The Appraisal Process
Thousands of commercial appraisals are ordered every day. If you own or have owned a commercial building, chances are that a commercial appraisal was ordered by your lending institution to evaluate the value of the property against the loan amount. An appraisal simply provides an educated opinion of the value in order to mitigate risk. If you’ve ever found yourself wondering what goes into a commercial appraisal, I’m here to shed some light.
To begin the process, the appraiser gathers data about the property in an attempt to evaluate its relative desirability. In particular, the economic, physical, and legal characteristics are evaluated. Typically, areas with high population, employment, and income growth are preferred. Physical characteristics consider the type, age, design, and functional utility of the improvements. Newer buildings with a modern design and layout often command premium prices. Legal aspects also have a significant impact on value. For example, the right to develop a residential tract with a higher number of dwelling units will generally result in a higher price.
Highest and Best Use
Data collected during the initial phase of the appraisal assignment culminates in an opinion of the ‘Highest and Best’ use of the property. A highest and best use analysis of the property ‘as vacant’ and ‘as improved’ (for improved sites or proposed improvements) enables the appraiser to evaluate how the property might best be utilized by market participants. Four criteria are used in this analysis. These include uses that are:
1) Legally Permissible
2) Physically Possible
3) Economically Feasible
4) Maximally Productive.
Such an analysis allows the appraiser to conclude a use that maximizes the overall property value and facilitates the identification of sales of property with similar overall utility, commonly referred to as ‘comparable sales’. This process also helps assess if improvements to the site (if any) have a positive or negative contribution to the overall value.
Generally speaking, there are three different valuation methods:
- The Cost Approach
- The Sales Comparison Approach
- The Income Approach
Each of these techniques is based on commonly accepted valuation theory and may, or may not, be applicable to various property types. For example, the cost approach would not normally be used to form an opinion of vacant land. The sales comparison approach may not be applicable to property types that are highly heterogeneous or where an inadequate supply of sales data exists (e.g. a nuclear power plant). The income approach is not typically meaningful for single family residences but is often used to value improvements specifically designed to generate rental income.
If more than one valuation technique is used and they result in different values, a reconciliation weighs their strengths and weaknesses, and the quantity and quality of data available. Often, the appraiser contemplates the criteria that would likely be used by the most likely purchaser for the specific property type under consideration before concluding a single or ‘final’ opinion of value.
The steps outlined above provide you with a broad overview of the appraisal process. As with any other profession, experience and education only serve to enhance the reliability. If you are curious about a specific aspect of the appraisal process, please feel free to call or email me for a quote. I’m available 24/7/365 on my cell phone.