If you’re considering a commercial real estate investment or liquidating an existing investment, there’s a good chance you might want to conduct a commercial real estate assessment. You may be curious about how such a procedure works. This article will cover all the information required to evaluate a real estate property. What is a commercial real estate appraisal? How is it done? And how can you increase the value of your real estate? Read more to find out.
What Is a Real Estate Appraisal?
A real estate appraisal assesses how much a property is worth. Unlike residential properties, a commercial real estate assessment helps estimate the value of different properties, including office buildings, multifamily units, or retail spaces, which are used for self-accommodation and generate various streams of revenues for their owners and operators.
Unbiased appraisals are primarily used to estimate the price at which a property may sell in the present market. However, they are also crucial in underwriting. Since lenders often won’t lend more money than an asset’s value, an appraisal aids them in determining how much credit they may safely extend.
An assessment can be a beneficial tool for investors as well. It could help you determine how much money it’s worth to invest, whether to expect additional spending on the property over the coming years and how much income it generates in leases. The appraisal will also assist you, and the property’s operator in deciding what improvements or changes to optimize the asset and its returns.
Related: Real Estate Investment: What’s the Difference Between Primary and Secondary Markets?
Commercial Vs. Residential Real Estate Appraisal
Although residential and commercial real estate requires appraisals, the two procedures are substantially different. Different methods are used to calculate the worth of the attributes. Appraisers for residential real estate frequently base their conclusions on the sale price of comparable properties. Then, they adjust the value according to the special qualities and specifics of the subject property.
In contrast, in commercial real estate appraisals, greater weight is given to the magnitude of income that the property can produce. Due to their complexity, CRE evaluations typically take longer to conduct than residential appraisals. As a result, they are also typically far more expensive. A commercial appraisal may cost several thousand dollars compared to a couple of hundred for a regular home appraisal. For a large CRE investment or sale decision, commissioning an appraisal might be worth your while.
Methods of Commercial Real Estate Valuation
Commercial Real Estate Appraisers are an important part of the real estate industry, playing an integral role in commercial property transactions. They provide objective assessment and analysis of the entirety of a commercial real estate asset, including its current value as a function of local market conditions. Appraisers must have deep knowledge and understanding of local real estate markets, current trends, and best practices to properly evaluate a given property for any transaction or management purpose.
A commercial real estate appraiser may choose from four approaches to determine a property’s value. The approach that is adopted will depend on the situation.
Cost Approach
The cost approach is uncommon but can be useful if a structure is extremely unusual or new. This approach assesses a property’s value by estimating the cost of completely rebuilding it. To calculate how much one can expect it to cost to build an identical structure in the present market, this method considers the land, labor, and materials expenses.
Commercial real estate appraisers calculate a property’s worth using the same calculation when using the cost approach.
Property value = Land cost + Building cost – Accumulated depreciation.
This approach operates under the presumption that it should not cost more to purchase a building than it would build it from the ground up. Newer structures respond better to this technique.
A building’s age affects how much opportunity is available for price variations. For instance, the rising price of materials and the expense of bringing a building up to code can both be factors.
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Income Approach
The income approach is unquestionably the most widely used valuation technique for commercial real estate. In this approach to commercial valuation, the appraiser determines how much revenue the property can reasonably be expected to produce in current market conditions by using popular investment formulae, like net operating income (NOI) and capitalization rate (Cap rate).
The income approach’s calculation formula is as follows:
Property value = Net operating income (NOI) / Capitalization rate.
This approach to property appraisal is frequently regarded as the most precise.
Having stated that, one must bear in mind two things. The pro forma of the property must accurately reflect the net operating income. If it’s incorrect, the appraisal will also be incorrect.
However, investors must locate the capitalization rates of similar asset deals to determine the cap rate to use in this formula. It might be challenging to determine a reasonable cap rate when few comparable transactions are available, which can also affect the valuation’s accuracy.
In the case of undetermined operating incomes and capitalization rates, a sensitivity analysis can be performed to understand how variations in each factor affect the property value. Then, through common sense and negotiation, parties can agree on the deal amount, which might differ from the appraiser’s evaluation.
Sales Comparison Approach
The technique most frequently employed in residential appraisals is the sales comparison approach. Comparables, which are the sale prices of comparable properties, are used in this method to estimate the subject property’s value.
As described above, commercial appraisers normally don’t have as many comparables to use as residential appraisers. The commercial appraiser might have to search well beyond the local market area for a comparable property, which can lead to a less trustworthy valuation.
Typically, individual investors use the sales comparison method to estimate how much money they should offer for a certain property. Commercial appraisers would usually turn to another technique.
Related: Real Estate Investment Basics: Loan to Value
Gross Rent Multiplier Approach
The gross rent multiplier approach is the last option for appraisals. Again, individual investors tend to use this method more frequently than professional appraisers. It’s a less formal, more off-the-cuff approach to real estate appraisal.
By using comparables, you can determine the average gross rent multiplier in the neighborhood where the property is located. To find out the property’s rent multiplier, you need to divide sold properties’ value (which you might find in tax reports or city records) by the average rent paid for such properties (which you might find in lease ads or by asking landlords to rent a property).
After you have these figures, you can apply the equation below to determine the property’s value:
Property value = Annual income x Gross rent multiplier.
This method is highly subjective and inaccurate, as with any appraisal by multiples.
It should be noted that if an appraiser uses multiple appraisal methods, she can come up with similar valuations that strengthen the appraisal’s accuracy or use an average of the appraisal methods used to determine a final appraisal amount.
Methods to Increase Your Commercial Property Appraisal
The estimated value of a property will differ according to the opinion of each professional appraiser. There are no certainties, but you can utilize these recommendations to increase the likelihood that the assessment will go favorably.
Gather Your Documents
Typically, when a business appraiser visits the property to inspect it, they follow up by conducting further research on the actual site. They might ask you for copies of several significant papers, such as your current rent rolls, any active leases, building blueprints, and site plans. By having this information on hand and prepared to use when needed, you can expedite the process and sustain the valuation.
Stay Up to Date on Improvements and Maintenance
Do your best to stay on top of routine building maintenance because, in general, properties in better shape are appraised for higher values. Making improvements to make an older structure look modern could also turn beneficial.
Find Methods to Generate More Income
Last but not least, think of all possible ways to increase income from the property. CRE appraisers favor the income strategy when appraising your commercial property, and any income makes an impact. For instance, a multifamily building’s owner can generate extra revenue streams from laundry services, vending machines, visitors’ parking garages, or solar energy.
Related: Top Ways Experienced Real Estate Investors Can Grow Their Net Worth
How do Sponsors and Real Estate Marketplaces Value Properties?
Investing in real estate is simple now that marketplaces exist, but it still requires trust in the marketplace’s valuation of the CRE asset or investment. SecondRE Marketplace’s real estate analyst Guy Rippel says, “When transacting in the real estate marketplaces and crowdfunding platforms, assets’ appraisal and valuation plays a major role. Most assets and investments are assessed by their sponsors, who have conducted various appraisals and have the deepest knowledge of the asset, its characteristics, and its potential. At the same time, they are interested parties with an interest in getting the highest appraisals. It is, therefore, the marketplace’s role to verify the data, run the numbers again, and use multiple appraisal methods to validate or adjust the asset’s value – or, if that’s not possible, to decide whether to offer the property or investment on the marketplace given its price and their estimates.”
The value of your property or real estate investment matters not only when you decide to buy it. Part of the sponsor’s job is to track and analyze the value of your investment on a quarterly basis. They will usually produce deal sheets and quarterly reports that would give you timely insight into the performance of the asset and the returns on your investment. If your investment allows for liquidity – like on the SecondRE Marketplace – this would allow you to decide whether to keep the investment or liquidate it and at which price to offer your holding.
What’s Your Commercial Property Worth?
If you’re getting ready to sell your commercial property, you need to know its worth. You’ll undergo a commercial real estate appraisal to get an accurate measure. Now that you understand the process, you know better what to expect.
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