I find that many are dumbfounded by the process we commercial appraisers go through to complete an appraisal of their property. They often don’t understand why the appraisal fee is “so high” and why we are quoting anywhere from three to six weeks to complete their appraisal. It is my sincere hope that this article will shed some light on the appraisal process.
To begin with, it is important to understand the laws governing the appraiser and the appraisal process. Many will remember the real estate bust of the early 1990s which was in large part precipitated by the mass takeover by the Resolution Trust Corporation of Savings and Loans. The governmental imposed reforms that followed included the passage of the Financial Institutions Reform Recovery and Enforcement Act (FIRREA) which called for state licensing all appraisers for assignments which include FDIC Insurance.
The passage of FIRREA brought in a much needed rigorous set of appraisal standards, called the Uniform Standards of Professional Practice (USPAP), to which state appraiser licensing bodies bind licensed appraisers. These standards to a large degree drive the appraisal process, and while dry, an understanding of those requirements would be enlightening to those who order commercial and residential appraisals on a regular basis.
When you order a commercial appraisal, you are essentially paying for the appraiser’s time and expertise. A typical commercial appraisal will take me anywhere from 30 to 60 hours. Moreover, a seven unit apartment building, reported in a summary narrative format, will likely take only a little less time as than a 14-unit building. Likewise, a 12,000 square foot industrial building will likely take about the same amount of time to complete as a 24,000 square foot industrial building. So it becomes readily apparent that sale price and property value have little to do with the commercial appraisal fee.
So what does affect commercial appraisal fees? There are essentially four factors affecting the fee of the commercial appraisal:
1) complexity of the assignment,
2) availability of data,
3) report format and
4) required turn-around time.
1) Complexity of the assignment-I could write for hours about this, but suffice it to say that the more complex the assignment, the larger the scope of the investigation, the longer it will take and the higher the fee will be.
We recently completed the appraisal of a 23,000 square foot industrial building in Los Angeles. It was an owner-occupied building located in an area of similar properties. The highest and best use was simple, in that it’s continued use as-improved was not in doubt and there were sufficient recent transactions, both sale and rental, so as to make the data gathering process a breeze. All of these points were factored into the fee when we issued the appraisal fee quote. The project took about 35 man hours and the appraisal fee reflected this.
Conversely, last year we appraised a ski resort. The income approach drove the appraisal process, and suffice it to say that it took many more man-hours than the industrial building described above. Simply put, the scope of the assignment was far greater, hence the time into the assignment and the resulting appraisal fee were higher accordingly.
Further, the size of the property has little to do with how complex the appraisal process will be, or become. Some of the most difficult commercial properties to appraise can be small mixed-use properties, such as a retail building with a house behind it, or office over retail. This is because there few similar property transactions, thus cash-flows and sales data sets need to be blended.
Take as another example the one acre redevelopment site that we recently appraised in Highland Park, California. The property was improved with a mix of five commercial buildings and a fourplex apartment building. In the highest and Best Use Analysis, it was determined that the value as-improved was outweighed by the value of the underlying site. Simply put, similarly located and zoned parcels of that size were selling for more than the overall value of the properties as-improved. To come to that conclusion, however, required the appraisal of each of the properties individually, followed by the appraisal of the land underlying the properties. To make things more difficult, land sales of that size in that market were very hard to come by and required significant analysis.
2) Availability of data – As the reader can see from the above examples, the scope of the assignment and data availability are intertwined. Another recent assignment was the appraisal of a portfolio of retail hardware stores with attached lumber yards. All had low-cost steel buildings on large sites located in very small market areas. Moreover, each was located many miles apart, thus there was no data crossover between the assignments. For each of these appraisals, we scoured the markets for transactions of similar buildings on similarly sized parcels. We visited and revisited the markets to inspect comparables, but found no sales that were relevant to the analyses at hand. It was clearly apparent that the value of the properties was primarily in the land, but what contributory value did the improvements have? In the end, the primary approach to value was the cost approach, whereby we appraised the land and added to that the depreciated value of the improvements based on cost, but taking into account external forces affecting demand for such improvements. This assignment turned out to be complex due to the lack of availability of similar comparable data.
3) Report Format is Purpose Driven – There are essentially two formats available to the appraiser, an Appraisal Report and a Restricted Appraisal Report. Samples of each can be reviewed on our Sample Appraisals page of this site. Required report format is driven by the purpose of the appraisal.
The typical lender must require an Appraisal Report due to FDIC insurance. If the appraisal assignment is complex, however, it becomes more likely that the report narrative increases significantly costing thousands of dollars more than the same commercial appraisal reported in a Restricted Appraisal format. It is important to note that USPAP defines the level of detail that is contained in each of these formats, but that no matter the reporting format, the scope of the appraisal is to be the same.
The most economical of formats, the restricted report, is what some refer to as a letter appraisal. However, these reports can be relied upon only by the client (again, USPAP), thus, if there is potential that a third party will need to rely on the value conclusions, this format is not allowable. A great example would be the appraisal of a property for estate taxes. Because the client needs the value to determine tax owed, the IRS is passively relying on the analysis, thus the restricted format is not allowable for that purpose.
However, we are often called upon to complete a commercial appraisal for purposes where the restricted format is allowable. Such a purpose would be to determine the listing price or acquisition price of a property, to make a sell/hold decision, or simply to determine one’s net worth.
4) Required Turn-Around – This is where the user of appraisals has the most influence on fee. We often receive calls asking for a summary appraisal of a property that is escrow with a closing date of say two weeks away. As stated earlier, the typical appraisal will take anywhere from 30 to 60 man hours, and in most cases the appraiser does not know the full scope of analysis required in the commercial appraisal until he actually sees the property. On short-order appraisals this presents a huge risk factor for the appraiser in that the fee quote is typically issued prior to seeing the subject and what data is available. As a result, the appraiser will usually factor such risk into the fee quote with considerations such as potentially having to work weekends to complete the assignment on-time. Again, per USPAP, there are no shortcuts – the analysis has to be completed to USPAP standards regardless of fee and turnaround time.
To sum it all up, the best advice I can give anybody in need of a commercial appraisal, is to give the appraiser as much latitude as possible. If you have it in your power to utilize a restricted report, your fee will be lower than if you require a summary or a full narrative appraisal. If you have a recent appraisal of the subject, or confirmable comparable data that is useful, let the appraiser know. Most importantly, if you can order your appraisal with a due date of four to eight weeks out, you will no doubt get a better fee quote than if you wait until two weeks before you need it.