10 Questions To Ask Before Hiring a Commercial Real Estate Appraiser
Before employing the services of a commercial real estate appraiser, it makes sense to engage potential appraisers in a thorough discussion about their appraisal experience, business background and general viewpoint about the type of property you would like to have appraised. Some relevant questions that you would want to ask include:
1. Do you currently have a Certified General appraisal license from the state the subject property is located in? A Certified General appraisal license is required to value commercial property in most states. Furthermore, an appraiser who holds state-certified licensure shows his level of professionalism that will make the client more comfortable when ordering an appraisal.
2. Are there any other distinctive designations held by the appraiser such as the MAI or RM from the Appraisal Institute, or the AM or ASA from the American Society of Appraisers? Although specialized designations are not required to perform commercial real estate appraisals, it shows that the appraiser has met the rigorous requirements concerning schooling, testing, and skills from experience. Appraisers with specialized designations are tested on their demonstration of understanding, knowledge of the overall appraisal process, and the ability to solve the challenging questions accompanying the many types of commercial property.
3. Have you appraised any other commercial properties in the subject property’s market area before? Though not absolutely necessary, it certainly helps when the appraiser is geographically competent and familiar with the local markets. Otherwise, the appraiser may have predetermined value indicators in his head, when the market may actually reflect something vastly different.
4. Have you appraised this particular type of property before? The appraisal of commercial real estate can include many different scopes of work, from simple assignments such as office or industrial buildings, to complicated properties, including land trust conservation easements or going concern values. Under most state’s appraisal certification Competency Rule, the appraiser is required to disclose a lack of experience and/or knowledge to the user of the appraisal before accepting the assignment. If the appraiser discovers at any point in the appraisal process that they lack the adequate knowledge and experience, they must stop work immediately to prevent the development of unreliable assignment results. It’s important to know whether or not the appraiser you are about to hire is familiar with the specific type of property that you want appraised.
5. If you haven’t appraised this type of property before, what will you do to familiarize yourself with it? The appraiser can affiliate with someone who has more experience for a particular type of property. Affiliation with an appraiser who has more experience can reduce a lot of the risk associated with an appraiser who is inexperienced. He can also study and do research to determine the best methodology for appraising the property.
6. How long have you been in the appraisal industry? A lack of years in the appraisal business does not necessarily mean that the appraiser is incompetent, but it does provide you with a basic understanding of their lack of experience.
7. What techniques or approaches to value are the best for appraising the type of property I need appraised? Asking this to a few different appraisers will tell you if an appraiser is trying to take a shortcut by providing less approaches.
8. What information do you need from me to write the appraisal? Appraisers often need documents up front such as (but not limited to) rent rolls, leases, income and expense statements, building plans, building costs, surveys, floor plans, etc. The sooner this information is provided to the appraiser, the quicker the appraiser will be able to complete the assignment.
9. What is the cost and the timeline for completion of the appraisal? Someone ordering an appraisal will want to know the answer to this upfront. If an appraiser is backlogged with assignments, you may want to find someone else to the appraisal. Basic statistics suggests that the more backlogged an appraiser is, the more expensive and longer turnaround time for the appraisal.
10. Can you provide me with a few references from your current clients? Like with all professional services, you should feel comfortable with the professional appraiser on several points, such as their professional competence, technical know-how, and their timeliness.
These 10 questions should be able to guide anybody through the appraisal-ordering process. Even someone who has never ordered an appraisal before can feel secure with their decision making if these questions are employed.
Estimating Capitalization Rates – Part III
In the first two parts of this series, we have introduced and defined four different methods of estimating capitalization rates. In this part of the series, we will take a detailed look at market-derivation methods and the factors that should be considered when extracting market-derived capitalization rates. As has already been discussed in the previous two installments of the series, market derivation is the most reliable and applicable approach in most cases. The band of investment and debt coverage ratio methods are the next best options, and the investor survey method can be a reliable check for the other methods.
The market derivation method is important because it is closely tied to market activity and it can easily be understood my market participants. It provides the best insight into how investors in the subject’s unique market are actually making decisions. Most of the drawbacks of a market derived capitalization rate occur when the appraiser does not consider that these rates are being extracted from comparable properties. The comparable sale that the capitalization rate is being extracted from should share similar characteristics with the subject property. The appraiser must consider if the comparable is similar to the subject in terms of quality, location, investment grade, and occupancy.
The date of sale of a comparable must be considered, in case conditions related to income rates and supply and demand may have changed. Since market derivation is partially a sales analysis, financing terms and conditions of sale should also be considered. Additionally, it is important that the income sources for the comparables be considered. The appraiser should analyze if the leases are at market rates, as well as the credit quality of the current tenants. Another important consideration is the type of buyer. Different types of buyers may have different expectations in regards to return requirements. For example, a real estate investment trust may have different requirements than and institutional buyer. When these factors have been fully considered and similar comparables can be produced, the market derivation rate is very reliable and the other methods can be used as a check. When market extracted capitalization rates are not available, the appraiser can turn to the other methods to produce a capitalization rate. In the final part of this series we will take a look at the factors that must be considered in the reconciliation of a capitalization rate.
Supporting Capitalization Rates – Part II
In the first part of this series we talked about the importance of accurately estimating the capitalization rate within a direct capitalization analysis and briefly introduced four common methods used to estimate a capitalization rate (OAR). In this part of the series we will more thoroughly describe and define these four methods which include market derivation, band of investment, debt coverage ratio, and investor’s survey. As we discussed in the first post, deriving capitalization rates from comparable sales is the favored method.
A market-derived capitalization rate can be characterized by several factors. It is the rate of return on the entire purchase without taking into consideration who contributes the funds (i.e. bank or REIT). The market derived rate is not influenced by the structure of debt and equity. The market derived rate indicates the connection between one year’s net operating income and the total purchase price. The market derived rate does not clearly consider projected future income or changes in property value. The market derived rate represents a going-in rate of return. The reciprocal of the market derived rate is a net income multiplier. If a market-derived capitalization rate is not able to be estimated, the next most credible methods include the construction of an OAR through component parts. The band of investment and debt coverage ratio methods represent two ways to construct an estimated OAR.
Band of investment analysis, by definition, “is a technique in which cash flow rates attributable to components of a capital investment are weighted and combined to derive a weighted average rate attributable to the total investment.” Because most investments are purchased with debt and equity capital, the overall capitalization rate must satisfy the return of both investors. The debt coverage ratio method, or DCR method, is based upon standard underwriting guidelines determined by commercial lenders. It is based on lender’s debt coverage ratio which represents the amount of net operation income needed to cover the debt associated with a property.
Finally, the Investor’s Survey can be used to estimate the OAR and is considered a good check on market-derived and constructed rates. Investors surveys are published by several different outlets and can provide good support in estimating a capitalization rate. In the next part of this series, we will look at the strengths and weaknesses of each of these approaches.
Supporting Capitalization Rates – Part I
The Income Approach is the main approach to value when appraising a property that is purchased for its income producing ability. This series will take a look at one of the key components of the direct capitalization analysis, a common technique used within the Income Approach to value. Direct capitalization is based on the simple formula of Value = Income / Overall Capitalization Rate. The estimation of an appropriate capitalization rate is probably the most critical step in the direct capitalization analysis, since in most cases the historic income data for a property is readily available and fairly reliable, and the future income can be easily estimated. Therefore, the capitalization rate plays a large role in determining the value of a property. Small differences in an estimated capitalization rate can lead to large differences in market value.
For example, let’s consider a 4,000-square-foot office building that is producing an annual net operating income of $50,000 per year. If an overall capitalization rate of 8% is considered it produces a value of the property of $625,000, or $156 per square foot. If an overall capitalization rate of 9% is considered it produces a value of the property of $555,556, or $139 per square, which is almost a $70,000 dollar difference (-11%) in value. This example clearly shows the importance of estimating an accurate and reliable capitalization rate. If a capitalization rate is not property developed it can lead to misleading results. Luckily, there are several methods an appraiser can use to estimate a reliable capitalization rate.
The overall capitalization rate is typically estimated using the market extraction method, the mortgage/equity band of investment method, the debt coverage ratio method, and the investor survey method, all though there are several other ways capitalization rates can be estimated. The most desirable and most reliable method is the market extraction method because the method is based on actual capitalization rates from actual comparable properties. If a market derived rate can be produced it should be still tested against other methods such as the band of investment of debt coverage ratio method. The market extraction method should be used as the primary method, while the other methods should only be considered if no meaningful capitalization rates can be extracted from the market. In part II of this series we will define each of these methods in further detail.
Extraordinary Considerations When Appraising a Commercial Condominium
When appraising a commercial condominium, the appraiser has additional considerations compared to the appraisal of a non-condominium real estate property. The appraiser must consider the land ownership, type of property, the strength of the association, and what things are covered within the association fee. Properly handling these issues is essential to providing an accurate valuation of a commercial condominium.
The major consideration is that the underlying land is not owned in fee simple by the condominium owner, but is owned by the condominium association. However, when describing the property, the appraiser will usually include the Site Description in the appraisal report for informational purposes. It is inappropriate to consider land value if the appraisal is of a single commercial condominium.
When identifying comparable properties, the appraiser must consider the type of property, since retail, office and industrial uses can all have condominium-type ownership. Also, the square footage of the unit is important, since smaller condominium properties generally sell for higher unit prices, and vice versa. The general condition of the property, especially the exterior, is an important consideration, since the exterior condition is usually beyond the control of the unit owner, and a poor exterior presentation can significantly alter the value of the property, even if the condominium unit’s interior is of excellent quality and condition.
Another important aspect of the condominium ownership is the "strength" of the condominium association, which is responsible for maintaining the common areas, imposing special assessments, paying for common area utilities, enforcing rules, along with many other duties. In effect, the condominium association is a form of government that the condominium owner must comply with, or else be fined and/or liened. A poorly run association could have a significant adverse effect on the valuation of a commercial condominium.
Another major consideration when appraising commercial condominiums is which services the association fees cover. The fees could cover the cost of tenant unit utilities, common area utilities, common area maintenance, insurance, and many other things. A proper understanding of what the association fees cover and who is responsible for paying the association fee (tenant or owner) is crucial to providing an accurate Income Approach to valuation.
Other important consideration in the appraisal of commercial condominiums include the number of units leased, as opposed to owner-occupied; any current litigation associated with the property; and the number of parking spaces included with each unit. If you need a commercial condominium appraisal, it is important to select a competent appraiser who understands the intricacies of the assignment. For more explanation on appraisal methodology, visit our website at www.commercial-appraisers.com.
Commercial Real Estate Appraisal and Estate Settlement
Although estate settlement can be stressful to the relatives of the deceased, it is an important task that requires conscientious decision making throughout the process. The executor of the estate has been given the duty to fulfill the desires of the deceased in a swift and committed manner. The real estate appraiser must also perform swiftly, being sensitive to those involved that have lost a loved one. Two things that appraisers need to clearly identify with the client in an estate settlement appraisal are the intended users and the report type.
An appraisal is often used to settle an estate in order to determine the Fair Market Value of the commercial real estate assets owned by the deceased. Since the date of death precedes the date that the appraisal services are solicited, a retrospective forensic appraisal is usually performed by the appraiser. Data regarding comparable sales, comparable rents, occupancy rates, expenses, capitalization rates, etc. that occurred on or before the date of death is gathered by the appraiser, and data that occurred post-date-of-death is usually ignored.
Users of estate settlement appraisals can include receivers of the estate, lawyers, trust-administration specialists, estate facilitators, will executors, accounting professionals, court-appointed administrators, business owners, partnerships, and enrolled mediators. Due to the many possible users of an estate settlement appraisal it is critical that the appraiser works with a client to clearly identify the intended user of the appraisal, assuming the intended user or users may have unintended consequences for the appraiser. For example, the client may only represent one party in a contentious estate settlement and the client may wish to limit the appraisal’s intended user to just himself. In this situation, if the appraiser made the assumption everyone involved in the settlement was and intended user it could have serious consequences.
Additionally, it is critical that the proper report format be selected. If the report only has one intended user who has a good understanding of the property, then a Restricted-Use Report may be sufficient. However, the report will more than likely have more than one intended user that may not be knowledgeable about the subject property or surrounding market. In this case, an Appraisal Report will more than likely be the best report option (based on the new USPAP reporting options beginning in January of 2014, which will only include a Restricted-Use Report and Appraisal Report formats.) Due to the emotion surrounding an estate settlement appraisal, the appraiser must clearly identify the answer to these questions in order to not add any more stress to a difficult situation. For more explanation on appraisal methodology, visit our website at www.commercial-appraisers.com.