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NGExpert financial copywriter
Page written by Ashlyn Brooks. Last reviewed on October 2, 2024. Next review due October 1, 2025.
Appraisals are like the compass in real estate. They guide our decisions and strategies by providing an accurate assessment of a property’s value before we commit to purchasing, selling, or financing. Whether you’re looking to secure a loan, invest, or determine a fair sale price, a reliable commercial real estate appraisal ensures all parties have a clear understanding of the property’s true market value.
Here at Swoop, we always aim to empower our clients in both knowledge as well as funding, this includes helping you navigate the appraisal process effectively. This guide will cover the fundamentals of commercial real estate appraisals, their importance, and how they influence key financial decisions.
An appraisal is the act of determining the fair market value for a piece of property. This process is the same for both commercial and residential properties. These appraisals are conducted by certified professionals and take into consideration the property’s condition, location, size, income potential, and current market trends.
They provide an objective assessment that helps lenders, investors, and buyers make informed decisions about the property’s value, ensuring transparency in transactions including purchases, sales, or financing.
Commercial real estate appraisals serve as an essential tool for determining the value of property across various business and financial contexts. They provide a reliable framework for making critical decisions related to property investments and transactions.
Commercial property appraisals establish accurate value, a factor that should not be taken lightly. Commercial property tends to be much pricier than residential property, therefore the appraisal needs to be thorough and accurate to protect both you and your financer.
Establishing an accurate value is crucial as it impacts decisions related to financing, investment returns, and risk assessments. For lenders, appraisals ensure that the loan amount does not exceed the property’s worth, reducing the risk of loan defaults and protecting the integrity of the transaction.
Commercial appraisals cover a wide range of property types, including:
Commercial appraisers take several critical factors into account when determining a property’s value, each of which plays a significant role in shaping the final appraisal. These include location, condition, the market, potential income and zoning. Here’s a more detailed look at the key considerations:
The location of the property is one of the most influential factors in its value. Properties near major highways, transportation hubs, and commercial centers tend to have higher values. Areas with heavy foot traffic or high visibility are especially desirable for retail spaces, while industrial properties may prioritize proximity to freight routes or ports.
The condition of the property is another critical factor. Buildings in good condition that require minimal repairs are generally appraised higher. Appraisers examine key structural elements like the foundation, roofing, plumbing, and electrical systems, as well as any recent upgrades or renovations. Properties needing significant repairs or approaching the end of their functional lifespan will typically receive lower valuations.
Market conditions also play a key role in the appraisal process. Appraisers consider the current state of the local real estate market, including the supply of and demand for similar properties. They look at recent sales of comparable properties to gauge value. In areas where demand is high and supply is low, property values are often higher, whereas an oversupply can lower a property’s appraisal.
The income potential of the property is vital for income-generating real estate. Appraisers analyze current rental income, vacancy rates, and future earning potential. Properties with stable, long-term tenants and strong rental income typically receive higher valuations compared to properties with high vacancy rates or lower rents.
Zoning and regulations significantly impact the appraisal. Appraisers assess the property’s zoning to determine permissible uses and potential for future development. Properties with flexible zoning that allow for diverse uses or future expansion tend to have higher values, while properties with restrictive zoning may see more limited valuations.
Commercial appraisers look for specific details that influence the property’s overall value including
Let’s take the example of a commercial office building located in a high-traffic area, which is centrally located near major transportation hubs and has recently undergone upgrades like modern HVAC systems and energy-efficient lighting. Here’s how the different valuation methods would apply to this property:
In the cost approach, the appraiser estimates how much it would cost to replace or reproduce the building, considering depreciation. For a relatively new office building in a high-traffic area, the appraiser would calculate the current construction costs for similar office spaces, then subtract any depreciation that may have occurred due to normal wear and tear. This method works well for newer buildings where construction costs are a major component of value.
Example: If constructing the office building from scratch would cost $5 million, and the building has depreciated by 10%, the appraised value would be approximately $4.5 million using the cost approach.
The income approach evaluates the property’s value based on its ability to generate income, which is particularly useful for rental properties. In the case of our high-traffic office building, which is fully leased to long-term tenants, the appraiser would calculate the annual rental income, deduct expenses, and use that net income to determine the building’s value.
Example: If the property generates $600,000 in annual rent and typical commercial properties in the area have a capitalization rate of 6%, the appraiser would divide the annual income by this rate, giving a value of $10 million ($600,000 ÷ 0.06).
The sales comparison approach looks at similar properties that have been sold recently in the high-traffic area to establish a market-based valuation. The appraiser would identify comparable office buildings in the vicinity that have similar square footage, amenities, and upgrades, and adjust for any differences between the properties.
Example: If a comparable office building in the same area with slightly fewer amenities sold for $8 million, adjustments might bring the value of our high-traffic office building closer to $9 million due to its better location and upgrades.
In this approach, the appraiser multiplies the property’s gross rental income by a market-based GRM. It’s a quicker method compared to the income approach but doesn’t factor in expenses like maintenance or vacancy rates. The high-traffic office building’s rental income would be multiplied by a GRM commonly used in the area.
Example: If the gross rent is $600,000 annually and the market’s GRM is 15, the appraised value using this method would be $9 million ($600,000 × 15).
Appraisals should be updated whenever a significant event affects the property’s value, such as renovations, zoning changes, or shifts in market conditions. However, many businesses and lenders recommend updating an appraisal every 1-3 years to ensure the valuation remains current.
The cost of a commercial appraisal depends on the property type, size, and location. Generally, appraisals can range from $2,000 to $10,000 or more for larger and more complex properties. Factors such as the appraisal’s scope and the appraiser’s experience can also influence the price.
Appraisals play a critical role in the loan approval process. Lenders rely on appraisals to determine the loan-to-value (LTV) ratio, which helps ensure the loan amount doesn’t exceed the property’s value. If the appraisal comes in lower than expected, it may result in a reduced loan amount or the need for additional collateral.
An appraisal determines a property’s current market value for transactions like sales or financing, while an assessment is used by tax authorities to determine property taxes. Assessments are typically conducted annually and may not reflect the market conditions as accurately as an appraisal.
Commercial and residential appraisals differ primarily in complexity. Residential appraisals typically focus on single-family homes or small multifamily properties, relying on comparable sales. Commercial appraisals, on the other hand, must consider factors like income potential, property use, and zoning, making the process more detailed and time-consuming.
To boost your property’s appraised value, you could:
At Swoop, we understand the challenges businesses face when it comes to financing commercial real estate. Whether you need help navigating the appraisal process, securing funding, or comparing loan options, Swoop is here to guide you. Our platform allows you to easily check available business loans and explore funding options tailored to your specific needs.
To get started and find the best financing for your commercial real estate project, register today and check available business loans.
Written by
Ashlyn is a personal finance writer with experience in business and consumer taxes, retirement, and financial services to name a few. She has been published in USA Today, Kiplinger and Investopedia.
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