For a banker, half the battle in lending is in avoiding the
pitfalls. Certainly, no one wants to be the lender whose
appraisal costs so much that the borrower goes elsewhere. On
the other hand, no one wants to be the lender who got an inadequate
appraisal and as a result is on the hot seat years down the road,
when the loan has gone bad. Better to get a good appraisal.
The first step in a good appraisal is to ask the appraiser the right
questions. Better to get the questions right at the start.
A lender needs an appraiser who can help define what questions need
to be answered. Here are a few of the main questions to help
frame the assignment.
Sales, Income, or Cost – Which Method?
An appraiser may (and usually should) apply more than one method of
analysis. But however many are applied, the final value
usually relies on one. For retail buildings, that most often
is Income. For owner-occupied industrials and offices, it is
Sales. For any property type, it is almost never Cost.
The Cost Method is often applied to special use properties like
places of worship and schools. But it can greatly
overstate what a property would bring if it were put on the market.
The lender who makes a loan based on Cost may have a loan that is
underwater on day one.
Simple Capitalization or DCF?
A Discounted Cash Flow analysis that spreads the number across the
page year by year can display some things better than can Simple
Capitalization. On the other hand, Simple Capitalization is
simple. It is more easily understood. The answer usually
is to use whichever method buyers and sellers would use.
Sometimes, the answer is Simple Capitalization. Sometimes it
Is the Value the Sum of the Parts?
Probably not. Are ten $500,000 condominiums worth $5,000,000?
Not if there is no one out there who would pay that. If the
buyer is someone who would sell out the units for a profit, the
buyer would incur holding costs and costs of brokerage and would
require that profit. Those factors result in a substantial
discount, to a price well below the sum of the parts.
“As Is” or Stabilized?
Do you need to know what that office building is worth now, when it
is half occupied and half built out, or what it is worth when it is
full and complete? Probably, both. The numbers can be
very different. The loan is safer if the lender knows the
value of the building at each step on the way to stabilized
What’s the Dirt Worth?
For some commercial properties, the building that is on the site is
really a diversion from the true value, which is in the land.
Industrial buildings are demolished to make way for apartments and
schools. Old gas stations are razed to make their sites into
bank branches. To assume that a property’s highest value comes
from whatever is on it without testing the land itself for value can
miss a large source of potential collateral.