Third-party reports can make or break your real estate purchase or sale.  The most typical third-party reports are appraisal reports, title commitments/policies and surveys. Let’s review these reports one by one.

An appraisal is normally required by most banks, and it is mandated for any commercial loan over $500,000 made by a bank insured by the FDIC.  Life insurance companies also almost always require an appraisal of a property they are taking as collateral for a commercial real estate secured loan.  Not all appraisers do commercial real estate appraisals.  In fact, most appraisers restrict their practice to single family homes.  There is a type of elite credential given to appraisers who are “certified” by the Appraisal Institute.  These appraisers identify themselves with the initials “MAI” (Member of the Appraisal Institute) after their name.  The MAI designation takes several years and lots of classes and examinations to get and is considered “the gold standard” for commercial appraisers.  MAI appraisers as well as non-MAI certified commercial appraisers are also regulated by regulations known as USAP.  This stands for the name “Uniform Standards of Professional Appraisal Practices”.  Unless the appraiser certifies that the appraisal report is done to USAP standards one should be suspicious of using it to rely on for a value conclusion.

There are 3 “methods” to use for obtaining value:  the “income approach to value”, the “comparable sales approach to value”, and the “reproduction cost” approach to value.  All 3 methods have their own validity.  The income approach bases the value of an income property on the net income the property produces.  This involves analyzing the rental income the property throws off, making sure that the rent per square foot is in line with other similar properties and then analyzing the property expenses, again comparing them to operating expenses from similar properties.  This way of looking at property value is very similar to the approach a savvy real estate investor uses when analyzing how much to pay for any given property.  The most complex part of the income approach to value is deciding what “cap rate” to use after determining what the net operating income (sometimes abbreviated as NOI) for the property.  The NOI is the total annual income minus all the operating expenses, not including depreciation and interest expenses.  The “cap rate” is the percent return on investment that typical investors expect.  This is a highly subjective number, and it is the single most important part of using the income approach to value.  The higher the cap rate the lower the value of the property.  Typically, the cap rate can vary between 4 and 10.  The lower cap rates apply to very stable income producing properties like high quality multi-family buildings, leased office buildings and leased industrial buildings with good credit tenants. Older buildings get higher cap rates and vacant buildings get even higher cap rates.  The real estate investor must make sure they clearly understand how cap rates work and how the cap rate the appraiser uses for this particular property is obtained.  Unless the investor has a clear understanding of this aspect of income approach to value appraisals they may end up making serious mistakes in valuation.

The other two third-party reports, title commitments and surveys will be discussed in Part two of this series.

If you have questions about a bridge loan request, contact Montegra today at 303-377-4181.