3.B1. Valuing Property
Valuing Properties in Commercial Real Estate
Understanding Property Valuation
- The value of a commercial property is primarily determined by its Net Operating Income (NOI) divided by the capitalization rate (cap rate).
- Unlike residential properties, which rely on comparable sales, commercial property valuation focuses on cap rates, allowing for potential income improvements to increase property value.
Cap Rate Insights
- Appraisers assess the cap rate based on market conditions specific to the type of asset being evaluated.
- For mixed-use buildings, appraisers analyze cap rates for each component (e.g., retail, office, residential) and calculate a blended cap rate for overall valuation.
Tracking Cap Rates
- Maintaining a spreadsheet of cap rates from various projects and appraisals helps in quickly analyzing property values.
- Key data points to track include project name, appraisal date, assessed cap rate, expense ratio, overall value, and property type.
Building Your Cap Rate Database
- New investors can build their database by requesting appraisals from experienced investor friends to gather valuable information about different properties.
- Accessing actual appraisals provides accurate cap rates and insights into comparable properties rather than relying solely on verbal reports.
Loan-to-Value vs. Loan-to-Cost
- Understanding the difference between loan-to-value (LTV) and loan-to-cost (LTC) is crucial; banks lend based on the lower of these two metrics during underwriting.
Understanding Loan to Cost vs. Loan to Value
Key Insights on Appraisal and Financing
- The appraisal value is set at $1.5 million, while the projected cost is $1.8 million; banks typically lend 70% of the lower appraised value.
- Banks often state they will lend based on loan-to-value (LTV), but it’s crucial to understand that they consider the lower of loan-to-cost (LTC) or LTV in construction financing.
- If your loan-to-cost is less than the appraised value, you risk leaving equity on the table; aligning costs with or above appraised values maximizes bank funding.
- It’s important to have a realistic understanding of potential appraisal values by analyzing cap rates and market trends before submitting costs to avoid underestimating expenses.