A timely, accurate appraisal is critical to the success of any commercial real estate deal. We base everything from lending to income projections and exit strategies on an accurate valuation of a property.
Yet, many appraisals miss the mark by a significant margin. One 25-year study found that the average appraisal was more than 10% above or below subsequent sales price. That’s a $50k divergence on a half-million-dollar exchange.
It’s easy to blame the professional charged with completing the appraisal. In reality, it’s often poor or delayed information from us—the buyers, sellers, and brokers—at fault. Garbage in, garbage out, as they say.
We all have a lot riding on appraisals, so we need to take some steps to help appraisers do their job quickly and accurately. A $50k misstep is not one many of us can afford to make often.
The physical property inspection is just one visible step of the appraisal process. Most of the valuation is a behind-the-scenes review of net income, comps, and market history. You can help move that part of the investigation along by having a document package ready for your appraiser when they begin.
Here are a few things your appraiser will find helpful:
Few appraisers will complain about having too much information. Whatever documentation you have that details net income, property health, and the market belongs in the packet you provide.
There are two types of appraisal reports referenced in the most recent USPAP, each with its own cost and typical use case.
A Restricted Appraisal Report is a short summary of the appraisal’s conclusions. It’s the least expensive appraisal report but is not appropriate for most situations.
In a recent change to the USPAP, multiple parties besides the client can now use a Restricted Appraisal Report, so long as they are listed as an “intended user” in the appraisal. Previously, only the client could use a Restricted Appraisal Report.
An Appraisal Report is more robust and so comes with a higher price tag, but is the most common option. It includes all, or almost all, of the data and analysis gathered and completed by the appraiser.
Users of an Appraisal Report can include both the client and any other person identified by name or position.
Each state offers rules regarding appraisal reports. Your appraiser can help guide you toward the right report for your situation.
An interesting aspect of appraisals is that the client who orders them can choose the date of valuation. Meaning, you can tell the appraiser to base their conclusion on the date of inspection, a date in the past (retrospective), or some date in the future (prospective).
Retrospective appraisals consider the value of a property at some date in the past. They’re often used in divorce or inheritance tax proceedings where the value of a property on a prior date is important. They can also be useful if some drastic, one-time occurrence in the neighborhood (like a freak flood or violent protest) temporarily reduces the value of your property.
A prospective appraisal estimates what the value of a property will be at some date in the future. It’s useful for valuating projects under construction, renovation, or that have just been proposed where there’s not yet a physical property or income history.
Both the condition of the physical property and the income it produces are highly influential in an appraiser’s opinion of its value. For the best possible valuation, make sure the appraiser knows what you’ve done to improve both the physical building and its ability to generate revenue.
This tip is important when you’re selling a building, but especially so when looking for a cash-out refi as part of a BRRRR [link] (buy, rehab, rent, refi, repeat) project. That’s because the success of BRRRR deals relies on your ability to increase the valuation—either by improving the revenue, structure, or both.
For the physical improvements, provide a list of each repair or addition you made after purchasing the building. Also, make it clear how those upgrades will make the property more attractive to higher-paying renters. And explain how any new amenities help your building compete against similar properties in the market.
Next up, share a list of any income streams over and above lease payments. These may include:
Also, make it clear how the revenue streams have increased since you purchased the building. That will lead to a higher valuation from your appraiser.
If the neighborhood your property occupies has improved recently, make sure your appraiser knows it.
The mantra “Location, Location, Location” doesn’t just apply to residential real estate. The market surrounding your commercial building will affect its property class, income potential, and assessed value.
Let’s say you own a multi-tenant retail/restaurant property in a growing part of town. The city planners have just approved a 500-unit condo and single-family neighborhood less than a half-mile away. There won’t be increased rental income on your books yet, but knowing about the project would help an appraiser understand the true value of your property.
Withholding or falsifying information will cause delays and make it hard for appraisers to trust you.
Most appraisers charge by the job, not by the hour or number of documents processed—it’s not in their best interest to review documents that won’t help form their opinion of value. Even if it’s not immediately clear why some information is needed, it’s best to provide it quickly so the deal can move forward.
Additionally, appraisers follow the strict Uniform Standards of Professional Appraisal Practice (USPAP) or risk losing accreditation. Among those standards is the requirement to provide a full and unbiased valuation. If an appraiser suspects you’ve provided false information, they’ll need to review everything you’ve sent—which will drag out the process.
Some appraisers may even test you with a question they already know the answer to early on to see if they can take you at your word. Transparency is truly the best policy.
Real estate appraisals are actually based on the rights and intended interests associated with the property, not the physical land and buildings themselves. This means your appraiser needs to know if you plan to occupy the building or offer it as a lease to tenants.
There are two common types of property interests where appraisals are concerned:
You’ll usually ask an appraiser to consider fee simple interest if you are looking to purchase a property to house your business. For most investors who want to buy a space for the purpose of leasing it out, you’ll ask for a leased fee interest.
The best way to make sure that your appraisal is both accurate and efficient is to hire the right appraisal professional.
Your appraiser should:
Also, make sure you know if the principal appraiser or one of their appraisers-in-training will prepare your report. Either person can do the job, but if it’s someone in training, ask about the principal’s level of involvement.