Rapidly Appreciating Market Creates Challenge in Assigning Values

Central Ohio’s rapidly appreciating commercial real estate market is leaving some brokers and buyers trying to figure out how to get the deal done.

As buyers are pursuing some sectors of the commercial real estate market with vigor, prices are climbing at a pace that is making it difficult for appraisers to keep up with the market.

Last year, the industrial sector saw record growth due to the e-commerce boom, and rent growth stemming from the pandemic. In Central Ohio, the industrial sector saw the price per square foot increase by a remarkable 15.8% in 2021 over the previous year, according to CoStar data. The office market, despite being arguably the hardest hit by the pandemic, still saw the average sale price increase by 6.1% last year.

“We as appraisers do nothing more than use historical information to try and predict the future and therein lies the difficulty of what we do. When you have a market that is going up as rapidly as the one we are in right now, it’s very, very hard to stay ahead,” said Sam Koon, a Central Ohio commercial real estate appraiser and owner of Sam Koon & Associates.

Historical information is typically analyzed by appraisers using the three approaches to value: the sales comparison approach, the income approach, and the replacement cost approach. Appraisers commonly use the sales comp approach combined with another approach, depending on the property type and use. But in some scenarios, the historical information doesn’t seem to be telling the whole story.

“What seems to be problematic, and even misunderstood in some appraisals, is that increased demand paired with rising construction costs for building new are driving up the offer price on existing buildings. However, lease rates are not increasing at the same pace, and the income approach is not supporting the price. It leaves buyers with few alternatives,” explained Matt Gregory, senior vice president of NAI Ohio Equities.

The sales comparison approach may also cause a problem in supporting current values due to the length of time commercial transactions can take to close.

“In commercial real estate, it can take on average, 3-4 months to close, and possibly even longer,” explained Gregory, “which means that sometimes the sales comps used to determine a value are already dated and not an accurate reflection of the market.”

Because of this, more buyers are encountering what is known as an appraisal gap, the difference between the fair market value determined by the appraiser, and the offer made by the buyer – and it can be a deal-breaker, specifically for owner-occupants who are seeking financing.

In order for buyers to circumvent this, Central Ohio commercial real estate appraiser and attorney Frank Hinkle, advises providing as much information as possible upfront.

Providing information such as sales in-contract, or even other offers, can help the appraiser, added Koon.

Additionally, it’s helpful if brokers meet the appraiser during the inspection, and make themselves available for any follow-up questions, he added.

What buyers need to understand is that an appraisal needs to pass lending requirements, and they need to provide enough information to the appraiser to help bridge that gap, explained Hinkle.

Brokers can advocate for their clients by developing relationships with banks and appraisers in an effort to share information about what is happening currently in the market and connecting their clients to lenders who may have more aggressive lending strategies, said Koon.

“It’s all about being able to defend the appraisal,” said Hinkle.