that. A commercial appraiser will not only inspect your property, they will also look at property records, previous titles and ownership, zoning history and regulations, tax records, and demographics. They may dive even deeper researching more about the historical supply and demand forces, rental and vacancy rates, look into the subject’s competitive market, and more. Their goal is to gather all of the necessary information to determine the highest and best use of the property.
What are the types of commercial appraisals?
The Cost Approach
The cost approach for a new building includes construction costs plus the market land value. Things get a little bit more complicated for existing land. The appraiser will still estimate the cost of property improvements today, but they will reduce that cost by any physical deteriorations, structural or functional obsolescence, or any external obsolescence from the surrounding area. This factors in the useful economic life of the building and the time that has elapsed since the property was placed into service. This takes into consideration obsolescence such as the increased cost to operate an older building, which is taken as a present value analysis based on differences in cash flow over time, assuming that these would occur in perpetuity. For these reasons, the cost approach is not ideal for anything other than a new structure.
market price = (cost of the land + cost of construction) – property’s depreciation
The Sales Comparison Approach
If the cost approach is not sufficient, the sales comparison approach may make more sense. The sales comparison approach uses comparable sales data from properties that were recently sold. Adjustments may be made to the value of your property based on differences in sale date, geographic location, building age, square feet, proximity to other landmarks, and other amenities or consumer draws that may exist. Therefore, the sale price of a property may be adjusted upward based on factors like a superior location, how new the building is, or how many amenities are available. This approach can be advantageous when you’ve had a lot of transaction activity in your month in the past year.
The Income Capitalization Approach
Finally, the income capitalization approach may be the best route to take. Within this approach there are three subcategories:
Gross rent multiplier approach
Involves dividing the sales price of comparable properties with the gross rent that those properties will generate on an annual basis. However, this approach will not work if there are not financially comparable buildings in the area.
Gross rent multiplier x annual income = Property valuation
Direct capitalization approach
Instead of just taking the gross operating income you are taking the net operating income into account which includes the operating expenses. This method applies a market appropriate cap rate to a net operating income value. The way that appraisers will come up with a market cap rate is by taking comparable sale data and determining what the cap rate was on those sales and applying the data directly to the property.
Discounted cash flow method
This method includes forecasting net cash flows, usually for a period of about ten years, coming up with the sales price of an asset, then taking those net cash flows, revenue, expenses, capital expenses, sales proceeds, and then applying a discount rate to discount the cash flows to come up with a valuation for the deal. This rate is a risk-free rate of return (or US Treasury rate) plus a risk premium that the real estate investor is taking on for investing in that deal.
If you have an immediate need for a commercial or residential real estate appraisal, contact us today! We are the most trusted appraisal company in New England and New Jersey, performing more than 10,000 appraisals every year!
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