What Are Real Estate Appraisals and How Do They Work?

Posted May 11, 2022

what are real estate appraisals and how do they work?-1150345395

If you have ever bought a commercial property or even a home to live in, you have probably experienced the anxiety of waiting for the appraisal value report. An appraisal estimates a property's fair market value and is made by someone qualified to do so because of their knowledge and expertise. You might need an appraisal for tax purposes, gain mortgage approval, qualify for insurance, or determine a sales price.

For example, suppose you are buying an office building. The development is new construction in a "trendy" part of the city, but with some substantial competition in the area and a longer than preferred walk to the closest subway stops. But the developer included some attractive features that are getting attention, and the construction is reputed to be high-quality. Still, the asking price seems a bit high per square foot, and you aren’t sure whether to proceed.

A professional appraisal can offer you some support when negotiating with the seller in this scenario. It will also be necessary when you initiate the search for financing. If the estimate supports the property's asking price, that may bolster your decision to acquire it. On the other hand, if the appraisal value is lower than the proposed price, you have some fodder for your negotiating stance.

What Information Belongs in a Commercial Appraisal?

There are three distinct types of appraisals, using different data points to determine the market value:

The cost approach considers the expense required to replace the property plus a value for depreciation. This method assumes that you could obtain a similar site and rebuild for equivalent costs. It's often used in situations with few comparable properties and is most applicable to new construction.

The market approach (also known as the comparison model) compares the recent sales prices of similar properties to determine the reasonable cost. Some data points to consider are location, size, age, condition, surrounding area, and amenities. For example, suppose you are buying a retail center, and the seller is asking $1 million. However, similar centers in the immediate area with similar tenants, amenities, and conditions are selling for $750,000. In that case, you may not want to pay the asking price based on comparable sales.

The income capitalization approach to appraising value analyzes the income that a property can produce. This method considers net income potential to assess the current market value, and appraisers typically apply it to income-generating developments like shopping centers. The property value is determined by the net operating income divided by the capitalization rate. Still, the appraiser has discretion in setting the capitalization rate, using factors such as the property age and how creditworthy the tenants are.

What Will an Appraisal Report Include?

The contents will depend partly on the appraisal’s purpose. For example, an assessment completed as part of probate may include details that aren't necessary to establish a fair market price or support an underwriting decision, either for a mortgage or for insurance purposes. However, any appraisal should include the following:

  •       Description of the property
  •       Estimate of the value
  •       Explanation of risks impacting the property or its value

The appraiser will typically present their findings in a written report with a summary section directed toward the purpose, typically highlighting the appraised value or income potential. It should also detail the process used to complete the assessment, including any assumptions made.

This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.

Learn Ways To Help Build Long-Term Real Estate Wealth

Get Tips For Managing Real Estate Wealth
Download eBook


Get Tips For Managing Real Estate Wealth

Learn Ways To Help Build Long-Term Real Estate Wealth

Learn new ways to use real estate to pursue your wealth goals.

By providing your email and phone number, you are opting to receive communications from Realized. If you receive a text message and choose to stop receiving further messages, reply STOP to immediately unsubscribe. Msg & Data rates may apply. To manage receiving emails from Realized visit the Manage Preferences link in any email received.