CRE Appraisals 101
October 31, 2017
Factors that influence a quality commercial property appraisal
By: Paulk Turner, Appraisal and Valuation Services
Choosing to buy or lease new property is a major decision for any business owner.
Due diligence is key, and hiring a commercial real estate appraiser to produce an accurate property value or determine an appropriate market rental rate is at the center of that due diligence.
That’s why one of the most important factors is knowing the quality of the appraiser by trusting his or her experience and qualifications. State licenses are a must, but designations such as the MAI for commercial appraisers (from the Appraisal Institute) indicate a higher level of experience and training, and therefore, a higher quality of work.
Commercial real estate is more than just a people business. Understanding the numbers and diving into the property and market research are key factors to attaining the most accurate and well-supported opinion of property value.
Availability of data and research
The first step to properly comparing the subject property to the market and comparable properties is gathering as much detailed information as possible. Properly compiling and analyzing the available data and research to understand the factors affecting the subject property such as its size, quality and overall condition, location, the income from the current tenants and structures of their leases, etc. are all essential to properly comparing the sales or leases of other properties to the subject.
It’s also important to consider external factors that influence the subject property. Understanding the subject property’s neighborhood characteristics and trends such as economic growth or decline, existing or proposed new developments, competitive properties, transportation routes, and finding quality, comparable nearby properties from which to compare to the subject to estimate the value or rental rate is important. A lack of quality comparable properties will ultimately diminish the strength of an approach to value.
Determining the Highest and Best Use of the property
The most important part of the appraisal process is determining the Highest and Best Use of the property. This analysis is the basis for selecting the appropriate comparable properties as the current use of the property is not always the use that will provide the greatest financial return or produce the highest value.
Take for example a major enclosed shopping mall that has been vacant for years. The era of enclosed malls with large anchor stores has passed and therefore, the challenge of this appraisal is determining the highest and best use of the property. Portions of the building could be reused for different purposes, but understanding the future use of a large land site with good access to interstates and other major roadways will ultimately provide the best value for the overall property. That could include renovating much of the existing property for an alternative use, demolishing all of the improvements for a completely different use, or a combination of these options. It could be possible that retail or commercial is no longer in demand in this area, and an industrial or institutional use is the most financially feasible development on the property.
Quality of tenants and leases in the building
A major factor influencing multi-tenant office properties is the quality of the tenants and leases in the building. For example, an office building is fully occupied by 20 tenants, but half of these tenants do not have signed leases on file and are leasing on a month-to-month basis, and many of these tenants are also leasing at below market rental rates. Due to the risk associated with these short-term tenants and the below market income being received, the price that a purchaser/investor would be willing to pay for the property would be lowered substantially to account for this risk. Despite the building being fully occupied physically, with all of the tenant suites filled, the tenants with month-to-month leases are not under contract through a signed lease and can legally vacate at any time, likely with only 30-days’ notice. Therefore, the perceived risk of losing these tenants and the income associated with the tenants negatively effects the value of the property. In this scenario, the client requested a value of the property. As Stabilized, at the projected time all of the tenants’ leases are converted to longer term leases at market rental rates based on comparable properties in the neighborhood, despite the property physically being fully occupied at the time of inspection.
Industrial properties are also influenced by the quality of tenants, but typically have fewer tenants than a multi-tenant office property. Factors such as office to warehouse ratio, number of loading doors, ceiling heights, storage yards, and access to major transportation arteries are also important in determining the value or rental rate. Regardless of the property type, the quality of research on the subject property and potential comparable properties is essential to producing a well-supported value opinion.