The Three Basic Approaches to Commercial Property Appraisal
Owners of commercial real estate often seek a professional appraisal when selling or refinancing their loans. Other times, appraisals are used as a means of determining accurate values for taxation purposes, among other considerations. Essentially, an appraisal gives an updated picture of the current market value based on factors like location, age, and how well it has been maintained. In turn, this allows for transparency and gives potential buyers or lenders a clear idea of what is an appropriate price range, loan amount, and/or insured value. Once hired, professional commercial appraisers typically employ one of 3 approaches to valuation: Cost, sales comparison, or income approach.
The cost-based approach to appraising commercial real estate calculates the funds that would be needed to reconstruct the property or build an identical property from scratch. After doing all the necessary research and investigation to establish an accurate figure, a professional appraiser then takes any applicable depreciation into account. These two figures combined can produce a helpful estimate of the property’s market value as a whole. Some appraisers and experts in the field of real estate take issue with some aspects of this method, however. Some details create doubt about being able to find a truly comparable building site on which to build the hypothetical “identical property”, for instance. Also, many question the ability to truly match equivalent cost figures for “reconstruction”. As a result of such common hesitancies, this approach is typically only employed by expert appraisers in particularly special cases. These include highly unique properties with very few comparable properties or brand-new real estate, which provide recent and comprehensive construction figures.
The sales comparison method estimates the market value and the price an investor or buyer would be willing to pay by comparing the property in question to carefully chosen similar properties. This entails obtaining the sales’ and transaction data from the chosen comparable and a detailed, in-depth analysis of similar features and amenities along with associated costs. Such details include anything from size, location/surrounding neighborhood area, state of maintenance, to floor plans. The sales comparison approach is the favored method of many professionals in the commercial real estate industry, believing it to be the most accurate given the inclusion of current market figures.
The income capitalization approach to valuation is based on the revenue an establishment brings in over time. To calculate meaningful figures, the net income, or generated income minus expenses, is divided by the “capitalization rate”. The capitalization rate is the rate of return expressed as a percentage which is calculated by dividing the net operating income by the asset’s current value. This method is considered most relevant for income-generating commercial real estates like shopping centers, large apartment complexes, and professional office buildings. In the case of rental properties, the net income is the focus. Prospective lenders for these, and other commercial properties, will then review all of the appraisal’s findings to ascertain the likelihood of loan repayment by the borrower.
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