An Investors’ Guide to Real Estate Appraisals

June 17, 2021

A real estate appraisal is also commonly referred to as a“property valuation”.

It is important to note that the appraised value is different than the assessedvalue. The assessed value is determined by the municipality in which the propertyis located, and can be drastically lower than the appraised value.


When would youneed an appraisal?

A real estate appraisal is needed whenever debt is beingplaced on a property or when an owner is looking to refinance. Someone mightalso have an appraisal done before listing their property for sale in order tohelp establish the listing price (this is particularly true if the property isunique and no local comps are available). Appraisals are also commonly requiredduring estate sales, divorces, and can be used to determine tax liabilities.


Who conducts anappraisal?

Most states require appraisers to be licensed orcertified. Appraisers have been specially trained to develop independentopinions of value. If an appraisal is required as a condition of your loan(purchase or refinance), the bank will initiate, hire and oversee theappraisal. New regulations prohibit Fannie Mae and Freddie Mac lenders fromhaving direct contact with appraisers, so most banks will initiate theappraisal through an appraisal management company that has a pool of appraiserson which to draw.


If you’re getting an appraisal done to establish aproperty’s value prior to sale, you can hire the appraiser directly.




There’s an important distinction to make betweenresidential and commercial properties. Typically, “residential” homes areconsidered those with 1-4 units. Anything with five or more units starts tofall into the realm of “commercial” property, even if the property type is housing.This is important to understand because appraisals, like financing, differdepending on whether a property is residential vs. commercial in nature.


The appraisal process is very different for residentialand commercial properties, so even if you’ve purchased a home before and havebeen through an appraisal, the experience may not have prepared you for thecommercial version. The main differences include how the properties are valued,the complexity of the appraisal, the cost, and how long the appraisals take tocomplete.


Residential Appraisals


Most residential appraisals are for single family homesthat will be owner-occupied.

Residential appraisals are pretty straight forward. Most use what’s known asthe “sales comparison” approach (more on this below). This approach compareslike-kind residential properties, generally in the same neighborhood. Mostappraisers have access to MLS and will use this to find comps nearby. Most willlook at four to five comparable homes that have sold within the past six monthswithin a mile radius, as well as one or two current listings.


Determining residential home values is relatively easy todo. Appraisers look at similar homes and what they sold for, adjust for anydifferences, and then calculate the value.


Commercial Appraisals


Commercial real estate generally refers to revenue-generatingproperty. Commercial appraisals are typically reserved for multifamilyproperties with five or more units, as well as any other commercial propertytypes – such as office buildings, retail centers, hotels, and industrialproperties.


Generally speaking, commercial real estate is valuedbased on the income it generates. There is less emphasis placed on thelocation, condition of the property, size and other factors that are analyzedwhen doing a residential appraisal. With commercial appraisals, the focus leanstoward factors like income and rental prices, tenants with long-term leases,and the recent selling price of similar properties in the area.


Commercial real estate appraisals take longer and aremore complex than residential appraisals. This is partially because commercialproperties are more complex to build, operate, maintain and value. Commercialproperties tend to be individually unique, which means that every appraisalmust be customized for the property. Whereas a residential appraisal might takea week to complete, commercial appraisal can take upwards of a month dependingon the nature of the property.


Commercial appraisals are also more expensive thanresidential appraisals. A residential appraisal might cost between $300 to$500, whereas a commercial appraisal will cost anywhere from $1,500 to $5,000.




There are three different approaches that appraisers useto determine a property’s value:


1.    The SalesComparison Approach: As the name implies, this method compares a property’scharacteristics with those of comparable properties that have recently sold insimilar transactions. Because no two properties are exactly alike, thevaluations of comparable properties are generally averaged to establish a fairmarket value for the property being appraised. Adjustments can be made asfeatures vary. For instance, a property may be discounted if the units aresmaller or if there is less parking. This approach is sometimes called the“market approach” and is considered the most widely used when evaluatingresidential real estate (assuming there are comps in the region).

2.    The Cost Approach: This method begins withan evaluation of the site’s value, as if vacant, and then calculates thereplacement cost of any existing building structures, less depreciation. Thecost approach assumes the buyer will not pay more for a property than it wouldcost to build an equivalent.

3.     The Income Capitalization Approach: Commonlyreferred to as the “income approach,” this method is often used when appraisinginvestment property because it values a property based upon its rental historyand revenue generating potential. This approach is more complicated. Aproperty’s direct capitalization, discounted cash flow, and gross income multiplierare all factors commonly analyzed when using this approach.


Most appraisals will use some combination of two or moreof these approaches. The values established through each approach arereconciled into one final opinion of market value.


What factorsinfluence a property’s appraised value?

There are certain factors that influence a property’sappraised value, including local market conditions (basic supply and demand)and macroeconomic trends (e.g. a national recession). The principles of substitution,balance and externalities can also help explain shifts in value.


How is a real estate appraisal used in practice?
Lenders use real estate appraisals to determine how much a property isworth. They need an accurate picture of the property’s value in order todetermine a mortgage’s loan-to-value ratio.

With owner-occupied residential real estate, a lender might be willing to go to95% or more loan-to-value. For simplicity’s sake, this would mean on a homevalued at $100,000 the bank would be willing to lend $95,000. The buyer wouldonly need to come up with $5,000 as a down payment.


Commercial real estate usually has much lowerloan-to-value ratios, usually closer to 60% or 70%. Using the same property asabove, if the buyer was planning to use the property as a rental, the bankmight only be willing to do a $70,000 mortgage, meaning the buyer would need tocome up with a $30,000 down payment.


If that same property appraises for $120,000, themortgage amounts and equity needed shifts accordingly.


Sometimes appraisals come in lower than anticipated.


Let’s say you planned to purchase an investment propertyfor $300,000 and planned to put down 25%. You would have been taking out amortgage for $225,000 and would have needed $75,000 in equity. The appraisalcomes back low. The property only appraises for $280,000.


There are a few strategies to mitigate a low appraisal.


The first strategy is to re-negotiate with the seller,trying to get them to bring the purchase price down to $280,000 from thepreviously agreed-upon $300,000. If the seller doesn’t agree but you still wantto move forward with the deal, you’ll have to come up with additional equity tomeet the bank’s 75% loan-to-value ratio. At a $280,000 valuation, the bank willlend $210,000. This means you now need to come up with $90,000 for a downpayment in order to purchase the property for $300,000.  


What if youdisagree with the appraisal?

If you feel that the appraisal is unduly low, you arewell within your right to challenge the appraiser’s analysis. Grounds for achallenge may include information about the property that is incorrect, or yourability to produce comps from the area that are more recent, closer or morecomparable overall than those used in the appraisal report. You might alsochallenge an appraisal if only one approach was used, and you feel that analternative approach would have yielded a different result.


Ultimately, it is up to the bank to determine whetheryour challenge has merit. The bank may be willing to entertain a secondappraisal, but that will be on your dime. The lender will then generally takethe average of the two values.



Real estate investors may occasionally hear someone refer to as a “BOV” – or abroker’s opinion of value. On the surface, BOVs seem similar to appraisals. Andto a large degree, they are similar.


In commercial real estate, a BOV is used to come up withan estimate of value for a specific commercial property. BOVs are used by manyCRE professionals, including investors /property owners, lenders, CPAs and realestate attorneys. BOVs are most often used by commercial property ownerslooking to determine their property’s worth, and as such, whether to sell theirproperty or not (and if so, for how much).

BOVs can be as simple as two or three pages, or as detailed as a 40-50+ pagebook. It depends on the purpose of the BOV, the property under analysis, and therequirements of the client.


There are a few distinctions to be made between BOVs andappraisals:


·      BOVs are typically put together by commercialreal estate brokers on behalf of their customers. Appraisals are put togetherby licensed third-party professionals who have no “skin” in the game, as itpertains to the deal at hand.

·      A BOV is essentially a broker’s “best guess” ata property’s value, albeit a “best guess” backed by market data and otherindustry knowledge. The guidelines for appraisals are much more stringent,including more robust data collection and analysis. That said, a skilled brokerwith access to up-to-date market information can create a BOV as thorough as acommercial MAI certified appraiser.


·      Appraisers will always charge a fee forconducting an appraisal. BOVs are often put together by brokers for free,especially if trying to win over a client to get a listing.

·      BOVs can be used to determine the value of anentire portfolio of CRE assets, whereas appraisals are generallyproperty-specific.




In any real estate transaction, the real estate appraisal is one of the mostimportant components—especially when intending to put debt on the property. Toget the best results, be sure you understand the appraisal process, the dataanalyzed, and the parties involved in the decision making. There are only somany factors you can control, so do your best to control those. And of course,challenge the appraisal if and when necessary.


Interested in learning more about how lenders utilizeappraisals? Contact us today. We would be happy to share our experience withyou having worked with most of the nation’s leading CRE lenders.