30 Commercial Appraisal Terms You Should Know
The 3rd blog in our 30th anniversary series
Throughout our 30 years specializing in commercial real estate appraisal, Argianas & Associates has accumulated a vast vocabulary. Our team came together to handpick 30 of our most used appraisal terms to celebrate the 30th anniversary of Argianas & Associates! Keep reading for our ABCs of commercial appraisal.
- 1. Abatement: The official reduction of an assessed valuation following review by the property tax assessment board (P-TAB).
- 2. Amortization: The financial schedule unique to a specific property’s financing that reflects the principle and interest due throughout the lifetime of the loan.
- 3. Assessed Value: The property’s determined market value (referred to as Fair Market Value) calculated according to the appropriate tax rates in a particular jurisdiction.
- 4. Average Daily Rate: Also referred to as the ADR and used in quantifying the income and profitability of a hotel. Generally (and assuming market rack rates apply) and in our experience, if the ADR is above 63-65%, the property is generally profitable.
- 5. Bridge Loan: Short-term financing used until a person or company secures permanent financing. Bridge loans generally have a higher interest rate and are almost exclusively interest-only.
- 6. Capitalization Rate: Otherwise known as a cap rate. It is calculated by dividing a property’s net operating income (NOI) by the current market value and is the rate of return based on the income that the property is expected to generate. Just remember, low cap rate good, high cap rate bad!
- 7. Condemnation: The act of enforcing eminent domain. Eminent domain is of course the right of the government to take private property for public use.
- 8. Conservation Easement: The easement created when a private property owner voluntarily agrees to limit the development/resources use of the property while retaining private ownership of the land. Often this process is completed for the benefit of tax incentives. The conservation easement also is codified and memorialized in the property’s deed. Importantly, however, once completed and tax incentives are received, the conservation easement cannot be reversed and if possible, all tax incentives received will have to be repaid.
- 9. Economic Occupancy Rate: The rate of paying tenants in an apartment or office building based on the total possible revenue and the actual revenue collected. The economic occupancy rate is calculated by dividing the actual revenue collected by the gross potential income.
- 10. Effective Gross Income (EGI): The true positive cash flow of an apartment community. EGI is calculated by adding the sum of the gross potential rent and the other income and subtracting the income lost due to vacancy, loss-to-lease, concessions, employee units, model units and bad debt.
- 11. Equity Dividend Rate: The ratio of a single year’s before tax cash flow and the total cash or equity in the property. Also referred to as the Cash on Cash Return.
- 12. Fair Market Value:
- a. IRS/Estate – The price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts. Treas. Reg. §20.2031-1(b)
- b. Bankruptcy – The price which a willing seller under no compulsion to sell and a willing buyer under no compulsion to buy would agree after the property has been exposed to the market for a reasonable amount of time. Section 522(a)(2) of the Bankruptcy Code.
- 13. Fair Cash Value: For IL Eminent Domain; Except as to property designated as possessing a special use, the fair cash market value of property in a proceeding in eminent domain shall be the amount of money that a purchaser, willing, but not obligated, to buy the property, would pay to an owner willing, but not obliged, to sell in a voluntary sale. Illinois State Statutes (735 ILCS 30/10-5-60).
- 14. Frictional Vacancy: Every appraiser’s favorite definition in the Highest and Best Use Introductory course! – In every market to function with stability there is a balance that is needed between supply and demand of properties. Frictional vacancy accounts for movement within the market including participants entering and exiting the market.
- 15. Gross Potential Rent (GPR): The hypothetical/actual amount of revenue that would be generated if the property were/is fully leased year-round. If the property does not have a concurrent rent roll then figures are estimated based on market rental rates (what tenants pay for like-kind products in the immediate market area).
- 16. Internal Rate of Return (IRR): A metric that is used to calculate the average annual return a property yields or will yield in the future over time. This is expressed as a percentage.
- 17. Loss to Lease (LtL): The revenue lost based on the actual rent being charged versus what could be charged at current market rates. LtL is calculated by subtracting the gross potential rent by the actual rent collected then dividing by the gross potential rent.
- 18. Market Value (FIRREA): The most probable price which a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently and knowledgeably, and assuming the price is not affected by undue stimulus. Implicit in this definition is the consummation of a sale as of a specified date and the passing of title from seller to buyer under conditions whereby: 1) Buyer and seller are typically motivated; 2) Both parties are well informed or well advised, and acting in what they consider their best interests; 3) A reasonable time is allowed for exposure in the open market; 4) Payment is made in terms of cash in United States dollars or in terms of financial arrangements comparable thereto; and 5) The price represents the normal consideration for the property sold unaffected by special or creative financing or sales concessions granted by anyone associated with the sale (Federal Register, Volume 55, 12 C.F.R. Part 34.42 (g), Page 34696, August 24, 1990, as amended at Federal Register, Volume 57 Page 12202, April 9, 1992; Federal Register, Volume 59 Page 29499, June 7, 1994).
- 19. Metropolitan Statistical Area (MSA): A geographical region containing a substantial population nucleus. MSAs are determined by the United States Office of Management and Budget.
- 20. Net Net Net Lease (NNN): Referred to colloquially as a triple net lease, such leases assume the tenant is responsible for all expenses (fixed and variable) of operating a property. As is often the case, the landlord is responsible for basic building maintenance, reserves and management. Properties with NNN leases are beneficial to owners as there are fewer expenses that must be removed during the valuation process.
- 21. Net Present Value (NPV): The difference between the present value of the property’s current cash flows and future cash flows while also considering the property’s discount rate. The discount rate is used to measure the current value of future cash flows from a property.
- 22. Operating Expenses: The costs of running and maintaining the property and its grounds. These include projects such as paint, new carpet, cleaning, ongoing maintenance and repairs, ongoing landscaping costs, payroll to employees, and utility expenses.
- 23. Physical Occupancy Rate: The percentage of available units occupied by paying tenants. Physical occupancy rate is calculated by dividing the number of occupied units by the total number of units.
- 24. Planned Urban Development: Referred to as the PUD, a planned urban development is an outline or agreement for how an area will be developed. Chiefly, what types of properties can be built, the infrastructure that should be included, and the mix of both residential and commercial spaces.
- 25. Present Value: The present value of the rights to future cash flows (future value) produced by an income-generating property. Any appraiser worth their salt will be able to calculate the Present Value (PV), the Payment (PMT), and the Future Value (FV) of a property’s financials. Put differently, if a property has a 100-year lease with 99 years remaining, there is value associated with the 99 years of guaranteed income.
- 26. Positive Leverage: The result of borrowing funds and then investing them to receive an interest rate/yield that is higher than the rate at which the funds were borrowed.
- 27. Pro-Forma: The projected budget of a property, displayed as a Profit and Loss statement.
- 28. Prospective Value: The price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts. Treas. Reg. §20.2031-1(b)
- 29. Ratio Utility Billing System (RUBS): A method of calculating a tenant’s utility bill based on occupancy, unit square footage or a combination of both. Once calculated, the amount is billed back to the resident, which results in an increase in revenue.
- 30. Regression Analysis: Encompassing simple linear regression (one variable) or multivariate regression (multiple variables), it is a statistical tool that allows the comparison of one or more characteristics of a property and allows for a more quantitative comparison of the subject. A safe rule of thumb, if your R2 value is near 1, the model is performing ok (but don’t forget about the F-stat, Significance F, t stat, and P values!)
- 31. Rent Roll: A document or spreadsheet including detailed information on each of the units at the apartment community, along with a variety of data tables with summarized income.
- 32. A Syndication (or syndicate): A temporary alliance created to handle a large transaction that would be impossible to execute individually. By forming a syndicate, members can combine their resources together, and share in both the risks and the potential for attractive returns.
- 33. Underwriting: The process of financially evaluating an apartment community to determine the projected returns and an offer price.
If you’re looking for an expert you can trust to approach your commercial appraisal with honesty, integrity and attention to detail, do not hesitate to give us a call at (630) 390-0113 or complete this form. Be sure to join our mailing list to receive our e-newsletter.