Glossary
Appraisal
An appraisal is an independent, written estimate of a property's market value as of a specific date, prepared by a licensed or certified appraiser. In commercial real estate it usually reconciles three approaches, income capitalization, sales comparison and cost, and lenders use it to determine loan to value and confirm collateral support.
Formula
Example
An appraiser estimates stabilized NOI of $900,000 for an industrial building and selects a 6.0% cap rate from comparable sales, giving an income approach value of $900,000 / 0.06 = $15,000,000. The sales comparison approach indicates $14,500,000 to $15,500,000, and the cost approach $16,000,000. The appraiser reconciles to $15,000,000. At a 70% maximum LTV, the loan could be up to $10,500,000.
How it is used in underwriting
Lenders rely on appraisals to size loans and satisfy regulatory requirements; federally regulated lenders must order appraisals independently from the loan production process for most commercial loans above specified thresholds. Underwriters review the appraisal rather than accepting it: they compare the appraiser's NOI with their own underwritten NOI, examine comparable sales for relevance, test cap rate selection and check that the property description, zoning and condition are accurate. Differences between the appraiser's and the underwriter's NOI are common and should be reconciled in the credit memo.
Appraisals may state several values: as-is market value, prospective value upon completion and prospective value upon stabilization. Construction and value-add loans rely on the prospective values, which carry more uncertainty. The income approach dominates for income-producing properties, while the cost approach is most relevant for new or special purpose buildings, and the sales comparison approach for owner-occupied properties with active markets. Common review issues include stale or distant comparables, cap rates inconsistent with the NOI definition, and unsupported market rent assumptions. For business valuations, a separate business appraisal or valuation report serves a similar role.
Run the numbers: Cap Rate Calculator
Frequently asked questions
What are the three approaches to appraisal?
The income capitalization approach values property based on its income, usually NOI divided by a cap rate or a discounted cash flow. The sales comparison approach uses recent sales of similar properties. The cost approach estimates land value plus the cost to replace improvements, less depreciation. Appraisers reconcile the three into a final value.
Who orders the appraisal for a commercial loan?
The lender orders the appraisal, typically from an approved panel of appraisers, to keep the process independent of the borrower and the loan officer. The borrower usually pays the fee. Regulations require appraiser independence for most loans made by federally regulated institutions.
What is the difference between as-is and as-stabilized value?
As-is value reflects the property's market value in its current condition and occupancy on the appraisal date. As-stabilized value is a prospective estimate of value once the property reaches stable occupancy and income after lease-up or renovation. Lenders use as-is value for most loans and as-stabilized for some construction and bridge loans.
Related terms
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