Posted on June 8, 2023
When — And Why — Are You Required to Have Commercial Real Estate Appraised?
If you’re buying, selling, or investing in a commercial building, having it appraised is an essential step in the process. So essential, in fact, that procuring an appraisal report from a licensed commercial appraiser is often mandatory rather than optional.
What are the different scenarios that make obtaining a commercial real estate appraisal necessary? Who enforces these requirements, and why? And are there scenarios in which obtaining an appraisal, while not necessary, is a wise business decision?
Keep reading to learn everything you need to know about the rules, regulations, obligations, processes, standards, and best practices that will (or can) prompt a search for a commercial appraisal company.
Commercial Real Estate Appraisal Basics
What are we talking about when we talk about appraisal in the commercial real estate space? In short, we’re talking about a process crucial to ensuring smooth, prompt commercial real estate transactions.
How? An appraisal furnishes decision-makers — primarily buyers, sellers, lenders, and investors — and other stakeholders, such as attorneys, with the information they need to understand any given commercial property’s fair market value.
Commercial appraisers take many factors into account when establishing fair market value, including:
- Market conditions, local, national, and sometimes international.
- The cost of new construction and/or renovation.
- Records of sales of similar properties, also known as comparable sales or comps.
- Tenancy and vacancy rates.
- How much income the property generates (and, in some cases, how much income the business that operates out of that property generates).
- The quality of the building’s exterior, interior, and assorted amenities.
Appraisers are licensed professionals who consult multiple sources and synthesize extensive data into a formal report. Appraisers also present context for their findings. For example, appraisal reports should contain definitions of key concepts as well as disclosures about the assumptions, extraordinary assumptions, hypothetical conditions, and limiting conditions relevant to the valuation methodologies the appraiser has applied.
This context is critical because fair market value is ultimately a matter of opinion. Appraisal reports contain highly informed opinions about fair market value delivered by unbiased experts with broad knowledge of key property types (e.g., apartment complexes, retail centers, hotels, warehouses, etc.), but they are opinions nonetheless. So, beyond presenting the most accurate property valuation the appraiser can present based upon the available data, appraisal reports also contain unique insights and actionable business intelligence.
Now that we’ve covered the basics, we’ll turn our attention to the scenarios that require the procurement of a commercial appraisal.
1. Commercial Real Estate Transactions Involving Properties with a Transaction Value of $500,000 or More
Enacted in 1989 during the savings and loan crisis, the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) established appraisal thresholds for residential and commercial real estate transactions. (See Title XI, Sections 1113 and 1114, of Public Law 101-73).
The goal of this legislation was to curb what L. William Seidman, former chair of the Federal Deposit Insurance Corporation (FDIC), called “unsound real estate lending” practices at banking institutions. These practices, coupled with a lack of expert oversight, were a major contributor to the failure of nearly 1,050 American savings and loan associations between 1986 and 1995.
Appraisal thresholds guarantee that real estate transactions over a certain dollar amount, which may expose stakeholders to a higher level of risk, are appraised by licensed professionals who adhere to uniform standards. The Uniform Standards of Professional Appraisal Practice (USPAP) are the most important of these standards. They set forth guidelines for ethical conduct, define key professional competencies, and establish reporting requirements. Appraisers are legally required to comply with USPAP when performing appraisals for federally related transactions.
Although they’re the law of the land for commercial real estate transactions, appraisal thresholds are not set in stone. They’re sensitive to market conditions. Between 1992 and 2017, the appraisal threshold for commercial real estate transactions did not budge from $250,000. In 2018, the Office of the Comptroller of the Currency (OCC), the Board of Governors of the Federal Reserve System, and FDIC raised that threshold to $500,000. Why?
The years following the Great Recession saw a boom in property values and a consequent explosion in the number of transactions over $250,000. Simply put, the volume of deals to be closed eclipsed the available supply of licensed appraisers. Lifting the appraisal threshold — so the theory goes — would allow those appraisers to focus on more complex and high-risk transactions, leaving lower-risk transactions to be processed using more turnkey valuation methods, such as Automated Valuation Models (AVMs).
More recently, both the National Credit Union Administration (NCUA) and FDIC have raised the appraisal threshold for residential real estate transactions from $250,000 to $400,000.
To summarize: the greater the value of the commercial property being bought or sold, the higher the likelihood of a mandatory appraisal.
2. Any Real Estate-Related Financial Transaction with a Transaction Value Greater Than $400,000
What distinguishes a real estate transaction from a real estate-related transaction? Let’s turn to the regulatory authorities in our home state of Texas to answer this question.
The Texas Administrative Code (TAC) defines a real estate-related financial transaction as “any transaction involving: the sale, lease, purchase, investment in, or exchange of real property, including an interest in property or the financing of property; the financing of real property or an interest in real property; or the use of real property or an interest in real property as security for a loan or investment including a mortgage-backed security.”
This definition is quite broad and means that a variety of transactions are subject to the appraisal threshold of $400,000. But of particular note is the inclusion of commercial mortgage-backed securities (CMBS).
CMBS are investment products backed by commercial property mortgages. Those mortgages are often mixed and matched, meaning a single CMBS may be secured by loans for different property types — from multi-family to industrial to everything in between — each with its own (generally fixed) terms and value. As a result, appraisals play a crucial role in establishing the value of these complex assets.
3. Qualified Business Loans with a Transaction Value Exceeding $1M
Starting and maintaining a business is costly. Qualified business loans are helpful options for many who do not have sufficient capital to pay these costs out of pocket. While business loans can provide significant funding, sometimes collateral is necessary for a lender to feel confident about extending credit.
Real estate is commonly used as collateral in such instances. This is especially true for long-term business loans, as property assets typically appreciate. Consider, for example, an owner seeking a business loan for $2,000,000 they can put toward the purchase of a rental property. They put up a commercial property they already own as collateral. Even so, the size of the principal to be borrowed would trigger an appraisal. Otherwise, the underwriter may not have the assurance they need that they can recoup any losses in the case of default.
4. Commercial Real Estate Mortgage Refinances
If you want to refinance the loan on a commercial property, a new appraisal is almost always a required step in that process.
Market volatility is a fact of life in the commercial real estate industry. After all, appraisals are snapshots of market conditions at a specific moment in time. A property’s value may have changed significantly since its last appraisal. These conditions place a premium on data that’s as up to date as possible. An opinion of value based on data that’s both current and accurate gives lenders assurances and helps borrowers assess the favorability of the loan’s terms (principal, interest, etc.).
More to the point, most commercial mortgage refinances entail the advancement of new monies, meaning they classify as new commercial real estate transactions. Therefore, the same appraisal threshold ($500,000) that applies in cases of buying and selling applies here — provided the lender is a federally regulated financial institution.
Other Reasons Why You Might Want to Obtain a USPAP-Compliant Commercial Appraisal
Even if you’re engaged in a commercial real estate transaction that does not require an appraisal, it still may be in your best interest to procure one. Consider the following scenarios.
If you’re interested in acquiring a foreclosed or distressed commercial property. An appraisal conducted by a state-licensed professional will contain their analysis of the property’s highest and best use. Just as importantly, the report will explain the reasoning behind the appraiser’s conclusion. This information can help prevent you from paying more than fair market value for the property.
If you’re protesting the taxes assessed on your commercial property. In Texas, you may lodge a formal disagreement with the valuation of your property as determined by your appraisal district. These authorities must reappraise all properties within their jurisdiction at least once every three years. But more current information about the state or value of the property in your possession may have significant tax implications.
If you have property involved in eminent domain or right-of-way proceedings. Suppose you own property whose title is to be transferred to make way for a highway expansion, municipal water line, or electric transmission lines (to name but a few instances in which the government may appropriate private property for public use). In that case, you’ll want to ensure you receive fair market value from the condemning authority. The best way to assess fair market value is with a USPAP-compliant appraisal report produced by a licensed appraiser who has ample experience in this field.
If your commercial property is involved in private litigation. Appraisals may be valuable pieces of evidence to submit in disputes with insurers over property damage, disputes with contractors over the quality of construction, and disputes with tenants over broken leases. Licensed appraisers can also testify as expert witnesses.
If you manage a portfolio of commercial real estate investments. Licensed appraisers with relevant experience can serve as strategic partners to investment advisers, pension funds, REITs, insurance companies, and large independent management companies, providing portfolio and property analyses as well as market research.
Whatever your reason for obtaining a commercial appraisal, you’ll want to work with a qualified appraiser with an outstanding reputation for accuracy, transparent communication, ethical conduct, and 100-percent on-time delivery. LPA’s valuation experts offer all the above in addition to wide-ranging property-type expertise and evaluations, appraisal reports, feasibility analyses, and restricted report appraisals designed for your ease of use.
Contact us today to learn how LPA can help you make highly informed decisions about your commercial real estate assets.