A Basic Guide To The Three Types Of Commercial Real Estate Appraisals

Commercial real estate purchases can be much more complicated than the purchase of an average single-family home. With concerns about both current value and income potential from rents and leases, commercial real estate transactions often take longer to close as studies, inspections, and the commercial real estate appraisal are performed. 

If you are interested in purchasing apartment complexes, retail spaces, warehouses, or any other type of commercial real estate, the following information will help educate you about the three most common types of commercial real estate appraisals and what you might learn from each one. 

Income capitalization

When buying large, multi-unit properties, like shopping centers or apartment buildings capable of earning high rental amounts, the appraisal process commonly used is called the income capitalization approach. This type of appraisal seeks to estimate the amount of income the property could be expected to generate over a period of time so that the buyer and their lender can better understand the potential value of the property. 

The income capitalization approach can also provide valuable insight when used to appraise rental property. When using this approach for the appraisal of rental property, the appraiser uses the net amount of income generated by the property over a specific time period as the basis for determining the current market value. 

Cost approach

When commercial real estate is appraised using the cost approach, the appraiser considers the cost that would be involved in building a duplicate of the property based on current construction and land costs. Cost approach appraisals are most commonly used for unique properties that have few or no similar properties to use for comparison. 

Market approach

The third, and most commonly used, commercial real estate appraisal method is called the market or sales comparison approach. Appraisers and lenders often consider this approach to be the most reliable because it uses information from comparable properties that are recently sold. 

When using this approach, appraisers choose properties that are as similar as possible, and then increase or decrease their valuation estimates as needed to account for any differences in the properties. For example, if a comparison property has more or less square footage, the appraiser would compute an estimated cost per square foot and use that figure to help finetune their appraisal of the subject property. 

Prospective buyers who would like to learn more about the valuation process should plan to discuss their situation with a reputable commercial real estate appraiser in their area.