Commercial Real-Estate Appraisal Scenarios: Market Value vs Liquidation Value

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Commercial real-estate appraisal is one of the crucial tasks that requires attention to details and a lot of patience. Lately, specialty lenders have sprung up to help savvy commercial investors to realize their investment dreams or acquire a property of their dreams at affordable prices and competitive interest rates. While selling or buying a building might present itself as an urgent task, it is better to perform a thorough appraisal before committing any funds to the purchase.

Real estate appraisal is good for both the buyer and the seller. While both parties get acquainted with the value of the property, they also develop an understanding of how far they are willing to go to dispose or acquire the property. For most people, holding on to your property until it is ripe for the market is a good way to benefit from your hard toil.

To fully understand the real estate appraisal process, there are two terms you need to familiarize yourself with.

Market Value

Market value is the price of an asset in a fair marketplace. Proper market value is not dictated by a buyer or a seller but rather by all marketplace participants. For a commercial asset to be appraised and given a market value, it must have been on the market for a considerable amount of time to compare with other properties for sale.

Market value is vital, and perhaps the most ideal form of an appraisal that can assist in adjudicating a fair price that the marketplace can hold and thereby guaranteeing a fair transaction. For a seller, knowing the market value of a piece of real estate gives them an idea of what the asking price is. If the seller does not know the property value, they might price the property higher or lower than its actual cost, which has adverse financial outcomes for both the seller and the buyer.

The best market value for commercial asset is arrived at over time. A proper appraisal based on market value can take 30 to 60 days depending on the urgency to sell the property and market trends. Nonetheless, when a property is appraised at its market value, the price the buyer acquires it for is fair, considering that it can be sustained in the marketplace.

There are critical conditions that must be met for an appraiser to determine a building’s proper market value. Both the buyer and seller should be motivated by genuine reasons. An example of a genuine reason for a buyer might be to expand their business while a seller might be disposing of the property in preparation for their retirement from business.  On the other hand, some atypical reasons such as avoiding bankruptcy, which might prompt a seller to sell using a building’s liquidation value which we will review further in the article.

Another vital factor required for proper appraisal is good market exposure. Generally, it takes a minimum of 30 days to gauge property on the open market and advertise it properly to come up with a reasonable market price. In some instances, it might even take longer than that.

Liquidation Value

Liquidation value is the salvage price of an asset. After an appraisal, the liquidation value of an asset is basically what can be collected from its sale. This method of valuation might be valuable for large enterprises with lots of money to spare but to a buyer who’s every penny counts, it becomes a risky bargain. Most people use liquidation value as a means of selling a building mostly when in need of urgent cash, or if there are unprecedented situations presented, such as a looming bankruptcy.

In some instances, the buyer often lands a good deal because the seller is in need of quick money and might undervalue the property. Most properties that are sold using their liquidation value have not been staying on the market relatively for as long of a time as properties getting seasoned for their fair market value. As such, its value might be under-prized leading to a situation where lenders run the risk of underwriting more money at the front end, but the liquidation criteria may shortchange the mortgage note, and thus adding to the buyers’ payback burden. Just like the market value, arriving at a property’s liquidation value might fit the mold of 30, 60, 90 or 180 days criteria.

Nonetheless, most pieces of real estate do not stay in the market for as long as 180 days if the seller uses liquidation value to dispose of the property. Still, even when considering a lender that follows liquidation value appraisal criteria, ensure that they accept the 180-day landmark before accepting their terms. Giving it time on the market ensures that the commercial asset obtains the maximum value afforded in the marketplace. A quick liquidation value appraisal might offer tempting figures, but considering how shifty the real estate market is, a little patience might earn a few extra bucks.

To arrive at a building’s liquidation value, all liabilities are subtracted from the assets. When using a lender, the existing assets should match the money requested to guarantee a worthy investment. In most instances, these evaluations add up prompting the lender to quickly hand out the money needed for the purchase to the buyer. Here are some other reasons why lenders opt to use a property’s liquidation value.

Market factors

Normally, the price of a product either increases or decreases over time. When using a lender to purchase a piece of real estate, their appraisal based on the property’s liquidation value entails the value of all the things therein according to their current market prices. Nonetheless, marketplaces dictate these values, and they might fluctuate over time which ultimately increases or decreases the value of the property.

To the lender, all that is required is a full refund of the money lent at the time of purchase regardless of the shifting market prices. Buying real estate using this method is more of a gamble seeing the value might increase and you might sell the property at a higher tier. However, in the alternative scenario, it might decrease and you will have ended up spending more than you should have.

Risk level and return

While purchasing a commercial property is part of regular business deal for prospective buyers, but to a lender, it is a matter of financial risk . Investors, brokers, and lenders alike have shared the same classifications of commercial properties when it comes to real estate. Lenders use these rankings to determine the amount of risk they are willing to take, the investment strategy to be employed, and most importantly the return objectives.

Graded, considering their outlook and location, these different classifications of real estate reflect varying risks and returns. The age of the property, income levels, facilities, appreciation, rental income, and growth aspects are also important factors considered when classifying a piece of real estate.

Here are the three different classes used in property classification.

Class A

Class A buildings have the highest quality on the market and the area in which they are found. Normally, they have high-earning tenants, the best facilities, low vacancy rates and are not older than 15 years. Their location is also strategic on the market which prompts most owners to seek professional management.

Also, they have little to no postponed maintenance issues and often have the highest rent of all the classes. Class A properties are easier to evaluate as opposed to the other categories seeing that most of the assets they contain still hold their market value. Nonetheless, the time factor can easily alter any appraisal even for new buildings based on the direction the area they are located in is heading to over the next few years.

Class B

Class B property has lower wage tenants and is significantly older than it Class A counterpart. As such, finding professionally managed Class B property is hard. Nonetheless, some owners still hire the service. This class also has deferred maintenance issues and is mostly viewed as a value-add investment by most lenders because the buildings often require regular maintenance.

Class B properties are relatively harder to appraise since most lenders view them as higher risk property compared to their Class A counterparts. As such, buyers seeking to buy Class B property are advised to use high CRP rates. However, if a lender is willing to take the risk and help you purchase a Class B building, opt for the market value as opposed to its liquidation value to reduce personal liability for a company’s debt.

Class C

These types of property are located in less desirable areas and are often older than 20 years. They require regular renovation which might include an expensive update of the building’s infrastructure. As such, expect to find low rental rates and substantial re-posting just so the investors maintain a steady cash stream.

Their undesirable location and unpredictable growth pattern make them high-risk investments for lenders. Their appraisal is also hard considering the regular updates required – some of which might cost more than the building would, if it was sold for its liquidation value. As such, they are sold and bought at a higher CAP rate to cushion the risk taken by lenders for their purchase.

Why choose market value over liquidation value?

Most buyers prefer to purchase buildings when their market value is low to save an extra buck. A real estate appraisal looks at the building’s condition, features, and location. When using a lender, a market value appraisal is a perfect way to assure them that they are not giving out more money than the building is worth.

To a lender, your piece of real estate is collateral for your mortgage. If a situation presents itself where you are unable to clear the mortgage – leading to foreclosure for example, they will be able to recoup their money by selling the building easily. However, the same feat is hard to achieve when a building is purchased using liquidation value.

For starters, the building’s appraisal might be below the market value, which is often the case, thereby the lender won’t be able to recoup their money, leading you into additional debt. AMC’s or Appraisal Management Companies are another reason to use market value as a form of appraisal as opposed to liquidation seeing that they provide fair values. AMC’s use licensed local appraisers to determine the market value of individual buildings. Local appraisers know the area well and have a proper understanding of the market within the area, as such, the information they feed the AMC’s is not only accurate but also adheres to federal appraisal requirements.

The lender can monitor the AMC’s for exactitude and can back up a property’s market value when the mortgage loan company comes into play. For this reason, most lenders opt to wait for the AMC’s appraisal to get an idea of the market value and further advise the buyer on whether or not to purchase as they assess the risk factors involved.

Liquidation value is also not ideal since it tends to focus more on the seller’s asking price as opposed to the appraisal. When the appraisal is lower than the asking price, the buyer ends up spending more cash. Add that to the loan’s down payment, which can be as high as 60% and most buyers will pull out of the deal before it even starts.

Importance of working with a qualified lender

It’s not enough to get a lender who can give you the money required for a real estate purchase or the one who offers the best buying advice. The best lenders are usually the one who cares for your asset both as an investment to them and for you as well. They should be well versed with ideal locations, the type of property you seek, and the best offers from all property classes.

A lender who understands all the above and still offers and still provides a clear market valuation criteria will help you save some money and purchase the building you desire with ease.

Conclusion

Low appraisal values can lead to delayed or canceled transactions. In most instances, these are due to building put on the market with their liquidation value as opposed to their market value. Regardless of the urgency to purchase a property or your overall buying and selling experience, a simple understanding of the appraisal procedure always works to your advantage.

 

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