When you are looking to buy or sell a commercial property, there are many different steps and considerations you are making. You may be thinking about growing or diversifying your portfolio. You may be thinking of selling a property that no longer fits your goals or generates necessary income. You may have found your dream property to add to your portfolio. No matter what your goals are with the purchase or sale of a property, an appraisal will probably be necessary.
A commercial real estate appraisal helps to determine the value of your property. Commercial appraisals are used by investors and lenders, as well as outside parties like the insurance companies and legal teams, in order to make important decisions about properties, like when purchasing a property or lending money to someone seeking to purchase a property. As with any real estate transaction, there is risk involved, and an appraisal can help determine the amount of money a property might really be worth so that the risk can be assessed more accurately. A certified commercial real estate appraiser helps investors and lenders determine the property’s value, so let’s take a look at what you need to know about commercial real estate appraisal as you begin the process.
What Is a Commercial Real Estate Appraisal Used For?
An appraisal is basically the same, whether it is for residential real estate or commercial real estate. It’s an unbiased opinion of the value of the property. With commercial real estate, the appraisal process is used to determine, through an appraisal report, the value of commercial properties like multifamily housing, office buildings, warehouses, or retail spaces.
An appraisal is used to determine what the property will sell for in the current market, and they are also used for underwriting. Lenders tend to require an appraisal because they won’t lend more than an asset is worth. For investors, the appraisal provides you with an idea of how much you should pay for it as well as what sort of investment or renovation you should make into the property once you’ve added it to your portfolio. However, the purchase or sale of a property isn’t the only time an appraisal can be beneficial. These are other reasons you might want to consider a commercial appraisal of your property:
- Disputing tax assessments
- Supporting lease negotiations
- Business dissolution
- Updating the fair market value of a property
- Calculating inheritance taxes
- Supporting feasibility studies for reconstruction and renovation projects
- Helping courts and zoning boards understand the impact of proposed actions
- Insurance purposes
How Is Commercial Real Estate Appraised?
The commercial real estate appraiser conducts several types of analyses in order to perform their appraisal. They look at the type of buyer and utilize a combination of the approaches discussed below to provide an accurate analysis of the commercial property. Many times, the real estate appraiser will also take into consideration other factors that can affect the value of the property, like the property’s geographical location and any specific risks involved with this type of property.
There are four methods for commercial property appraisal: cost approach, income approach, sales comparison approach, and gross rent multiplier approach. Two of these methods are used by appraisers, while two are used more often by investors wanting to determine on their own a value before going through a formal valuation process. Let’s take a closer look at what goes into each of the methods:
- Cost Approach: This one isn’t used as often anymore, but it is helpful for new or unique buildings. This determines the value of a property by examining how much it would cost to rebuild it (cost of the land, materials, and labor). The formula for this approach is land cost + cost to build new – accumulated depreciation = property value.
- Income Approach: This is a popular method for commercial real estate appraisal. A real estate appraiser uses investing calculations, like net operating income and cap rates, to determine how much income that property can generate. Two important things to consider here: The net operating income needs to be correct in order for the valuation to be correct, and investors need to have comparable cap rates that make sense for an accurate valuation calculation. The formula for this approach is net operating income / cap rate = property valuation.
- Gross Rent Multiplier Approach: This approach is often used by investors (as opposed to a real estate appraiser) to determine commercial valuation when considering how much to offer. Investors need to know comparables to find an average gross rent multiplier for that property’s area. The values need to be accurate in order to get the right valuation. The formula for this approach is gross rent multiplier x annual income = property valuation.
- Sales Comparison Approach: This approach, used a lot in residential real estate, uses comparable sales prices of other properties to determine the value of a property. In commercial real estate, this approach is used more often by investors than appraisers to determine property valuation and how much to offer for a certain property.
How Accurate Are Commercial Real Estate Appraisals?
Investors and property owners often want to know how accurate a commercial real estate appraisal is. The answer is not so cut and dry. It really does depend. But most of the time, appraisals are pretty accurate. Finding a qualified, certified commercial property real estate appraiser is key to making sure you get an accurate result from your appraisal.
A study looked at 25 years of data (including two up and down market cycles) and determined that appraisals are off by an average of 4 to 5 percent of value, allowing for an offset of positive or negative differences. This information gives guidance to investors and regulators, as well as anyone needing an appraisal, on what to expect and how to interpret their appraisal.
Don’t worry too much about whether it’s an exact number because, just like residential real estate appraisals, it might not be 100 percent correct or what you expected, but know that appraisals are pretty accurate most of the time. They are often used for new loans or refinancing, but they do have other uses, which is why they are generally understood to be fairly accurate when conducted by a qualified appraiser. Some of the other uses for these appraisals include real estate taxes, asset division during divorce or business dissolution, and eminent domain.
What Do Commercial Appraisals Consist Of?
Because an appraisal might go through different processes depending on the property and the appraiser themself, a commercial appraisal building cost depends on the size, cost, and complexity of the subject property. Inspection and data review, as well as additional research, are all steps that a typical appraisal will go through.
A commercial real estate appraisal may have different processes depending on why it’s being done and the appraisal itself. However, a typical commercial appraisal consists of a few key steps:
- Determine the use and characteristics of the property
- Research and analysis on the property
- Collect, verify and analyze data, including market area data and comparable properties, to look at four factors (scarcity, desire, utility, purchasing power)
- Valuation of property and appraisal report is completed
4 Tips to Prepare for a Commercial Real Estate Appraisal
If you are having a commercial appraisal done on a property, you are getting ready to sell, or even when you are preparing to purchase a property, you can do a few things to make the process easier. A smooth appraisal process and acquisition of an appraisal report will help you feel less stress throughout the purchase or sale of a commercial property. Here are a few tips so you can be ready for a commercial property appraisal.
Have your documents ready: A commercial appraiser will visit the property to conduct some research, but they will often follow up for additional research. Some items they may ask the property owner to provide include building or site plans, current rent rolls, current leases, and other relevant documentation. If you have this ready to go, then you can help to speed up the appraisal process.
Keep up with maintenance: Properties in good condition, or properties that have been recently updated, tend to appraise for a higher value. If you are able to make quick updates and keep up with maintenance needs, you should see a higher appraisal. This is especially important if you have an older building, so if there’s an upgrade you can make prior to an appraisal might be a good time to do so.
Add more income streams: Certain properties can increase their appraisal value by adding in other ways to generate income. With an apartment building or multifamily housing complex, this might be a coin-operated laundry facility. For office buildings, a vending machine might provide income opportunities.
Be patient: Commercial real estate appraisals have a process they go through, so be prepared to wait while they work through all of the steps. You’ll receive an update and the report once the appraisal is completed, but you may have to wait while your appraiser works.
Navigating the Commercial Appraisal Process with Expert Support
If you are looking for a trusted partner for your next commercial real estate transaction and appraisal process, you need a qualified CRE expert. Sands Investment Group is knowledgeable in all types of commercial real estate and triple net leases. We offer a comprehensive BOV (Broker Opinion of Value) Report at no obligation, request a copy of your report today. Our brokers bring the expertise to ensure that the valuation of your property is accurate, so you can experience an easy appraisal process. From finding the right properties to navigating the appraisal process to financing your next investment, our CRE experts are ready to help.
If you want to learn more about the commercial real estate appraisal process and speak with an industry expert about how an appraisal might benefit your property, get in touch with Sands Investment Group by calling 844.4.SIG.NNN or sending us an email at info@SIGnnn.com.