How Commercial Real Estate Appraisals Are Different Than Residential

29 September 2022
 Categories: Real Estate, Blog

An appraisal is a tool used to determine value when purchasing a piece of property. Residential and commercial appraisals are entirely different, however. Here's how.

The lender orders an appraisal to determine the value. Both residential and commercial lenders need to understand how much the property, house, or building is worth to determine the LTV or loan-to-value. While the required LTV may vary based on your credit score, the property's condition, and even outside influences, like the state of the economy, most lenders want you to have some skin in the game. In other words, they want you to put some money down on the purchase.

This can be as little as three and a half percent for residential borrowers with an FHA-backed (Federal Housing Administration) loan product. However, commercial lenders have different requirements. They often require at least 20 percent of the purchase price as a down payment, sometimes more. In fact, it is not unheard of for a hard money lender to insist on a 65 percent LTV or more.

The key difference between residential and commercial real estate appraisals, however, is in how the appraisal is performed.

A residential appraiser will drive by and look at the house. They may or may not get out of their car to see the inside of the home. Their focus is on the comps. Comps, or comparables, are homes for sale in the same general area that are similar in size. Under typical circumstances, an appraiser would use several comps that were the same square footage and had the same number of bedrooms and bathrooms. The square footage is simply divided by the sales price, giving them a price per square foot. The subject property's square footage is then multiplied by that price per square foot to determine an accurate appraisal of value.

Appraisers often adjust the price up or down when the subject property is slightly different. For example, a home with an extra half-bathroom may be adjusted up a few thousand dollars in value, while a house that has one less garage space may be reduced in value accordingly.

Commercial appraisers approach value determination completely differently, however. While they may visit the subject property for a quick picture for the lender, they do not compare the property to other recent commercial sales. Rather, commercial real estate appraisals are based on potential earnings. So while they will want to know the property's square footage, they are more interested to know how much revenue that square footage can make. In other words, a multi-family property that has 30 two-bedroom units is worth how much rent those 30 units can generate. The property itself could be falling down or brand new. It doesn't matter as much as the potential income does.

An appraisal is an important tool for both residential and commercial real estate purchases. However, commercial real estate appraisals take a completely different approach when determining a value. 

For more info about commercial real estate appraisals, contact a local company.