Posted on May 30, 2019
What Makes for a Truly Accurate Commercial Real Estate Valuation — and Why Your Business Should Care
Markets fluctuate. But the conventional wisdom states that commercial real estate (CRE) almost always appreciates, provided you treat it like the investment it is. Key to achieving the highest rate of return on that investment is equipping yourself with the right data about your real property holdings, both those you own and those you’re considering acquiring.
But not all CRE valuations are created equal. Methodology matters, as does the integrity of the vendor providing this all-important service. In fact, and as widely reported, inflated valuations and appraisals were a significant contributor to the 2008 financial crisis.
Accurate valuations do more than provide the kind of actionable intelligence you need to make the right business decisions. They also protect you from liabilities and the sort of unpleasant surprises that can damage your company’s bottom line, future prospects, and reputation.
Read on to learn more about how businesses benefit from procuring accurate, principle-driven, unbiased commercial real estate valuations.
Imagine this scenario: all signs in your region point to a seller’s market in CRE. But how do you chart a course between the price you’d like to command, the amount of cash buyers are willing to spend, and what counts as fair market value?
You need numbers you can trust. Moreover, since the value of real property is realized over time, that means your situation is almost always fluid. Demand, utility, scarcity, and transferability can all be defined by volatility, even in a seller’s market. A truly accurate valuation will factor in these complexities when quantifying market value.
Valuations help underwriters assess and manage risk. They rely on these documents and expect them to be accurate, transparent, and free of potentially misleading information. In fact, the number one question underwriters need to answer is: “Does the actual value of the property justify the loan amount being requested by the borrower?”
Most underwriters will not approve a CRE mortgage unless they can establish a 60- to 80- percent loan-to-value ratio. An expertly prepared commercial real estate valuation report will provide the information the underwriter needs to feel confident in their calculations.
A valuation report can provide useful insights into how much you should spend on improving any given property. More importantly, it can also indicate whether or not you should develop the property at all. An accurate commercial real estate valuation will therefore take into consideration:
- The current value of the land itself.
- The costs (labor, materials, etc.) of replacing the property’s existing structures.
- Any accumulated depreciation. In weighing depreciation, the valuation should assume that buyers wouldn’t spend more for commercial property than they would for acquiring land and building from scratch. The cost of these improvements might not exceed potential depreciation and can make prospective buyers wary.
Finally, a high-quality valuation will determine your property’s highest and best use — that is, the most profitable use of the property. If the cost of proposed improvements exceeds the highest profitable use, you’ll want to adjust your budget accordingly.
Compliance and Due Diligence
When you’re looking to expand your portfolio, you want to minimize your exposure to buyer’s remorse. Doing so entails being as thorough as possible before making any purchasing decisions. You have to dig beneath the surface to reveal hidden risks, unforeseen (but inevitable) losses, and any shaky foundations, all of which can doom your investment.
A qualified, credentialed commercial real estate valuation expert can help you at every step of the buying process. They will inspect the fundamentals of the property, vet sellers, and survey your compliance obligations to mitigate financial uncertainties. They will also assist in assessing the condition of the property (the land as well as any existing structures) as well as any potential use issues that might require additional investment to balance the cost of acquisition.
The Rise of Automated Valuation Models (AVMs)
The rise of Automated Valuation Models, or AVMs, has exerted some downward pressure on traditional real property appraisals. While AVMs are readily available to lenders, consumers, and real estate agents (especially those concentrating on residential properties), most of these algorithms have a major blind spot — specifically, they fail to account for a property’s physical condition. That’s because AVMs determine value using market averages and public records, both of which are notoriously slow to update with the latest data about real CRE transactions.
Furthermore, by relying on online information — the quality and integrity of which can vary significantly — AVMs can be influenced by misinformation, generating inaccuracies that can tilt negotiations in favor of buyers hoping to score on lowball offers. An experienced valuation expert who is both on-site and capable of telling the story of a property’s actual status is therefore increasingly valuable in an industry in which technology is still not as sophisticated as some may believe.