- What Is an Appraisal for a Commercial Property?
- How Do Commercial Real Estate Appraisals Work?
- The Income Approach
- The Capitalization Rate Method
- The Discounted Cash Flow Method
- The Sales Comparison Approach
- The Cost Approach
- The Replacement Cost Method
- The Depreciation Recovery Method
- How to Prepare for a Commercial Real Estate Appraisal
- How Often Do Commercial Real Estate Appraisals Need to Be Updated?
- 5 Things to Keep in Mind When Getting a Commercial Real Estate Appraisal
- What Is the Difference Between Appraising a Residential and Commercial Property?
- Common Appraisal Challenges
- What to Do if You Disagree With the Appraisal
- Related questions
- Get Financing
After finding the right property to invest in and you’re ready to move forward with the purchase, the next step is to apply for a commercial real estate loan. However, for a lender to underwrite your loan, you will need to prepare several documents, including a commercial real estate appraisal. While this may sound like just another hoop to jump through, a third-party appraisal of the investment property is an essential part of the loan process and will help to ensure you're paying a fair price for the property.
What Is an Appraisal for a Commercial Property?
A commercial real estate appraisal is a third-party opinion of a property’s value. Third-party appraisals are typically ordered by lending institutions when a borrower is looking to take out a loan to purchase a property. The appraisal is used to help the lender determine whether the property is worth the amount of money being borrowed.
In most cases, the lender will hire a licensed third-party appraiser to perform the appraisal. The appraiser will visit the property and take into consideration several factors, including the location, condition of the property, recent sales of similar assets in the area, and more. Once the appraisal is complete, the appraiser will provide a report that includes their opinion of the property’s value.
How Do Commercial Real Estate Appraisals Work?
There are a few different methods that appraisers can use to value a commercial real estate property, but the three most common are the income approach, the sales comparison approach, and the cost approach.
The Income Approach
The income approach is the most common method used to appraise commercial real estate. With this method, the appraiser estimates the value of a property by considering the income that it generates.
There are two main ways to calculate income: the capitalization rate method and the discounted cash flow method.
The Capitalization Rate Method
With the capitalization rate method, the appraiser estimates the value of a property by dividing the property's net operating income (NOI) by the property's capitalization rate.
Here's the formula:
Value of Property = NOI ÷ Capitalization Rate
For example, let's say that a property has an NOI of $100,000 and a capitalization rate of 5%. The property's value would be estimated at $2 million.
The Discounted Cash Flow Method
The discounted cash flow (DCF) method is a more complex way of appraising a property using the income approach. With this method, the appraiser estimates the value of a property by discounting the property's future cash flows.
Here's the formula:
Value of Property = Sum of Discounted Cash Flows
To calculate the value of a property using the DCF method, the appraiser first estimates the property's future cash flows. These cash flows are then discounted to account for the time value of money.
For example, let's say that a property is expected to generate an annual cash flow of $100,000 for the next 10 years. The appraiser would then discount these cash flows using a discount rate.
Let's say that the discount rate is 5%. The appraiser would then discount the first year's cash flow by 5%, the second year's cash flow by 10%, the third year's cash flow by 15%, and so on.
After discounting the cash flows, the appraiser would sum them up to arrive at a value for the property. In this example, the appraiser would value the property at $1.4 million.
The Sales Comparison Approach
The sales comparison approach is another common method used to appraise commercial real estate. With this method, the appraiser estimates the value of a property by comparing it to similar properties that have recently sold.
To do this, the appraiser will look at several factors, including the location, size, age, and condition of the property. The appraiser will also consider the sales price of similar properties.
The appraiser will then adjust the sales price of the comparable properties to account for any differences between the properties. For example, if a comparable property is located in a better location, the appraiser will adjust the sales price upward to account for this difference.
Once the appraiser has adjusted the sales prices of the comparable properties, they will then arrive at an estimate of the value of the property being appraised.
The Cost Approach
The cost approach is the third most common method used to appraise commercial real estate. With this method, the appraiser estimates the value of a property by considering the cost of replicating the property.
There are two main ways to calculate the cost of replicating a property: the replacement cost method and the depreciation recovery method.
The Replacement Cost Method
With the replacement cost method, the appraiser estimates the value of a property by considering the cost of replicating the property. The appraiser will consider the cost of the land, the cost of the building, and the cost of any improvements that have been made to the property.
The appraiser will then estimate the property value by subtracting the depreciation from the replacement cost.
The Depreciation Recovery Method
With the depreciation recovery method, the appraiser estimates the value of a property by considering the property's original purchase price and the depreciation that has occurred since the purchase.
The appraiser will then estimate the value of the property by subtracting the depreciation from the original purchase price.
How to Prepare for a Commercial Real Estate Appraisal
If you're planning on purchasing a commercial real estate property, it's crucial to prepare for the appraisal process. There are a few things that you can do to ensure that the appraisal goes smoothly and that you get the most accurate estimate of the property's value.
First, you must provide the appraiser with as much information about the property as possible. This includes the property's square footage, the number of bedrooms and bathrooms, the age of the property, and any recent renovations.
You’ll also have to provide the appraiser with information about the property's income and expenses. This includes the property's rent roll, operating expenses, and capital expenditures.
Finally, it's essential to provide the appraiser with comparable sales data. This includes information on similar properties that have recently sold in the area. The more information you can provide the appraiser, the more accurate the appraisal will be.
How Often Do Commercial Real Estate Appraisals Need to Be Updated?
The frequency with which commercial real estate appraisals need to be updated will vary depending on the lender. In some cases, the lender may require an updated appraisal every year. In other cases, the lender may only require an updated appraisal every few years. It's important to check with your lender to find out their requirements.
5 Things to Keep in Mind When Getting a Commercial Real Estate Appraisal
If you're thinking of buying or selling commercial real estate, you'll likely need to get an appraisal.
Here are five things to keep in mind when getting a commercial real estate appraisal:
Appraisals are based on market value. An appraiser will look at recent sales of similar properties to determine the market value of the property you're interested in.
The appraised value of a property is not set in stone. If you think the appraised value is too low, you can try to negotiate with the appraiser.
Appraisals can take a few weeks to complete. So, if you're in a hurry to buy or sell a property, an appraisal can slow down the process.
Appraisals can be expensive. Appraisals can cost a few hundred dollars. So, be sure to factor the cost of an appraisal into your budget.
Appraisals are just one factor in the buying/selling process. Other factors lenders will consider include your current level of debt and your capacity to take on more. They will also inquire about the collateral you have to offer and your character — that is to say, whether or not you are trustworthy enough to repay a loan.
What Is the Difference Between Appraising a Residential and Commercial Property?
Commercial real estate appraisals are typically more complex than residential appraisals because there are more factors to consider when it comes to commercial properties.
Firstly, commercial assets can be used for a variety of purposes, which can impact their value. For example, considering the current market conditions, it might be harder to underwrite an office property than an industrial one. Additionally, commercial properties are often much larger than residential properties, which can also impact their value. As a result, commercial real estate appraisals can be more challenging to complete accurately.
Common Appraisal Challenges
There are a few common challenges that can arise during the commercial real estate appraisal process.
One of the most common challenges is when the appraised value comes in lower than the purchase price. This can be a major problem if you're relying on the appraisal to help you secure financing for the property. In some cases, you may be able to negotiate with the seller to lower the purchase price to match the appraised value. In other cases, you may need to come up with additional cash to make up the difference.
Another common challenge is when the appraiser is unable to find comparable properties to use in the valuation process. This can be a problem if the property you're buying is unique or if there hasn't been much activity in the area recently. In these cases, the appraiser may need to use a more general approach to estimate the property’s value.
Finally, you may run into problems if the appraiser is not familiar with the local market, as this can lead to an inaccurate appraisal of the asset. To avoid this, you may want to provide the appraiser with a list of comparable properties in the area or even hire a local appraiser who is more familiar with the market.
What to Do if You Disagree With the Appraisal
If you disagree with the appraised value of the property, you have a few options. First, you can try to negotiate with the lender to have the appraisal redone. This is usually only an option if you have a good relationship with the lender and if you believe that there were errors made in the appraisal process.
Another option is to have a second appraisal done. This is typically only an option if you're paying for the appraisal yourself. Keep in mind, however, that the second appraiser may come back with a similar value, so this may not be the best use of your time and money.
Finally, you can try to negotiate with the seller to lower the purchase price. This may be an option if the seller is motivated to sell and if you can show them that the property is worth less than the asking price. If you're unable to negotiate a lower purchase price, you may need to walk away from the deal.
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- What's the next step after an appraisal?
- Once you have your appraisal in hand, you'll have a better idea of your property's value. If you're happy with the appraisal, you can move forward with your plans. If you're not happy with the appraisal, you can try to negotiate with the appraiser or get a second opinion. Either way, an appraisal is a helpful tool for understanding the value of your property.
- How do I prepare for an appraisal?
- The best way to prepare for an appraisal is to be organized. Gather all the documents you have related to your property, including purchase agreements, lease agreements, and any other relevant paperwork. It's also a good idea to have a list of any recent improvements you've made to the property, as well as any planned improvements. This will give the appraiser a clear picture of your property's value.
- How long does a commercial real estate appraisal take?
- The time it takes to complete a commercial real estate appraisal depends on the type and size of the property being appraised. A small office building can be appraised in a matter of days, while a large shopping center or industrial complex can take weeks or longer.
- How much does a commercial real estate appraisal cost?
- The cost of a commercial real estate appraisal depends on the type and size of the property being appraised, as well as the complexity of the assignment. A small office building can cost a few thousand dollars to appraise, while a large shopping center or industrial complex can cost tens of thousands of dollars.