sources for income approach for appraisal on 8 unit bldg

4 Replies

Last year I had a fire in my 9 unit mixed use building. There were seven apts and 2 storefronts. The building is mostly gutted and we've taken the opportunity to redo the layout to make it flow better since it is a 90 year old office building converted into the current configuration. We were underinsured and only had the bldg for 8 months when the fire occurred. We will be going back to the bank to ask for a construction loan for the renovations. The renovations are going to be between 600k and 700k. Because of the existing loan the numbers will be very close so it's really up in the air whether we'll get approved or not. I'm juggling the rent numbers with the construction costs against what may be calculated as the appraised value.

The bank has already told me the income approach will be used to approve the loan. I don't know yet whether the same appraiser will be involved in the 2nd appraisal. The loan officer told me he uses a GRM calculation with a value of 7 to do his preliminary analysis to see if it's worthwhile bringing in an appraiser. So in preparation for the appraiser doing a more in-depth analysis, I've been using the bank's GRM calculation to estimate my building's ARV. I tried looking at MLS for apts that have been rented in the area, which is what I assume the appraiser will look at, but in the past couple years there are only 2 apartments that were rented through MLS. I looked at HUD's FMRs which are about in par with my rents however, the FMRs from HUD include utilities and in my bldg tenants pay all utilities so in that context the rents are much different. Note that I do not plan to rent to Section 8 but rather was just using the HUD FMRs as a guideline for my area.

So my question would be for anyone, especially appraisers, reading this, if MLS doesn't provide sufficient listings to show what market rents are for my small-town area, then what other sources will an appraiser be able to use? I want to be able to preview those same sources so I can ensure that my rents will be able to provide a sufficient valuation based on GRM so I know my max budget for construction costs to make the building valuation be above that.

I've also called around to some of the larger apt complexes in the area to see what they charge and based our rent off theirs (with some adjustments). But I don't want to get my hopes up that my numbers look good and then suddenly the appraiser comes back with wildly different numbers that are much lower. When he conducted the original appraisal he low-balled us then on the gross income for the bldg by quite a bit. His avg unit rent came out to be $497 but with the rent we were getting for our units the avg would have been just above $600 at full occupancy. This is despite his report saying he obtained info from market data (but he never talked to me about the bldg while writing his appraisal nor mentioned specifically the source of the market data) so I'm concerned we may get low-balled again and then be stuck with a building we can't renovate.

Brandon:  If you had existing leases at the time of the fire with tenants paying $600 per month, then you can discuss with the appraiser the appropriateness of his rent conclusions.  In this case you will be a newly remodeled building and up to current code, which has more value than a similar property not renovated.  Typically, the appraiser should look for comps in the area.  If no comps are in the area, they typically widen the search area.  If none are found, the appraiser may utilize older data and make adjustment for market conditions, quality, economic characteristics, etc.  The two commercial store fronts are easy.  Just look at similar properties in the area.  Since you mentioned its a small town, I don't expect you get to much of a premium for the storefronts unless you are in a hot area.  Back to the apartments, depending on how close you are to another town that has similar demographics you can utilize them as a starting point and adjust for you being newly renovated.  When your bank presents you with the appraisal, you can go back and question assumptions made by the appraiser and present them your facts and sources and request they be considered.  Sounds like you have a good start by checking with apartments in your area.  Find a commercial broker that has experience with your property type and ask about rents and valuation.  He should have sale comps to support his value conclusion.  I hope this helps.

@Richard Copeland

Thanks for taking the time to reply and the info you provided. I have existing leases showing the higher rents for the units occupied at the time which, when fully occupied, equates to an avg of $600/unit/mo. Probably not much reason to do that now given the casualty loss but I'll keep that advice in mind.

Although a newly remodeled building up to current code has more value in my mind, I don't know if that translates to paper because both the bank and the appraiser said that the income approach will be used for the valuation, which means that being up-to-code won't manifest in the valuation unless it shows by our being able to demand more rent. The fact that it's new should definitely be passed through to the rents but things like fire suppression that we are now adding probably won't have any bearing on the new rents since tenants (at least the residential ones) wouldn't care about that. Maybe the commercial tenants would?

You mention comps. The key question I have, and the purpose of this post, is to determine where would the comps come from? Is MLS the sole source for comps or do appraisers use less official sources to confirm what the going rents are? What about Craigslist (which of course only shows what people are asking, not what they get) or HUD FMRs used at all?

The larger complexes in our area that have 20+ units (1 complex is for students and another isn't) don't use MLS; they don't need to because they get rented by word of mouth or Craigslist due to how well known they are. So those wouldn't be factored in to the appraiser's numbers if he only looks at MLS. This would be unfortunate to some degree if true since those larger complexes are the units in our area that are actually garnering higher rents compared to the onesy-twosy units that private individuals are trying to rent out in our area. Those larger complexes are generally offering units that are larger, up-to-date with amenities and are of higher quality than units being rented out by individuals. It was one of these complexes I called as a basis for my initial rent numbers.

For commercial units, in the same town there really isn't anything that is higher than Class C but 20 minutes north or south on the interstate there are Class A and B office spaces. So I've priced mine at $16/sqft/yr vs the units 20 minutes away at $19-22 (and the local units are around $8-12) because of the building being new, has fire suppression, etc. I don't know what the appraiser will decide for these but I hope that he agrees with my logic of the higher rent due to the fact mine will be renovated compared to the ones run down elsewhere in town. But he did tell me that if I have a lease that is above market rent then he can use that for the calculations. There is a chance that I may have a letter of intent with a particular company but I don't know for sure yet.

Regarding being close to another town with similar demographics, the town I'm in is a college town but 20 min north is West Virginia University, which is in a town that is booming and has thousands of townhouses, student rentals, you name it. I've been looking at their rents and have priced accordingly but can't quite match due to the fact that mine aren't in the same town and don't have the same amenities due to not being large complex (i.e. fitness center, pool, etc.). The appraiser said that the growth from the town up north won't really have a bearing on my valuation, at least from a cap rate perspective. Accordingly, I assumed I have to also adjust for supply/demand dynamics between my town and the larger college town up north even though it's only 20 min away.

Do loan officers actually sometimes consider information provided by the building owner and allow that to override what an appraiser has said (assuming the sources are reliable)?

Hey brandon, I see where you are coming from. I may be able to answer some questions for you my man

Best, 

Blake

Brandon: Typically, rents are based on the neighboring competition. In your case, the larger complexes are not competitors. The appraiser will look at the smaller units and should compare similar units even if its outside your area as appropriate. The appraiser shouldn't just stated there is a duplex next door at X dollars, so that's your market rent. Your property is a commercial asset and not residential. Depending on your area's MLS, it may or may not have commercial properties. That why it's important to get with a experienced commercial agent in your area, because they will/should know of transactions (have comps) not necessarily posted on the MLS. Also, reach out to other appraisers, try one in the WVU area. You can try Loopnet as well for comps, but verify. Most commercial agents don't utilize the local MLS, because it's geared for residential agents. Additionally, most commercial buyers utilize Loopnet or something similar, because it's easier than trying to know every areas MLS system. CoStar is another option as well for comps, but it can be pricey. If you have nothing in your area that's similar, then the appraiser has to increase his search area or explain how he came to his conclusion. If you don't like the conclusion, then challenge it based on the merits (facts) and not feelings. If you have a similar property up the road, the appraiser shouldn't simply dismiss the comp because its up the road. Even near WVU, there are pockets which may mirror your area characteristics.

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