Friday, January 15, 2016

My Commercial Real Estate Didn't Appraise...Now What?

Image Attribution: www.kroegerappraisal.com
Appraisals of commercial real estate are required if you are financing your purchase through a lender - conventional or otherwise.

The possible exception might be an owner financed purchase. In that case, the owner becomes the bank and may not require an appraisal.

An appraisal is a lender's way of "hedging their bet" to insure the agreed upon value - the negotiated purchase price -  is consistent with the market.

An appraiser is generally engaged by your lender and looks at three measures of value: market approach - recent sales of comparable buildings, the income approach - capitalized market rents, and cost replacement approach - the price of land plus depreciated construction costs . These three value measures are compiled, reviewed by the lender and a value is determined. The appraised value is then compared to the negotiated purchase price. If the appraisal supports the negotiated purchase price, great! If the appraisal is less than the negotiated purchase price, there is an issue.

So what can be done if the appraised value is less than the price that you and the seller have negotiated? In my experience, one of several solutions exist.

The seller can reduce the purchase price. The solution is simple but not easy to accomplish - especially in a robust market where buyers are plentiful. The seller chose you as the buyer because you had the best offer, the greatest motivation, or for another reason. Remind the seller of this fact. Also, if the building didn't appraise with your lender, there is a high likelihood that the building will not appraise with another lender. The low appraisal is now a material fact that will need to be disclosed to the next buyer - hmmm. Maybe a price reduction isn't so bad after all.

You can invest a larger down payment. If the seller is adamantly against reducing the purchase price, you can bridge the gap by making a larger down payment. Just understand your lender believes you are paying too much for the building so examine your reasons for buying the building.

A combination of the two solutions above can be used. Frequently, the seller and buyer will compromise and the seller will reduce the price slightly and the buyer will invest additional dollars to close the transaction. I would say this is the most common way in which a low appraisal is remedied -  both parties participate to solve the issue.

An appeal can be made to the appraiser. Prior to the economic collapse of 2008, this was a viable option. We could "massage" the appraised value by talking to the appraiser, looking at the value measures and suggesting other comps, capitalization rates, or construction costs. These days, we have very little latitude because brokers are divorced from the appraisal review and the final determination of value. If all else fails, however, this is worth a shot.