Valuing Commercial Real Estate

Appraisal – an estimate or opinion of the value of real property based on supportable evidence.

The role of an Appraiser is not to determine VALUE rather they gather supportable information about the VALUE of the property.

The Appraiser does not establish the property’s worth- they verify what the MARKET indicates the property is worth.

The Appraiser seeks to justify the appraisal by looking at past events-not forward events.

The appraisal process is not an exact science, the key lies in the collection and analysis of data.

MARKET VALUE: the most probable price the property will bring in a fair sale in a competitive market with both parties acting prudently and knowledgeable and the price is not affected by unusual circumstances.

An opinion of VALUE based on analysis and data.

The most probable PRICE is not the average or highest price.

The most difficult item for an appraiser to estimate is ECONOMIC LIFE of the property.

MARKET PRICE: is what the property actually sells for. Property COST does not equal MARKET VALUE.

 

Factors That Influence VALUE

* Location – the most important factor in valuing real property

* Demand/ Transferability – need or desire; a buyer will place more value on aproperty that can be sold quickly

* Utility – usefulness; what can the property be used for?

* Scarcity – finite supply; what is the supply of this type of property being appraised?

 

Economic Principals of VALUE

  1. Anticipation – expectation of events
  2. Change – past, present, future behavior of market place
  3. Competition – intersection of supply & demand
  4. Conformity – maximum value when property conforms to surroundings
  5. Contribution – any part of property is measured by the effect of the whole
  6. Highest & Best Use – most profitable single use
  7. Increasing and Diminishing Returns – improvements increase value only to assets maximum
  8. Plottage – merging adjacent lots into one lot produces greater value
  9. Regression – better property is affected by lower quality property
  10. Progression – lower quality property is affected by better quality property
  11. Substitution – not paying more for a similarly priced property
  12. Supply & Demand – price affected by the number of properties available
  13. Highest & Best Use (single most profitable use of property)
  14. Legally permitted
  15. Financially feasible
  16. Physically possible
  17. Maximally productive

 Increasing Returns – improvements produce an increase in income or value

Diminishing Returns – the point where improvements do not add value to property

Depreciation – loss in value due to any cause, it adversely affects the value of the property

Curable Depreciation (physical depreciation) – economically feasible to repair and adds value

Incurable Depreciation – defect caused by wear and tear and if repaired would not add value

Physical Depreciation – is Curable

Functional Obsolesce – is not economically curable

External Obsolesce – always incurable, outside economic factors on property beyond control of owner

 

VALUATION  TECHNIQUES

 Sales Comparison (best for residential)– comparing recently sold similar properties

* appraiser selects several recently sold similar properties as “Comparables”comparisons are made between properties

* dollar adjustments are made to properties to estimate the value of subject property

 

Cost Method- how much to reproduce or replicate the property

* Cost if constructed today minus depreciation plus value of the land    (land never depreciates)

* Combining the present value of improvements with present value of the land

Formula: Cost if constructed today minus depreciation plus value of the land (land never depreciates)

 

 Income Method (commercial) – future income generated by property

* Gross income minus vacancy % and collections loss = gross income

* Minus expenses: taxes, insurance, mgt fee, repairs, maintenance, etc. (debt svc not an expense item

* = net annual income

Select CAP RATE which include all risks of owning property

Capitalization Rate is referred to as the risk rate or return on investment, plus depreciation rate: V = I/R

Reconciliation: the process of combining all three methods to arrive at the MARKET VALUE of the property.  The appraiser weighs each method in relation to the specific appraisal situation and then applies a weighted value to each method resulting in a combined value.