Commercial property appraisals determine a business's loan eligibility, tax obligations, and selling price. However, many property owners don't understand the appraisal process and what it's costing them. Inaccurate appraisals can lead to inflated property taxes and missed savings opportunities.
Learn how you can use appraisal data to appeal an overvalued assessment, avoid common appraisal mistakes, and ensure your commercial property is fairly valued.
What Is a Commercial Property Appraisal?
A commercial property appraisal or commercial real estate appraisal assigns value to commercial properties such as office buildings, rental properties, and industrial facilities. It involves a detailed analysis conducted by a licensed and certified appraiser. During an appraisal for commercial property, factors such as market conditions, property condition, and income potential are used to determine a property's fair market value.
Ensuring a fair appraisal of your commercial property is crucial. A property's appraisal value influences everything from the amount of money you can borrow and future operating expenses to property tax assessment and the purchase and sale of the property.
Methods of Commercial Property Appraisal
A commercial appraiser may use one of several methods to determine the appraised value of a commercial property:
1. Income approach: This values a property based on its potential to generate income. The appraiser estimates the potential property income or rate of return, also called the capitalization rate. That number is used to divide the net operating income (NOI) to find a property's appraised value. The calculated income is used to value income-producing properties that consistently generate revenue, such as retail spaces or apartment complexes.
For example, if a property has an NOI of $300,000 and a market cap rate of 6%, its estimated value would be
$5,000,000 ($300,000/0.06).
2. Cost approach: This method considers the cost of constructing a similar structure minus depreciation deductions based on the property's age or condition. It's most often used to assess newer properties or those with unique features that make finding comparable sales data difficult. However, the cost approach relies heavily on estimates, so it may not accurately reflect a property's true market value.
3. Sales comparison approach: This method examines recently sold properties in the same market and compares their selling prices to determine value. Adjustments are made to account for differences in size, location, and features. The sales comparison approach is used to appraise residential or single-family rental properties.
Conducting the Appraisal
All commercial real estate appraisals should be performed by a licensed and certified appraiser with expertise in the above methods. The appraiser's role is to provide an impartial and objective assessment of property values. At the end of the process, the appraiser should be able to produce an accurate estimate of the property's market value, which is the price knowledgeable real estate investors would be willing to pay to knowledgeable sellers.
Many counties utilize local county appraisers to conduct property tax appraisals. These appraisers also employ the abovementioned methods, which are not always accurate. Thus, it's essential for property owners and investors to appeal their appraisals.
Step-by-Step Guide to Commercial Property Appraisal
These are the steps your appraiser will take when determining commercial property valuation:
1. Establish the purpose of the appraisal: Although the reason for the appraisal may not directly impact the property value, it is helpful for the appraiser to know the appraisal's intended purpose, which could include loan financing, property investment, or the sale of the property.
2. Collect data: The appraiser gathers information about the property, such as physical characteristics, income potential, anticipated operating expenses, and data on comparable properties in the area.
3. Conduct an inspection: The next step is an on-site evaluation of the property's condition and physical features.
4. Comparable sales analysis: Your appraiser examines recent sale prices of comparable properties within your market. Commercial spaces with similar square footage, age, and features give the appraiser a starting point.
5. Carry out valuation assessment: An evaluation method is chosen, and the appraiser arrives at an assessment value. Some appraisers will conduct all three commercial property appraiser methods and then compare the findings to arrive at a final valuation.
6. Reconcile values: The appraiser analyzes and reconciles the values determined by different appraisal approaches to arrive at a final fair market value for your commercial property.
7. Report findings: You and any other interested parties are provided with a detailed appraisal report outlining the appraiser's findings.
Appraisal's Role in Property Tax Planning
Counties' commercial real estate appraisals play a crucial role in determining annual property taxes. With taxes figured using property values, an accurate assessment is critical. One valued too high can cost you thousands of extra dollars each year in tax liability. Be sure your tax bill reflects the actual market value of your commercial property. You have the right to a property tax appeal if it doesn't.
Some states offer exemption incentives for commercial businesses that lower property tax liability. Commercial property tax deduction formulas can also reduce your taxable income and save you money. There are several other ways to save on commercial property taxes as well:
Cost segregation study:
Request a cost segregation study to ensure a truly accurate commercial property appraisal. This type of appraisal breaks down properties by components rather than considering building value as a whole. Engineers, appraisers, and tax professionals inspect a property's plumbing, electrical system, and HVAC to determine the repair costs and depreciation life for each component.
Example: A building may have a depreciation value of 40 years, but the HVAC system could only have seven years of life left. In that case, the HVAC is depreciated to seven years, lowering the value of the property. This allows commercial property owners to write off larger portions of a property's value, creating a more favorable investment opportunity and significantly reducing tax liability.
1031 exchanges:
This is a federal tax provision that allows investors to defer payment of capital gains taxes when selling an investment property. A capital gains tax is the tax you pay on profits from the sale of commercial real estate.
A 1031 exchange also enables you to defer those taxes by reinvesting the proceeds of the sale into another similar commercial property. While 1031 exchanges don't affect your property taxes, they defer capital gains tax, which saves you money.
Decision-Making Impact
In addition to tax implications, appraisals influence other decisions regarding commercial property:
Purchase and sales: Appraisals set a fair market value when the decision is made to buy or sell a property, which helps the buyer and seller determine how much to pay and a fair asking price.
Lending and financing: Mortgage underwriters use commercial property appraisals to determine loan amounts and assess lending risks for business loans.
Estate planning: Appraisals establish commercial property value for future inheritance or property transfers.
Investment decisions: They provide investors a foundation for informed business planning.
Enhancing Investment Returns
Commercial property appraisals enable buyers to make informed, strategic decisions. For example, investors may consider a property's capitalization rate and NOI when deciding whether to purchase it. Appraisals can help investors make more intelligent decisions by identifying both overvalued properties to avoid and potential bargains that offer better returns on investment.
Ensure You Receive a Fair Property Valuation With Ownwell
Receiving an accurate commercial property appraisal is crucial to long-term financial planning. The experts at Ownwell specialize in reducing commercial property taxes by fighting unfair county appraisals.
On average, we achieve 31% more savings than our competitors.
