What it means
Appraised value is a considered opinion anchored to a valuation date and a basis of value such as market value, replacement cost or value in use. Change the date or the basis and the number changes with it.
That is why lenders insist on a recent report rather than accepting one prepared three years ago. The figure has direct financial consequences.
A lender offering 80% loan to value will lend against the appraised value rather than the agreed price, so a low appraisal shrinks the loan and the buyer must cover the shortfall in cash. Insurance works the same way in reverse, since cover set below appraised replacement cost leaves the owner underinsured when a claim arises.
For income-producing assets the appraised value is usually derived from the income approach, which divides net operating income by a capitalisation rate taken from comparable market transactions. Small movements in that rate move the value a long way, which is why the choice of rate is the most argued-over line in any commercial appraisal.
Appraised value should not be confused with assessed value, market value or book value. Assessed value is set by a tax authority and often deliberately lags the market; market value is what a willing buyer and a willing seller would agree today; book value is historical cost less accumulated depreciation as recorded in the accounts.
Mixing these up in a board paper is a quick way to lose credibility. Appraised values also carry conditions worth reading.
A report may assume vacant possession, a clean title or the completion of works in progress, and each assumption can materially change the conclusion if it turns out not to hold.
In practice
Real-world examples.
Example
A couple agree to buy a warehouse conversion for $640,000, but the appraised value comes in at $600,000. Their lender advances 80% of $600,000, which is $480,000 rather than the $512,000 they had planned for, and they renegotiate the price with the seller to close the gap.
Example
A manufacturer revalues its specialist machinery for insurance and finds the appraised replacement cost is $3.4m against a sum insured of $2.2m set eight years earlier. The premium rises modestly, but a total loss would no longer bankrupt the company.
Example
A local authority assesses a retail unit at $410,000 for property tax while a recent appraisal for refinancing put the value at $560,000. The owner accepts both figures without contradiction, because assessed value follows a statutory cycle while appraised value reflects current market evidence.
Formula
Calculation
Under the income approach: appraised value = net operating income / capitalisation rate.
Consider a small multi-tenant office building. Gross potential rent is $360,000 a year. The valuer allows 5% for vacancy and bad debt, which is $360,000 x 0.05 = $18,000, giving effective gross income of $360,000 - $18,000 = $342,000.
Operating expenses, covering management, insurance, maintenance and property taxes, run at $126,000 a year. Net operating income is therefore $342,000 - $126,000 = $216,000.
Comparable office sales in the same submarket support a capitalisation rate of 8%.
Appraised value = $216,000 / 0.08 = $2,700,000.
If the valuer had judged the correct rate to be 7.5% instead, the appraised value would be $216,000 / 0.075 = $2,880,000, which is $180,000 higher from a half-point change in one assumption.Case study
Seen in the real world.
Draymont Storage is an illustrative, fictional self-storage operator that wanted to refinance a facility it had owned for six years. Management assumed the appraised value would track the 9% revenue growth they had achieved, and they budgeted a loan of $4.2m on that basis.
The appraisal used the income approach and confirmed net operating income of $340,000, but the valuer applied a capitalisation rate of 9% rather than the 7.5% implied by management's own model, citing two comparable sales completed that quarter. The resulting appraised value of roughly $3.78m reduced the available loan by several hundred thousand dollars.
In this fictional case the finance director's response was to accept the number and change the plan, deferring one refurbishment and drawing a smaller facility. The episode taught the team to build refinancing models around a market-evidenced rate rather than the rate they hoped for.
Watch out
Common mistakes.
- Treating appraised value as a promise of sale price, when it is an opinion about a date and a set of assumptions rather than a guarantee.
- Comparing appraised value with the assessed value on a tax notice and concluding one of them must be wrong.
- Building a refinancing plan on the capitalisation rate management prefers instead of the rate recent comparable sales actually support.
Questions
People also ask.
Why did the appraised value come in below the agreed price?
Usually because comparable evidence does not support the price, or because the buyer paid a premium for reasons specific to them, such as owning the adjoining site.
Does appraised value appear in the financial statements?
Only where the accounting framework permits or requires fair value, such as investment property or revalued assets; otherwise the accounts stay at cost less depreciation.
How much does a capitalisation rate change matter?
A great deal, since moving the rate from 8% to 7.5% on the same income raises value by roughly 7%, which is why the supporting evidence deserves careful reading.
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