A meticulous process is in place to help determine the market value for buyers and sellers
Everything that’s up for sale has a price tag. We take it for granted. Whether it’s a piece of gum or a skyscraper, someone has to make an educated estimate of the item’s market value.
In the world of commercial real estate (CRE), we do this methodically, taking pains to get it right. It’s not just a matter of placing a finger to the forehead and making an informed guess. The process involves a great deal of data research, analysis and reconciliation.
Obviously, it’s important to get an accurate value of any CRE property. If you underprice a property, it won’t deliver the full value to the seller. But overpricing a property entails the same problem. There’s a danger it can sit on the market too long, losing money for the seller and then undergoing excessive discounting to attract buyers.
Another reason it’s so critical to price real estate correctly is that banks must be convinced of its worth before they lend the money. Price a property far above its actual market value and you’re unlikely to get the lending institution onboard.
Doing the inventory
The first part of the appraisal process is an inventory of the property. We go through an analysis of the region, the neighborhood, the site itself and the improvements the owner has made over time. We find out the size of any buildings, the dimensions of the property and its zoning standards (making sure there’s no noncompliance issue). Then we look at all the taxes and utility costs.
From this data, we move to the “Highest and Best Use analysis.” Often, the Highest and Best Use is obvious, like the duck theory: If it looks, walks and sounds like a duck, it’s a duck. But the market changes, so we have to see if an improved property may have a higher value as vacant land. The pandemic has created issues for several property types, such as hotels and restaurants, where a change in use may be the Highest and Best Use.
During the appraisal process, it’s important to account for population density, traffic counts, median household incomes, area amenities and many other factors. You may be appraising a property in a bedroom community with no hospital – say, an optometrist’s office in a commercial condominium project. Equating such a property with a freestanding medical facility in Sarasota across the street from a major hospital will likely yield an inaccurate value. The surrounding community has a marked influence on CRE prices.
A three-phase process
After determining the Highest and Best Use analysis, you begin a three-phase appraisal process, beginning with the Cost Approach. In this first step, you estimate the land value. Then you estimate the replacement and reproduction cost of the improvements, in addition to the accrued depreciation. Simply do the math from there: Take the land value, the improvements and subtract the depreciation.
The next step is the Sales Comparison Approach. You research properties with similar Highest and Best Uses that have sold recently, making unit comparisons. Sometimes it’s a square-foot comparison (for example with an industrial property). In the case of a hotel, it’s the price per room. The appraiser will analyze all this data, making adjustments for any improvements.
Next comes the Income Approach. You estimate the rental value. Then you deduct vacancy, credit loss and operating expenses (such as property taxes and insurance), and estimate the net operating income (NOI). The NOI is capitalized into the value by the Income Approach.
Getting a picture from the data
All of this data enters, as it were, the top of a funnel. And as we synthesize it, an increasingly clearer picture of the property’s worth begins to emerge as the data moves down through the bottom of the funnel. The three approaches are reconciled. An experienced appraiser considers the three approaches and makes the value estimate based upon the quality, quantity and applicability of the data and analysis.
Sometimes unexpected variables arise that can threaten to skew the numbers. Last March, many in the field expected the pandemic lockdown to influence CRE prices in short order. Real estate advisors were bracing for it. But in the end, it didn’t happen – at least not in Florida for most property types. We did see serious losses in the restaurant and hospitality sectors. But we also had gains that offset those losses: Droves of business owners bought commercial properties in Florida after fleeing states with heavy-handed COVID-19 restrictions (e.g., New Jersey, New York). In the final analysis, the pandemic didn’t fulfill its threat to lower overall commercial property values in Florida, thankfully.
A lot of hard work goes into the appraisal of a property. There are no shortcuts. A sound, empirically based appraisal gives buyers and sellers alike the confidence that they are dealing with correctly valued CRE.
Jim Boyd, MAI, Senior Advisor
SVN | Commercial Advisory Group