Commercial Real Estate Appraisal: Everything You Need to Know About This Assessment Tool

If you’re building your commercial portfolio, you’ve likely already experienced a commercial real estate appraisal. And if you haven’t? You will. Fortunately, we have everything you need to know all in one place. A commercial real estate appraisal involves paying an independent third-party organization to assess a commercial property’s value. When seeking an appraisal for official purposes, it’s important to hire a licensed appraiser. Otherwise, officials aren’t likely to consider the resulting documents as legally binding. What else should you know about commercial appraisals? There’s a significant amount to cover, so read on for your crash course. 

What Circumstances Require a Commercial Real Estate Appraisal?

An appraisal is required more often than not in commercial transactions. But just to add some clarity, you can expect appraisals on properties being:

  • Sold
  • Insured
  • Mortgaged
  • Updated
  • Taxed

Who Benefits from a Commercial Real Estate Appraisal?

Technically, all parties should benefit from a property appraisal. We’re trying to do honest business, after all. But again, for clarity’s sake, we’ll provide some examples along with specifics of how they possibly benefit:

Property Owners

Sometimes, an owner can use an independent appraisal as ammunition for contesting a tax assessment. Why would they want to do this? Because they feel the assessment is egregious, resulting in reduced property taxes. Likewise, if an owner wants to sell their commercial property, an appraisal can also identify a reasonable price.  

Potential Investors

When getting into property investment, there’s always a risk of losing money. Fortunately, those seeking commercial property can reduce the risk of overpaying by hiring an independent appraiser. But this isn’t the only benefit to investors. An appraisal can also highlight whether renovations are a sound move. 

Individuals Involved in Legal Disputes

There are a slew of legal reasons a commercial real estate appraisal could be useful. Say a law firm decides to split its partnership. An appraisal can help to make the distribution of assets fair and legal. 

Commercial Mortgage Brokers

A commercial real estate appraisal can help potential property purchasers identify the most ideal lenders for their scenario. 

Lenders

Lenders use commercial appraisals for a variety of reasons including:

  • Determining a reliable value for a mortgage
  • Course-correction to prevent overextended loans
  • Finding a reasonable balance between their loans and property values

Government Officials

Representatives of the government regularly use commercial real estate appraisals to help them acquire property. 

Understanding the Three Modes of Commercial Real Estate Appraisal

The techniques used to measure the value of residential real estate don’t work when applied to commercial property. Why? Because commercial properties are often unique and thus more complicated. They also typically accrue revenue which makes them a completely different animal. There are several ways an appraisal can be conducted, but most in the industry agree that these boil down to three major methods. While the typical appraiser will have a preferred method based on the property type, some choose to analyze a property using multiple appraisal methods. 

The Cost Method

This method estimates the cost of creating an exact replica of the structure. This is the preferred method when a comparable property isn’t available. It’s also often employed for recently constructed buildings. 

Depreciation is factored into the calculations. 

The Sales Comparison Method

Offering the most similarities to the methods of residential property appraisal, the Sales Comparison Method works on the philosophy that investors will reference similar properties before purchasing a commercial space. This technique’s accuracy is reputable for considering the current market value. In most cases, the appraiser will look directly at highlighted features shared by similar properties to estimate this amount. Examples include:

  • Square footage
  • Date of construction/current condition
  • Location

The Income Method

This technique predicts the amount of income a commercial property will accumulate over a set time. Therefore, it’s the method of choice for properties designed for earning large amounts of revenue. Upon estimating a property’s net income, the appraiser uses a multitude of additional factors to determine the property’s market value. From there, it’s up to the lender to decide the likelihood of recouping their investment. Examples of properties that popularly use this method of commercial real estate appraisal include:

  • Shopping complexes
  • Major apartment complexes
  • Office buildings

What Factors Will an Appraiser Consider During Their Assessment?

With three primary methods of commercial real estate appraisal at their disposal, licensed appraisers can consider a variety of details before reaching their conclusion. 

  • The dependability of their chosen method in the context of the appraised property
  • The significance/amount of the data collected
  • The reasoning behind initiating the appraisal

Is There a Difference Between a Commercial Real Estate Appraisal and a Property Inspection? 

Those new to commercial investments may believe that an appraisal and an inspection are one and the same. But these are two different processes with two different focuses. An appraisal is very much focused on determining a property’s monetary value. By comparison, an inspection could cover a multitude of intentions. Chief among them? Safety. But an inspection is a much more comprehensive process. Just a few examples of what might be included in an inspection report include condition of the following:

  • Roofing
  • Foundation
  • Plumbing
  • Heating
  • Air conditioning
  • Walls/structure
  • Windows 
  • Doors

In some instances, an inspection report can be provided to an appraiser to help them reach their conclusion. But it’s important to recognize that an appraisal and an inspection are not the same.

Conclusion

An unbiased commercial real estate appraisal often helps to bring a sense of fairness and transparency to commercial transactions. While some may dread them and others may look forward to them, they ultimately should be viewed as bringing balance to a complex system. Just make sure that you choose a licensed appraiser if you’re initiating an appraisal for your own interests or honoring the request of another. The last thing you want is to pay for a process that has no legal standing! 

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