3 Keys to Commercial Appraisals

Discover 3 keys to commercial appraisals that will help you better understand how the appraisal process works and what to do if you don’t agree with the appraised value.

What is a Commercial Appraisal?

A commercial appraisal is a calculated estimate of value on a commercial property. This would include multifamily, self-storage, office or retail space, industrial buildings, and mobile home parks. You can get your own commercial property appraised at any time. However, when you have a deal under contract, the lender will order the appraisal for you during the loan process. You pay for it, but the lender will hire a professional licensed appraiser with specialized skill and knowledge on commercial real estate. This will NOT be a residential appraiser. You must have a licensed commercial real estate appraiser.

7 Reasons Investors Get a Commercial Appraisal:

• To determine the value and listing price of a commercial property you are selling.
• To determine the value of a property you are considering buying.
• A lender will use an appraisal to estimate or calculate your loan amount.
• An appraisal could be helpful during lease negotiations.
• When disputing your property taxes.
• For legal matters, such as disputing a contract.
• To determine the liquidation value of an asset for forced sale or short sale.

Key #1: What Commercial Appraisers Look For

Property Details: A commercial appraiser will use property details to help determine the value of a commercial property. They’ll consider the type of building, square footage, size, the functionality of the property, the condition of the property, any amenities in the property, and unit mix. Unit mix is particularly important, especially in multifamily. A 12-unit apartment building with 12 three-bedroom units is obviously worth more than a 12-Unit with 12 studio units.  So, unit mix is an important property detail when appraising multifamily.

Zoning: Zoning and how the property can be used determines how valuable the property can be. For example, an office building with a parcel of adjacent land that is zoned residential is worth more than a similar office building with a parcel of land that is zoned agricultural. On the property with land zoned residential you can build a multifamily apartment building, however the property with the land zoned agricultural is limited to farming.

Recent Sales Comparables: A key metric appraisers use when evaluating commercial property is recent comparable sales. They will look at recent sales of similar properties in the area so that they can make a comparison.

Rental Information: Appraisers will look at the rental income, occupancy, and length of leases. How does this impact the value? Well, if the occupancy is low, the income will be lower and that will lower the value. Also, a property with longer leases has more value than one where leases expire in the next year.

Current Market Trends: An appraiser will look at current market trends. Is the area growing and prospering? Is it stable? Or is it on a downward trend, job losses, businesses closing and a declining economy? An appraiser will consider all these factors because it does affect the value of the property.

Replacement Costs:  Appraisers will use the replacement costs of a property to help them determine what a property is worth.

Key #2: How Appraisers Value Commercial Property

Commercial appraisers value commercial properties 3 ways: through the income, comparable sales, and replacement costs.

Sales Approach: For this method the appraiser needs recent comparable sales data from similar properties in the area. They will gather the sales price from several recently sold comparable properties and calculate the average price per unit on those sales. For example, let’s say the appraisers calculations average out to be about $100,000 per unit. For a twelve-unit apartment, the appraiser would multiply the average of $100,000 per unit by 12, which values the 12 Unit apartment at $1.2 million.

Income Approach: With this method the appraiser uses the net operating income of the property to determine the value. The NOI is the value driver in commercial property because as your NOI increases, the property value increases. Which means, with commercial real estate you can increase the value of the property by improving the property’s financial performance. So, the appraiser uses the NOI of the property and the market cap rate (the cap rates of other properties when they sold), to calculate the value of a property. To determine the value of a property using this method, you divide the NOI by the market cap rate. For example, if the NOI of a 12 unit apartment is $72,000 per year, and the market cap rate is 6%, the apartment is appraised at $1.2 million.

Cost Approach: This approach is based on the replacement value of the property. To determine value using this method, the appraiser must get the cost to rebuild the property (an exact replica of the building) as dollar per square foot. For our example, let’s say the appraiser determines the replacement cost for a 12-unit apartment is $300 per square foot and the building is 4,000 square feet. To calculate the value, multiply the square footage (4,000) by the dollar per square foot ($300). The appraised value of the property is $1.2 million.

Key #3: What to Do If You Don’t Agree with the Appraised Value

What do you do if you don’t agree with the appraised value? Sometimes the appraised value comes up short. For instance, in the above 12-Unit apartment example, what can I do if I have it under contract for $1.2 million and the appraiser values the property at $1.1 million? There are several steps you can take:

• You can move forward and pay the difference. Just because a property appraises for less than the purchase price doesn’t mean the deal’s dead. If you have a good deal with upside potential, you might want to do the deal and pay the difference.
• You can get a second appraisal and use it instead.
• You can dispute the value of the appraisal. Maybe the data in the appraisal is outdated and you have more up to date information. Or maybe the sales comparables are based on properties outside the market and you can provide numbers from properties in the neighborhood to support the value.

Bonus Tip for Contesting Appraisals: When contesting an appraisal do not use the words “contest” or “dispute”, which are offensive to the appraiser. They are professionals and by contesting your are challenging their work. They can take it the wrong way, so you need to take a gentler, more professional approach. Instead, of contesting the appraisal you are going to “submit a reconsideration of value”. An appraiser will be more receptive to this wording, but be sure to back up your request with concrete data.

Frequently Asked Questions

Here are the top 5 frequently asked questions for commercial appraisals.

1. Can I hire my own appraiser if I’m under contract?

No. If you have a property under contract the lender will not allow you to hire the appraiser because they do not want you to influence the appraiser. The bank will hire the a qualified appraiser and you will pay for it.

2. What does a commercial appraisal cost?

The price varies depending on the size of the property. For a small commercial property, it could be as low as $500, but for most average sized commercial real estate it will cost between $2,000 and $5,000.

3. Who gets a copy of the appraisal? Do I give a copy to the seller?

You paid for the appraisal so it belongs to you. The lender gets a copy, and you get a copy, anyone else needs your permission. If you have a deal under contract do not give a copy to the seller, especially if you think you have a good deal. You do not want to show the seller that it appraised for $1.3 million when you have it under contract for $1.2 million.

4. How long is the appraisal good for?

A commercial appraisal is typically good for 3 and 6 months, depending on the area, the market, and the lender.

5. Can I increase the property value before I have the appraisal?

Yes, in fact, there are several reasons why you would want to make improvement before the property is appraised. First is because first impressions are important. Imagine the appraiser driving up to your property and seeing attractive landscaping and newly painted front doors, an immaculate property. That makes a good first impression and will affect how the appraiser perceives the property. But if he drives up and sees unkept landscaping, peeling paint, and trash everywhere, his mindset will be negative when he does the appraisal. It’s also important to let the appraiser know if you have updated any electrical, plumbing or HVAC because that will help with the appraisal. And lastly, present the property in its best financial picture. If you show the appraiser a rent roll with 50% vacancy and the financials reflect that poor occupancy, the appraised value will be lower. .