Commercial Real Estate Appraisal 101: Property Valuation Basics

Property owners, real estate brokers, investors, and other real estate professionals have likely come across an appraisal report at some point in their career. Whether it be for financing purposes, challenging real estate taxes, or legal disputes, an appraisal is an integral, and often misunderstood part of the real estate process. Appraisal reports can be dense and cover many topics and aspects of real property including zoning, easements, market analysis, and others. Simply put, appraisers are licensed professionals whose role is to determine the value of a property through comprehensive analysis. In this blog, we will take a dive into commercial real estate appraisal, the appraisal process, and how you can benefit from an appraisal.

What is a Commercial Real Estate Appraisal?

A commercial real estate appraisal refers to the process of valuing of a commercial property based on comparable sales, replacement costs, and income. A licensed real estate appraiser conducts thorough research to reach an opinion of a property’s market value based on a host of factors including location, size, and income potential. The appraiser typically analyzes properties within the marketplace, comparing their attributes to the subject property.

During the appraisal process, a qualified appraiser evaluates the property by conducting a detailed analysis that includes site inspection, research on market conditions, and examination of relevant documents such as leases, site plans, development costs, and property tax records. For income producing properties, the appraiser will consider projected cash flows and income and expense statements. After the relevant property information is analyzed, typically the appraiser produces an appraisal report often including 40-80 pages of detailed analysis and additional supporting documentation.

Commercial appraisals can be conducted on all types of commercial asset classes including land, industrial properties, retail, general and medical offices, apartment buildings, and other special use properties such as schools, places of worship, golf courses, marinas, and much more.

What are Commercial Real Estate Appraisals Used For?

Users of commercial real estate appraisals will have varying needs prompting an independent valuation. Among the most common reasons are financing, portfolio valuation, and internal real estate investment analysis. Below is a comprehensive list of appraisal uses:

  • Financing
  • Internal Decision Making
  • Real Estate Investment Analysis
  • Portfolio Valuation
  • Acquisition / Disposition
  • Property Tax Reviews & Appeals
  • Various types of Litigation
  • Property Insurance Coverage
  • Dispute Resolution
  • Divorce

Residential vs. Commercial Appraisal

There are two main property types that are appraised somewhat differently.  Residential appraisals typically include single family homes, condominiums, attached homes such as townhomes, duplexes (two attached homes), and smaller multifamily properties with two to four rental units.  Skills and licensing for residential properties are a bit different than commercial and you would typically go to an appraiser specializing in residential appraisals.

Commercial real property appraisals include basically all other forms of real property, including the four major properties types, industrial, office, retail, and multifamily (5 units or more are considered commercial).  Additionally, there are a host of more specialized uses. Examples include churches, schools, and recreational uses (golf courses, equestrian facilities). Other common special uses include car washes, hotels and other hospitality related real estate.

Should I Get a Commercial Appraisal?

Getting your commercial property appraised can help you better understand your property, saving you money and helping you maximize value:

  1. Fair Market Value Determination: Appraisers provide an unbiased opinion of your property’s value based on established appraisal standards. This can help you establish a fair market value for internal business decisions when contemplating an acquisition or disposition, during negotiations, or helping to navigate legal matters regarding your property.
  2. Legal and Tax Compliance: Appraisals are often necessary for legal purposes, such as property settlements, estate planning, or litigation. A professional appraiser’s expertise and comprehensive reporting can provide credible evidence in legal proceedings or appeals such as challenging your property taxes. A professional appraisal can help you navigate these difficult legal situations effectively and ensure compliance with relevant local and state regulations.
  3. Property Insurance and Risk Management: Accurate appraisals can assist in determining appropriate insurance coverage for your commercial property. An independent valuation can ensure you are not overpaying for property insurance. Insurers rely on appraisals to estimate replacement costs, making sure you have adequate coverage in the event of damage or loss. Additionally, appraisals aid in risk management by identifying potential issues or hazards you may not know of that could negatively affect your property’s value or insurability.
  4. Cost Segregation Analysis: A cost segregation study breaks down construction and acquisition costs of your property into specific asset classes with varying useful lives. By segregating components and allocating depreciation accordingly, the majority of property owners find significant tax savings. These categories include personal property, site improvements, buildings / structures, and land.

Overall, engaging a professional appraiser for your commercial property offers the advantage of an accurate, unbiased, and comprehensive evaluation. An appraiser’s expertise, analysis, and in-depth knowledge of the local market can provide valuable insights and support your decision-making process. From acquisitions and dispositions to financing and risk management and legal matters, an appraisal can be a helpful tool. These insights allow you to gain a thorough understanding of your property and can help in maximizing your properties value.

How Do I Get a Commercial Appraisal?

A good first step would be to contact a local licensed commercial appraiser to discuss your specific needs. This initial consultation will allow you to provide specific details of your property and the appraisals intended use and purpose. This information would provide the appraiser with the necessary information needed to determine an appraisal fee.

If you decide to move forward, the appraiser will send you an engagement letter. This will outline the appraiser’s fee, timing, and valuation approaches used in the analysis of the commercial property. The appraiser will then begin the appraisal process by requesting any property data needed. Typically, this includes leases, income and expense statements, construction documents, and surveys. A property inspection will be scheduled as well so the appraiser can see the property in person.

What Does the Appraisal Process Look Like and How Much Does it Cost?

Once initial property information is received, the appraiser will gather relevant data like market trends, rental rates, and vacancy rates. Other factors impacting property values will also be considered. This information will then be applied in the valuation approaches the appraiser has deemed most relevant for the subject property.

McCoy Valuation offers 1-3 week turnarounds with appraisals generally ranging between $1,500-$5,000.

The Basics of the Real Estate Valuation Process

Generally, appraisers have three separate appraisal processes they use to determine the value of a property:

Cost Approach

The Cost Approach considers the cost to replace building and site improvements as well as the current depreciation impacting the subject property. The market value of the land is estimated which reflects the cost to acquire a similar development site.  Indirect costs and entrepreneurial profit of the development are also addressed.  The Cost Approach ultimately reflects the cost to develop a property similar to the subject, also accounting for any depreciation present in the existing property.

Income Capitalization Approach

The income capitalization approach simulates the reasoning of an investor analyzing future cash flows from a property throughout its lifetime. The net operating income reflects potential cash flow remaining after vacancy and operating expenses. This net operating income is then capitalized at an appropriate rate to derive an estimate of value. Thus, two key steps are involved: (1) estimating the net operating income applicable to the subject and (2) choosing appropriate capitalization rates.  The Income Capitalization Approach analyzes the cash flows associated with a property and applies a valuation multiple or capitalization rate.

Sales Approach

The Sales Approach focuses on price relative to comparable properties that have sold in the past.

Once the analysis and valuation process is complete, the appraiser will compile their findings in a detailed appraisal report. The report will include information about the property, analysis of relevant market data, methodology used for the valuation, comparable sales and income projections, and a final opinion of value.

If you are considering an appraisal for your commercial property, McCoy Valuation is here to help. Our team provides high-quality and independent valuation services for lenders, investors, and property owners. With more than 30 years of appraisal experience, McCoy Valuation is equipped to handle analysis of all types. Our expertise covers multifamily, industrial, retail, office, land valuation, cost segregation, tax appeals, market rent studies, and more.

Written by Thomas McCoy and William Wilson.

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