Formal appraisals take time and money. A fair value analysis may give portfolio companies a speedier and more cost efficient alternative.
By Kemp Moyer, Directory, Advisory
By definition, real estate portfolio companies own and manage multiple properties. The portfolio may be concentrated in one city or region, or, conversely, spread out over various states or even spread across multiple global locations. When a broader portfolio exists, it can be a challenge for larger companies in this industry to determine the accurate and up-to-date fair value of their portfolios. For certain businesses, a formal appraisal may either be required for financial reporting or a deeply entrenched habit. But many investment companies that have reporting requirements under generally accepted accounting principles, or GAAP, may be able take advantage of a streamlined fair-value assessment process for their portfolio.
Appraisal vs. Valuation
There are several ways to conduct a formal property appraisal. The three most common are market comparison, income/investment, and the replacement cost approach:
- Market comparison: The appraiser develops a valuation by searching for similar properties recently sold in the same neighborhood to establish an estimated price.
- Income/investment: The appraiser develops a model to value the cash flow a property is generating or could potentially generate.
- Replacement cost: The appraiser analyzes much it would cost to acquire land and build an identical replacement building.
The appraiser decides which method to use based on several factors, including the quantity of data available, quality of the property, location and property type. These appraisals can be necessary to secure financing, to comply with regulatory reporting requirements, or to appeal a tax assessment. Other occasions for getting an appraisal include filing an estate tax return, gifting property, conducting a business merger, or acquiring insurance coverage. Federal government regulations require a formal appraisal for all real estate transactions valued above $500,000.
However, not all situations require a formal appraisal in the traditional sense. Under Accounting Standards Codification (ASC) 820, some portfolio companies can use simplified fair value analyses for their properties. This streamlined method is generally less expensive, saves time, and is more likely to be efficiently repeatable for organizations that use this method.
What Are Fair Value Analyses?
A fair value analysis, which is related to a fair-market value but differs slightly, is the development of the estimated value of an asset if it were to be bought or sold in an open market without any pressures to sell. To calculate the figure for real estate, valuation experts look at several factors, including location, square footage, purchase transaction history, sales of comparable properties in the same area, and other market data sets. Valuations can also include income-based analyses, which help determine an investment’s profitability based on actual or projected future income. Many of the processes are often similar to a traditional “appraisal” process, but the procedures are streamlined and, once completed, highly repeatable, as there will typically be only incremental changes in key metrics. Formal appraisals, by comparison, require owners to run multiple processes, including in-depth property visits, each time they are completed. Additionally, once formalized procedures are developed for fair value reporting and agreed upon with the firm providing a company’s assurance function, this process can help with the development of a more efficient audit completion process.
A quality fair value analysis process will include proper market adjustments based on changing circumstances since an enterprise first purchased the property or the prior analysis was completed. Case in point: The impact that the COVID-19 pandemic has had on commercial real estate. Due to lockdowns, many retailers, offices and restaurants have been forced to close or forego paying rent for extended periods. This pressure has impacted commercial real estate and depressed prices in various jurisdictions. Rather than needing an in-depth onsite appraisal update, fair value specialists can utilize market indications and marketplace data analytics to adjust the fair value analyses across a portfolio of like properties, often in a more efficient manner than a more granular appraisal process.
Appraisal vs. Valuation: Find Out Which Is Best for Your Business
Developing a fundamental valuation approach for properties has a definite benefit for portfolio companies with recurring reporting requirements. It is more efficient and generally less expensive than a formal appraisal and will still meet GAAP reporting requirements. There will still be many circumstances, such as when trying to secure financing or meet tax reporting requirements, where a formal traditional appraisal will still be needed. However, knowing when a formal appraisal or a streamlined valuation process can be used is vital for resource and time management. To determine which method is correct for your business, contact Kemp Moyer, Director in our Advisory practice and Head of our Valuations and Appraisals team, today.