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The facts about commercial real estate appraisals

On Behalf of | Jan 17, 2023 | Real Estate

Commercial real estate appraisers in North Carolina provide an estimated opinion of value for income-producing property. Depending on the complexity, this process may take anywhere from a week to a couple of months. A five-unit multi-family property takes less effort than a skyscraper office building.

How to prepare

Buyers need to have the property’s square footage and financial information, which the seller provided, verified and ready to give to an appraiser. Required documents may include the following:

  • Rent role and leases
  • Financial income statements and projections
  • Property tax bill
  • Building diagrams
  • Cap rate of comparable sales
  • Projected income from enhancements like vending machines, parking garage or laundry facilities

Commercial property appraisal methods

There are three main approaches that commercial property appraisers use. Depending on the project’s scope, an appraiser may use one or more of these to derive an opinion of value.

Cost approach

This approach is most useful for new buildings with no depreciation. The appraiser calculates the cost to replace it, including land cost and any improvements, such as landscaping or a garage. If an appraiser uses this method for an older building, they subtract an estimated depreciation value from the replacement total.

Income capitalization approach

To understand the income approach, you need to familiarize yourself with the terms “net operating income” (NOI) and “capitalization (cap) rate.” NOI is basically the property’s annual profitability before taxes or mortgage payments. Cap rate is the rate of return on an investment, expressed as a percentage. The income approach formula used by appraisers is as follows: property value = NOI/cap rate. The cap rate used in this equation is the average rate of return on comparable properties, where cap rate = NOI/property value.

Sales comparison approach

This approach uses three or more recently closed sales that most resemble the appraised property. The appraiser adjusts for the differences and calculates an estimate of value based on their adjusted closed sales price.

Challenges

The appraiser may have a difficult time if there are no comparable sales. Without the cap rates from past sales, the appraiser may have to resort to less reliable methods to determine value.

The buyer may have difficulty if the appraisal value is less than the accepted offer price. In this case, the situation plays out exactly how it does in a residential real estate transaction. Here are the main options:

  • The seller lowers the asking price to match the appraisal value.
  • The buyer agrees to make a larger down payment that covers the difference between the purchase price and the appraisal.
  • The buyer requests an appraisal review.
  • The buyer pays for a new appraisal from a different lender and hopes for the best.

Appraisals can make or break a deal. It’s important to provide the appraiser with the most complete and accurate documentation that you can gather.