Commercial Appraisal

How a commercial appraisal works

A commercial appraisal answers one question for the lender: if this loan goes bad and the bank has to sell the property, what would it sell for? The answer is a market value opinion, written by a state-licensed or state-certified appraiser who follows the Uniform Standards of Professional Appraisal Practice (USPAP). The report describes the property, the market it sits in, the data the appraiser used and the reasoning behind the final number.

The lender hires the appraiser, not you. That is deliberate. Federal rules for regulated banks require the appraiser to be independent of the lending, investment and collection functions and to have no direct or indirect interest in the property (12 CFR 34.45). The agencies' published guidance goes a step further: a regulated institution may not accept an appraisal the borrower ordered. You normally pay the fee, but you do not choose the appraiser or see the report as a deliverable you control. The report belongs to the lender’s file.

The appraisal sits at a specific point in the process. It is usually ordered after you accept a term sheet and often before the commitment letter is final, because it is one of the third-party reports a lender needs before final approval. It is also one of the longest items on the closing checklist, so slow or contested appraisals are a common reason a permanent loan or owner-occupied purchase misses its closing date.

The three approaches to value

Appraisers estimate value through up to three methods, apply the ones that fit the property type, and then reconcile the results into one conclusion. The reconciliation is a reasoned judgment about which method the market relies on most for this property, not a simple average.

Approach	What it measures	Where it carries the most weight
Sales comparison	Recent sales of similar properties, adjusted for size, age, condition, location and lease terms	Small retail, apartments and other property types with plenty of nearby sales
Income capitalization	Stabilized net operating income divided by a market cap rate, or a discounted cash flow for properties with changing income	Offices, multifamily, retail centers, industrial and hotels — anything an investor buys for its income
Cost	Land value plus the cost to build the improvements new, less depreciation	New construction, special-purpose buildings and properties with few comparable sales

For an income-producing building, the income approach usually drives the conclusion because that is how investors price it. The formula is the same one you can run yourself:

Value = Stabilized NOI ÷ Market Cap Rate

Two inputs in that formula belong to the appraiser, not to you: how much income counts as stabilized, and which cap rate the market supports. The appraiser starts from your rent roll and trailing 12-month operating statement, then adjusts. Rents above market get pulled toward market, vacancy is set to a market level if yours is lower, and expenses are normalized — including a management fee even if you manage the building yourself. The cap rate comes from sales of comparable properties. A small difference in either input moves the value a lot, which is why the next section matters.

Worked example: how a half-point of cap rate changes the loan

You contract to buy a commercial building for $2,000,000. The lender’s term sheet offers $1,400,000, a 70% loan-to-value ratio on the contract price. The property produces $140,000 of stabilized NOI, which is a 7.0% cap rate at the price you agreed to pay. The lender’s maximum is 70% of the lesser of appraised value or price.

Appraiser’s cap rate	Appraised value ($140,000 ÷ cap rate)	Maximum loan at 70%	Extra cash you need vs. a $1,400,000 loan
7.0%	$2,000,000	$1,400,000	$0
7.5%	$1,866,667	$1,306,667	$93,333
8.0%	$1,750,000	$1,225,000	$175,000

At a 7.5% cap rate, the same $1,400,000 loan would be 75.0% of the appraised value, five points above the 70% limit. The lender does not renegotiate the ratio; it shrinks the loan to $1,306,667, and you bring $93,333 more to the closing table. Nothing about the building changed. Only the appraiser’s read of what investors currently pay for this kind of income changed. You can run the same arithmetic on your own deal with the LTV calculator and the cap rate calculator.

When federal rules require one

For banks regulated by the OCC, the Federal Reserve and the FDIC, a federally related commercial real estate transaction with a transaction value above $500,000 must be appraised by a state-certified appraiser. At or below $500,000, the bank may rely on an evaluation of the collateral instead, which is a less formal estimate that does not need a certified or licensed appraiser, though the bank can still order a full appraisal on a riskier loan (12 CFR 34.43 for national banks; the Federal Reserve and FDIC have parallel rules). The threshold was raised from $250,000 in 2018. Credit unions follow a separate NCUA rule with a different threshold, so the $500,000 figure does not apply to every lender.

In practice the threshold matters less than it sounds. Most lenders, including non-bank lenders that are not bound by these rules, require a full appraisal on essentially every commercial real estate loan because they are lending against the collateral and want a defensible number. If a lender offers to skip it, ask why and what it is using instead.

Appraisal vs. similar valuation documents

• Broker opinion of value (BOV). A real estate broker’s informal estimate, often used when you are deciding whether to sell. It is not USPAP-compliant and a lender cannot use it to size a loan.
• Evaluation. A lender-side estimate of collateral value that regulated banks may use on commercial loans at or below $500,000. It is a documented analysis but not a full appraisal.
• Assessed value. The county’s figure for property tax. It follows tax rules and a different schedule, and it can sit far from market value in either direction.
• Purchase price. What you agreed to pay. The lender sizes the loan off the lesser of price or appraised value, so a price above the appraisal does not raise the loan.
• Replacement cost for insurance. What it would cost to rebuild. Related to the cost approach, but set for a different purpose and not a market value.

Appraisals can also be written with different valuation premises. An as-is value reflects the property today, while an as-stabilized value assumes planned lease-up or renovation is finished. Construction, bridge and value-add lenders often size on one and test the other, so confirm which premise your loan is based on.

Why lenders care

The appraisal is the lender’s protection against overpaying for collateral. Three parts of the loan decision depend on it:

• Loan amount. Banks usually cap leverage at a percentage of value. Bank commercial real estate loans typically run 65–75% (80% multifamily) of value, so the appraisal is what turns the percentage into dollars. See loan-to-value for how each lender type sets its ceiling.
• Pricing. A lower loan-to-value ratio usually earns a better rate and fewer conditions, so the same property can price differently depending on where the appraisal lands.
• Refinance and takeout risk. For a refinance, the appraisal sets how much equity you can cash out. For a bridge loan, the lender is also watching whether the future stabilized value will support the permanent loan that repays it.

The appraisal does not replace the income tests. A property can appraise well and still fall short on DSCR or debt yield, and the lender sizes the loan at the lowest of its tests. Our LTV guide and cap rate guide cover how the pieces fit together.

What to do before and after the appraiser visits

• Hand over a clean package. Give the lender, for forwarding to the appraiser, a current rent roll, copies of leases, a 12-month operating statement, a tax bill, a list of recent capital improvements and any known environmental or zoning facts. Gaps in the file tend to get filled with conservative assumptions.
• Know the number you are paying for. If your purchase price implies a 7.0% cap rate and comparable sales point to 7.5%, you can see a gap coming. Ask your broker for the comparable sales that support your price before the appraiser asks for them.
• Be present for the site visit, but do not coach. Answer the appraiser’s questions, point out improvements, and keep your conversation factual. Lender independence rules exist because the appraiser cannot be steered toward a number, and attempts to do so can derail the report.
• Read the draft for factual errors. Square footage, unit counts, lease terms or an overlooked renovation are fixable. A different opinion is not. The lender may let you send corrections, but the lender decides what goes back to the appraiser.
• If the value is low, ask about a reconsideration of value. Supply comparable sales or income evidence the appraiser did not consider. Lenders are not required to grant it, and pushing back on the opinion alone rarely works. New facts sometimes do.
• Plan for a gap. Decide in advance whether you would renegotiate the price, add cash, bring in a second lender or a mezzanine layer, or walk. Many purchase contracts include an appraisal contingency that gives you a deadline to act on a low value, so read yours before you need it.

Common mistakes

• Treating the price as the value. The lender lends on the lower of price and appraisal. Budget for a value that comes in below the contract.
• Paying for your own appraisal to use with the lender. A lender subject to the federal rules cannot accept a borrower-ordered appraisal. A private valuation can help you negotiate, but it will not size your loan.
• Ignoring the valuation premise. A report that values the property as-is can be far below the as-stabilized number a bridge or construction loan assumes. Confirm which one the lender uses.
• Missing the timeline. The appraisal is one of the third-party reports gating the closing. Ask for the lender’s order date and expected delivery date so the report does not become the reason you miss your contract deadline.
• Forgetting the other reports. Lenders usually order an environmental assessment, a survey and a title search alongside the appraisal. They are separate documents with separate timelines.

When you have a property under contract, bring us the rent roll and operating statement and we will compare your numbers with the cap rate and loan-to-value limits each lender type applies, so you know the likely range before the appraiser is hired.

Sources: 12 CFR 34.43 (appraisals required; transactions requiring a State certified or licensed appraiser) and 12 CFR 34.45 (appraiser independence), law.cornell.edu; parallel rules at 12 CFR 323.3 (FDIC) and 12 CFR 225.63 (Federal Reserve); OCC Bulletin 2018-10 (April 2018 commercial real estate appraisal threshold increase to $500,000); Interagency Appraisal and Evaluation Guidelines on borrower-ordered appraisals; NCUA LCU 2005-06 Q&A; 12 CFR 722.3 (NCUA appraisal rule for credit unions). Example values calculated with the BestLoanUSA cap rate and LTV calculators; cap rates are illustrative, not market quotes.