10 Things to Know About Commercial Real Estate Appraisal
Small business owners have a lot to digest when it comes to the subject of commercial real estate—especially these days. That goes double for the notion of obtaining an appraisal on a piece of commercial real estate, a process that can differ quite a bit from appraisals done for residential properties. "Commercial is very different from residential in the fact that appraisals are much more subjective in nature," says Scott Everett, founder and president of Supreme Lending, a mortgage lender in Dallas. "Much of the value derived from a commercial building is based on the rental rates received relative to the expenses paid out. The underlying asset is important, but not even close to the same way that a residential properties value assets."
In other words, if you're looking to get an appraisal done on a piece of commercial property—perhaps because you want to buy or sell it or even because you want to establish a value of a lease or lodge a property tax appeal—there could be a bit of a learning curve in knowing what you're about to embark on. Inc. contributor Darren Dahl asked Douglas McKnight, a 22-year veteran commercial real estate appraiser and managing director at CapStruc Valuation in Malvern, Pennsylvania, for some insight into his profession. What follows is a list of the top 10 things McKnight says you need to know about commercial real estate appraisals:
1. The Inspection Is Only a Small Part of the Appraisal Process
Depending on the size and complexity of the property to be appraised, it might take less than an hour to several hours to inspect the property. Some clients perceive this as the entire process but the truth is that it is just the beginning. Appraisers research public ownership and zoning records, investigate demographic and lifestyle information, and compile comparable sales, replacement costs, and rentals. They then analyze this information as it relates to the value of the property. Finally, they write a report on their findings. The inspection is just the beginning of an appraisal process that may take several days or even weeks.
2. Don't Try to Misrepresent the Facts
Appraisers are professional skeptics. They will seek to verify anything that you tell them from other sources. McKnight says he often ask questions that he already knows the answer to just to test the credibility of the people showing him the property. Appraisers are always thinking about how they will defend their opinions if they are ever brought to court, even in assignments in which litigation appears unlikely. If you misrepresent anything, the appraiser will discount the credibility of anything else that you say.
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3. Don't Withhold Information
You will probably be asked if you can provide a property tax bill, a set of drawings of the property, income statements, and other things. You might not know why an appraiser is asking you for something but it is best to provide whatever you can. Appraisers have no interest in unduly expanding their work files but they do need certain information and the more you provide, the more quickly they can complete the assignment. If you subsequently dispute the appraisers value opinions and produce additional information that wasn't provided from the onset, you have wasted valuable time.
4. Appraisers Must Adhere to a Strict Code of Ethics
Appraisers must follow the Uniform Standards of Professional Appraisal Practice, which, among other things, requires them to provide an unbiased opinion. Failure to follow this might result in disciplinary action from the state, including revocation of an appraiser's certification. If an appraiser refuses to do something that you ask for, it is probably because of the obligation to adhere to these ethics.
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5. The Client Is the Party That Orders the Appraisal
If the appraisal is for financing, the lender is the client. Appraisers are obligated to maintain client confidentiality, so if you are the borrower or any other party, the appraiser cannot release the appraisal report or any other confidential information to you. If you order an appraisal as part of a property tax appeal and are afraid that the appraised value might be higher than the assessed value, you can rest assured that the appraiser won't release the results to the property tax board without your permission.
6. Identify the Intended Users
Make sure the appraiser knows who you want to use the report. If you are looking to buy a property, that might mean you intend to share the appraisal with the seller, your lender (though they will likely obtain their own appraisal) and possibly your local property tax appeal board. These people or parties will be identified in the appraisal report and are the only ones who are authorized to use the report.
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7. There Are Three Types of Preports
A "restricted use report" is the shortest and least expensive type but can only be used by the client. Fees can vary based on the size of the property as well as the scope of the appraisal, but a good starting point for a restricted report might be $2000 to $2,500. A "summary report" summarizes the data and analysis and can be used by any intended user and can cost upwards of $3,000. A "self-contained report" contains all of the details of the data and analysis, but is rarely requested. If you tell the appraiser how you intend to use the report, he or she can guide you as to what type of report you will need.
8. The Type of Report Is Separate From the Scope of Work
The amount of work involved in reaching conclusions does not depend on the type of appraisal. With a restricted use or summary appraisal, the appraiser will compile large amounts of information that are retained in a work file but are not included in the report. For this reason, the differences in fees between the various types of reports are less than the amount of information contained in the reports might indicate.
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9. Consider the Date of Valuation
Several years ago, McKnight appraised a nightclub. The weekend after he inspected the property, someone was shot in the club. This introduced stigma that reduced the value of the property. This indicates the importance of establishing the date of valuation. Appraisers can appraise property as of the date of inspection, as of a past date (a "retrospective appraisal") or as of a future date (a "prospective appraisal"). It is important that you establish the correct date of valuation for your needs.
10. Consider the "Property Interest" Appraised
Last but far from least, it's important to tell the appraiser what your interest in the property is. For example, if you want to know what a property is worth free and clear – such as a warehouse you want to move your business into – you are interested in what's called the "fee simple interest." In other words, you simply want to know the value of the building and its property. On the other hand, if you want to know what a property is worth to a landlord when occupied by a particular tenant or tenants, you want a "leased fee interest." Finally, if you want to know what a lease is worth to a tenant, you want a "leasehold interest." This is a common request when people look to buy businesses, as they need to know what the value of the lease is to that business. "Be sure to identify which property interest you want appraised," says McKnight.
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Darren Dahl is a contributing editor at Inc. Magazine, which he has written for since 2004. He also works as a collaborative writer and editor and has partnered with several high-profile authors. Dahl lives in Asheville, NC.