Commercial Real Estate Appraisals Are More Complicated Than the Typical House Appraisal
That is hardly a surprise. Unlike most home appraisals, there are usually far fewer comprable (comps) properties with which to do an accurate valuation based on market activity.
Appraisers use three approaches to value in Appraisal Practice when determining the Market Value of a property:
- The Sales Comparison Approach
- The Cost Approach
- The Income Approach
The Sales Comparison Approach is the primary approach used with typical residential situations, but extends beyond that market.
Definition: The Sales Comparison Approach compares recently-sold local similar properties to the subject property. Price adjustments are made for differences in the comparable and subject property.
The sales comparison approach is the foundation for the real estate professional’s CMA, Comparative Market Analysis. This is a process used to determine the current market value of a property based on recent sales of comparable properties in the area.
The Cost Approach is most useful with newly constructed properties, but can be applied to other properties if depreciation is dealt with effectively.
What is a ‘Cost Approach’
The cost approach is a real estate valuation method that surmises that the price a buyer should pay for a piece of property should equal the cost to build an equivalent building. In cost approach appraisal, the market price for the property is equal to the cost of land plus cost of construction, less depreciation. It yields the most accurate market value when the property is new.
The Income Approach is most appropriate of course for properties that produce income. This can be anything from a single family rental home, duplex or apartment building. It can also include a wide range of retail stores fromthe corner grocery to the Mall of America in Bloomington, Minnesota.
It is particularly common in commercial real estate appraisal and in business appraisal. The fundamental math is similar to the methods used for financial valuation, securities analysis, or bond pricing. However, there are some significant and important modifications when used in real estate or business valuation.
While there are quite a few acceptable methods under the rubric of the income approach, most of these methods fall into three categories: direct capitalization, discounted cash flow, and gross income multiplier.
In a formal appraisal, for commercial properties we look at all three approaches where applicable and can on occassion come up with three distinctly different valuations. These tend to be close in most cases, and they it becomes an educated process of determining the most appropriate weighting each deserves.
Obviously, there is much more detail that can be offered on each approach. For more information on how to effectively value your property consult a qualified Real Estate Appraiser.
For complicated properties, you really want to find an experienced appraisel like Clarke Goset of Minnesota Real Estate Appraisal Services. They offer upper tier support for complicated properties and those in contentious legal situations. While they do apartment buildings, their focus is on commercial and industrial property valuation.