Getting a property appraisal is one of the first steps when you’re in the market to buy or sell commercial real estate. An appraisal estimates how much a particular property is worth on the current market. How do you ensure you get the best possible appraisal valuation?
There are a few ways to improve the chances of obtaining an accurate commercial real estate appraisal. From working with the right appraiser to understanding the different approaches to valuation, let this guide help you get a fair appraisal, whether you’re a buyer or seller.
What Is a Commercial Real Estate Appraisal?
A commercial real estate (CRE) appraisal is a report prepared by an independent third party examining a property and determining its fair market value.
Typically required by lenders and investors before acquiring a loan or purchasing a commercial property, the purpose of an appraisal is to establish current market value, which is how much a buyer could expect to pay a seller for the property.
Commercial appraisals can also be helpful for other purposes, such as tax assessment or insurance. Many factors potentially affect the value of a commercial property, so it’s crucial to have a professional CRE appraisal before making any significant financial decisions.
An experienced appraiser will consider several factors, like the property’s location, square footage, condition, and recent sale prices of similar properties in the area, to arrive at an estimate.
While it’s possible to get a general idea of a property’s value by doing your own research, consulting with a professional who provides appraisal services may be more helpful.
This is partly because commercial properties must meet zoning requirements and specific use restrictions set by local governments, unlike residential properties.
As a result, commercial real estate investments often require extensive due diligence before an investor makes any final decisions. Part of the due diligence process involves obtaining an appropriate appraisal on a property.
What Are the Different Approaches to Valuation in CRE Appraisals?
Professional appraisers may consider several valuation methods to figure out the value of a property. Four of the most common are the market approach, income capitalization approach, cost approach, and sales comparison approach.
The market approach is a method of determining property value by observing the sale prices of similar commercial buildings and properties in the market, including retail centers and industrial warehouses. This is done by analyzing recent sales of comparable properties and adjusting for factors that may affect value, such as location, condition, and amenities.
When using this approach, appraisers start by collecting data on the latest comparable sales in the market area. This data can be collected from public records, real estate agents, or other sources.
Then they analyze the information to figure out trends in the market and develop a valuation estimate for the subject property. This approach is advantageous when a large number of comparable properties are available for comparison.
Income Capitalization Approach
This approach capitalizes, or values, the property by its potential income. As a result, the appraiser estimates the property’s potential gross income and operating expenses, then applies a capitalization rate to determine the property’s value.
Ultimately, the income approach assumes the investor will not pay an excessive amount for a property compared to the present value of the future net benefits the property is expected to generate. The benefits take the form of rental income and are discounted back to present value using a discount rate that reflects the level of risk associated with the property.
Used to appraise stabilized properties or properties fully leased and generating consistent income, this method can also value properties that are not yet producing cash flow but are expected to do so in the future. This includes properties that are under development or newly constructed properties.
Based on the principle of substitution, this approach to valuation estimates how much a property is worth by considering the cost of reproducing or replacing the subject property with another with a similar utility.
This cost is then discounted to present value using an appropriate interest rate. The result is added to the land value to establish the value of the property under consideration.
Sales Comparison Approach
To value a commercial real estate property using the sales comparison approach (SCA), appraisers often compare the real estate to similar properties that have just sold in the local market.
They consider factors such as the size of the property, as well as its age and neighborhood demographics.
The appraiser then adjusts these comparables based on their differences and the property in question. For example, if the property is larger than the comparable properties, the appraiser could adjust the value upward to account for this difference.
This means the final value determined using the sales comparison approach reflects an estimate of what the subject property would sell for on the open market. Appraisers can use SCA for various property types, including office buildings, shopping centers, and apartment buildings.
What Common Issues Affect Commercial Real Estate Valuation?
Many factors can influence the value of a property when a buyer or seller is trying to get a commercial real estate appraisal valuation. One of the most common issues is the location of the property.
For example, if a multifamily investment property is in an area prone to crime, this can lower the property’s value. Remember that despite substantial neighborhood crime statistics, properties in high-demand locations like San Francisco or other Bay Area cities can still command a hefty purchase price.
Zoning changes can also significantly impact property value, which could make a property less desirable and worth less than similar pieces of real estate. Likewise, a property in poor condition could be valued lower than a comparable property in better condition, especially if it needs repairs or is not up to code.
In addition, the size of the property can also affect its value. A larger property will generally be valued higher than a smaller one, all else equal. Not to mention, any liens or other encumbrances on the property may lower the going rate.
These are only a few of the issues that can affect property value. This is why it’s vital to collaborate with reputable appraisers who know how to account for these factors when valuing a property.
How To Choose the Best Appraiser for Your Needs
When it comes time to get a commercial real estate appraisal, a buyer or seller will typically want to choose the top appraiser for the job. First and foremost, do your due diligence to ensure the appraiser has the necessary education and experience to provide accurate property valuations.
Here are other tips on how to decide on which appraiser to partner with on a project:
- Get recommendations: Talk to your real estate agent, lender, or other professionals in the industry and get suggestions for qualified appraisers in your area.
- Check credentials: Ensure the appraiser is licensed and certified in your state and has experience appraising commercial properties.
- Ask for references: Ask the appraiser for references from previous clients and call to ask about their experience with the appraiser.
- Get an estimate: An approximate figure from the appraiser of the property’s cost can help you budget ahead of time.
- Meet with the appraiser: Before hiring an appraiser, meet with them in person to get a feel for whether you will work well together.
It may make sense to interview multiple appraisers before making your final selection. This way, you can verify their qualifications and expertise and assess their communication style and overall professionalism.
The Bottom Line on Commercial Real Estate Appraisals
A commercial real estate appraisal is an invaluable tool that helps investors, property owners, and lenders determine the value of a piece of commercial real estate. After all, the appraised value is used to decide whether to buy, sell, or finance a property.
Professional appraisers use their expertise to consider all relevant factors, including location, market conditions, and the physical condition of the property, to come up with a fair and accurate estimate. Property owners may order an appraisal when they are considering selling their property.
An appraisal can help them determine how much to sell their property for. In addition, investors often use commercial property appraisal to decide whether to buy or sell a particular piece of real estate. An appraisal can help them assess if the property is worth the asking price and whether its value will endure appreciation or depreciation over time.
Lenders may also require an appraisal when someone applies for a loan to purchase or refinance a piece of commercial real estate. The appraised value determines how much money the lender is willing to lend.