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COMMERCIAL FINANCE 701 — Appraisals, cap rates & loan dollars

Commercial Finance 701 is a continuing series on commercial loans written exclusively for the Mississippi Business Journal. This series is geared to lenders, developers, investors and transactional attorneys.


An appraisal is one of the most significant obstacles to a competent developer’s obtaining a commercial loan.  Once received, the anticipated appraisal chiefly goes unread – except for a few critical numbers.  This article discusses appraisals, cap rates and loan dollars.

What is an appraisal?

Not surprisingly, the feds have their own definition of “appraisal.”  At 12 CFR 225.62, the FDIC decrees an appraisal is “a written statement independently and impartially prepared by a qualified appraiser setting forth an opinion as to the market value of an adequately described property as of a specific date(s), supported by the presentation and analysis of relevant market information.”  The Mississippi Appraisal Board uses a similar but slightly different codified definition.

For our limited purposes, a real estate appraisal is a third-party report prepared by a certified professional who may provide up to three valuations: (1) the current as-is value, (2) the future as-constructed value, and (3) the future as-stabilized value.

When is a real property appraisal required?

12 CFR 225.63 advises an “appraisal performed by a state certified … appraiser is required for all real estate-related financial transactions” over $250,000 unless one of twelve enumerated exceptions apply.  As if to disprove any suggestion that regulators lack a sense of humor, exception #3 excuses an appraisal if the “transaction is not secured by real estate.”  Another exception, #2, exempts situations where a lien is taken merely as an “abundance of caution.”

Estimates & cap rates

Prior to the engagement of the appraiser, the parties have likely conjectured the expected appraised value using market savvy and a capitalization rate calculation.   Mathematically, the “cap rate” equation is simple:  Property Value = Annual Net Operating Income / Cap Rate.  Of the three values, the mostly easily quantified is the yearly income.  As for the other two values, well … we need an appraiser.

It is common for developers to assume a cap rate and utilize it to calculate a property’s value.  For example, assume a property has NOI of $1 million and a cap rate of 7.69 percent.  The “value” is $13,003,901 [calculated as $1,000,000/0.0769]. An assumed cap rate of 9 percent on the same income stream produces a value of $11,111,111. A 6 percent cap rate yields a value of $16,666,667.  Cap rates of 6 percent, 7.69% and 9 percent, equate to values of $16,666,667, $13,003,901 and $11,111,111, respectively, on the same property.

The determination of a cap rate is, however, problematic, with multiple variables underlying the number.  A recent 2015 appraisal we reviewed discussed the Band of Investment concept:  “Because most properties are purchased with debt and equity capital, the overall capitalization rate must satisfy the market return requirements of both investment positions. The debt component of the overall rate is known as the mortgage constant and the equity component of the overall rate can be measured by the equity dividend rate.  The mortgage constant is a function of the interest rate, the frequency of amortization and the term of the loan.  The equity dividend rate or equity capitalization rate is the ratio of annual pre-tax cash flow to the amount of equity investment.”  Clear as mud?

Appraisal methodology, independence & review

Generally, an appraiser considers three approaches – (1.) cost, (2.) sales comparison (“comps”), and (3.) income.  The income approach utilizes the vital cap rate and generally yields the most relevant value.  The appraiser analyzes income and expense information (actual or estimated), details and amenities of the particular project, and the characteristics of the local market.  Assumptions and estimates can vary widely.  A college town (e.g., Oxford, Miss.) and an oil city (e.g., Houston, Texas) are apples and oranges.

The final appraisal must undergo an internal bank “compliance review” by a “qualified and adequately trained individual” to assure compliance with minimum federal appraisal standards, including the required “independence” from borrower or loan officer influence.  At many institutions, the appraisal process is handled by a bank’s credit department.  Prior to final approval of an appraisal on large commercial loans, the appraisal is also subjected to a technical quality review, frequently handled by an internal, licensed “review appraiser.”

Using the numbers

In most commercial loan commitments, the maximum loan amount is a percentage of a yet-to-be obtained appraised value.  Historically, the commitment might have provided for a maximum loan-to-value ratio of 80 percent of the “as complete” value of a commercial construction project.  Now, however, with new Basel III/HVCRE requirements, prior to advancing the first loan dollar, the lender will also likely require cash equity injection of 15 percent of the “as complete” value.  (See “Commercial Finance 701: Basel III, HVCRE & real estate loans”, Mississippi Business Journal, May 14, 2015.)

Costs and timing of appraisals

In 2015, we have seen commercial appraisals with costs ranging from $2,000 to $12,000 for commercial projects ranging from $5 million to $40 million.  Appraisals for higher-end and more complex projects can be more expensive.  A six-week turnaround time is customary, assuming the relevant information can be provided to the appraiser upon engagement.

FIRREA & closing

The current appraisal landscape was shaped by the Financial Institutions Reform Recovery and Enforcement Act of 1989 (which, if it had followed the then-existing “Depository Institutions …” naming scheme, would have regrettably been known as DIRREA instead of FIRREA).   The appraisal world is more regulated and complicated than it has ever been. Predictably, we have glossed over numerous important issues and have narrowed our discussion to commercial project financing.

Oscar Wilde, in his satirical comedy Lady Windermere’s Fan, described a cynic as “a man who knows the price of everything and the value of nothing.”  Au contraire, the proficient appraiser knows the price and value of everything.  The appraisal report is chock-full of market data and worth reading in its entirety.

» Ben Williams and Molly Jeffcoat Moody are attorneys in a commercial law practice at Watkins & Eager PLLC (watkinseager.com).   Ben is recognized by Chambers USA and Best Lawyers in America and was selected as Best Lawyer’s 2014 Commercial Finance Lawyer of the Year in Jackson.   Molly is recognized by Chambers USA in the area of Real Estate Law. 


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About Contributing Columnist


  1. You might want to correct your exhibit. You have “MIA” instead of “MAI” – the designation for commercial appraisers available for members of the Appraisal Institute. I think I’ve done some work for you guys in years past. Have a great day!

  2. Frank Waltman, MAI, AI-GRS

    As a senior review appraiser at a large bank, I must say your well written overview accurately describes the commercial appraisal process as it relates to lending. It is a little known fact outside of the appraisal industry that the average age of appraisers who have the MAI designation is 62. The concern going forward is that there will be a shortage of designated commercial appraisers to perform complex appraisal assignments that will comply with FIRREA.

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