Business Appraisal Vs. Real Estate Appraisal

3 people looking at an appraisal

Real Estate Appraisers mainly rely on “Market Comps” to derive a value of the property that they are appraising.  Business Appraisers are typically more concerned with the amount of cash that flows through a business after all of the other bills are paid.  This is the core difference between business appraisals and real estate appraisals, but let’s dig a bit deeper. 

How Much Does A House Appraisal Cost?

Expect to pay anywhere from $300 to $750 depending on the size and task that the bank assigns to them.  We just purchased a home last week and the lender (Chase) ordered our house appraisal and charged us $500 for it.  After it was complete they then tacked on another $250 for Chase to review it.  Let’s assume that is the market cost for a formal real estate appraisal in Scottsdale, Arizona.  Sometimes the lender will request a “desk review” appraisal.  This is where the appraiser checks out the comparable sales in the area and provides a ballpark estimated value.  Since the comps are the most important real estate valuation method, this generally leads to similar results as the formal appraisal.

How Much Does A Business Appraisal Cost?

This is a tricky question to answer as businesses are not homogeneous like real estate.  Is this a single owner business, or is this a multi-billion dollar business?  Does the business have 5 employees or 5,000?  What is the purpose of the appraisal?  Is this for divorce?  A potential sale?  Is the bank requesting it?All of those factors come into play, which means that the process of hiring an appraiser typically involves getting bids from a few different companies.  Each of those appraisers needs to know what the purpose of the assignment is along with an idea of the complexity of the business structure.  He or she would then estimate the amount of hours needed to complete the scope of work and would then prepare a quote for the job.Hourly rates for appraisers are typically in the $200-$500 range depending on the seniority, training and certifications of the appraiser.  An appraiser who specializes in family law, and spends a good deal of time in court, will command a higher hourly rate than one who specializes in franchise or restaurant valuations.Knowing an hourly only answers half of the question: How much does an appraisal cost?  The other side of the equation is how much time should it take to complete the assignment.  Again it is difficult to answer, so I’ll give you a few estimated times for some of the projects that I have worked on during my 15 year career as an appraiser.

Expect a Dental Practice Appraisal to take 10-15 hours to complete.

Restaurant appraisals are on the easier end of the appraisal world so expect around 8-10 hours of work.  However, if it is involved in a divorce case, assume double the hours.

Assume that an appraiser needs about 10 hours per appraisal of an optometry clinic.  So 20 times 10 is equal to 200 hours for this assignment right?  Fortunately, no.  Typically, the owner of a business will have consolidated financials so that the appraiser can produce one report that covers the entire business.  It will be more work than just a one office clinic, but you could expect that an appraiser could preform the work in about 30-40 hours.

How to Value Real Estate

Real Estate appraisals require state licensed real estate appraisers.  They are typically hired by a bank to ensure that the house or commercial property will provide sufficient collateral for a loan.  Licensed real estate appraisers use three approaches to value:

  1. Market Approach
  2. Cost Approach
  3. Income Approach

Market Approach

The market approach is heavily favored in Real Estate Appraisal.  For the most part houses are homogeneous, land is land and dirt is dirt.  Real estate agents always preach location, location, location.  What better way to figure out what the location is worth, than looking at the comps to find out what houses in the neighborhood sold for?  The market approach allows an appraiser to take certain statistics from nearby house sales and apply them to the house that they are appraising.  Statistics that they are looking for are:

  • Square footage
  • Number of Bedrooms
  • Number of Bathrooms
  • Number of Garage Spots
  • Is there a Pool, or other upgrades to the backyard?
  • Has the house been updated recently?
  • Date Property was Built
  • Date Property Sold
  • Price Paid for the Property

Once they have pulled up certain statistics like Price per Square foot, or Price per Bedroom, the appraiser can then apply those metrics to the house they are appraising.  

Market Approach Example in Real Estate

In this neighborhood 2 houses have recently sold.  Both had the same model of home design (same builder) and are 2,000 sqft.  The only difference is that Comp A has recently been upgraded with a new kitchen.  Comp B has the same kitchen from when the house was built in 1995.  Comp A sold for $600,000 or $300 a sqft.  Comp B sold for $560,000 or $280 a sqft.  

The appraiser then looks at the condition of the subject house and decides that it also has not been updated since it was built in 1995.  The appraiser selects $280 a sqft as a reasonable estimate of the value of the subject house.  Knowing that the subject house is 2,500 sqft, the appraiser calculates a value of $700,000 for the subject property.

The appraiser could do the same for many other metrics to get a sense of what the value should be.  Backed by a solid statistical database the real estate appraiser is armed with more than enough metrics to provide an appraisal of either a commercial property or a residential one.  

Cost Approach

The cost approach in real estate appraisal is pretty straight forward.  The appraiser needs to estimate what it would cost to build that structure today.  Using data and knowledge of local housing costs per square footage the appraiser can estimate the cost to replace the subject property.

Income Approach in Real Estate

Treating the subject property as an investment yields a different result for an appraiser.  The appraiser examines local rent and assumes marketing costs and the time between renters to calculate a value of the rental stream of income to the property.  The appraiser can choose to use a gordon growth method or a more complex discounted cash flow method.

How to Value a Business

Business appraisers are not state licensed, in fact there are no licenses for business appraisers in the US.  In order to find a qualified appraiser, one needs to examine the credentials of the appraiser.  If an appraiser doesn’t have an ASA, CVA, or ABV after their names, they likely wouldn’t pass a Daubert Challenge in court.

Certified Business Valuators follow guidelines called the Uniform Standards of Professional Appraisal Practice (USPAP).  Business appraisers typically rely on 3 approaches to value.

  1. Income Approach
  2. Market Approach
  3. Asset Approach

Income Approach in Business Valuation

This approach is the favored approach in business valuation.  The appraiser assumes that a hypothetical buyer would come in and purchase the business.  This investor uses two things to value the business:

  • How much profit can they make after paying all the bills and making sure that management is appropriately paid?
  • How risky is this business compared to all of the other investment choices available?

The appraiser will use statistics to determine an investors required return for different business categories and asssign a risk (cap rate or discount rate) to the subject property.  The appraiser then needs to examine the business to determine how much cash flow is available to this hypothetical investor.  From this point the appraiser can use a capitalization of excess earnings method or a more complicated discounted cash flow method.  Using the same growth rate for the business will yield identical results.

Market Approach in Business Valuation

Just like in the real estate example above, the appraiser pulls comps from a database and applies certain metrics to the business.  Unfortunately, businesses are not homogeneous and the data sources filled with comps are no where near as good as the data sources that real estate appraisers have access to.  Further, only successful businesses sell and make it into the databases.  Think about that for a second, if 50% of restaurants fail in the first few years, none of those make it into the database.  The same goes for a medical doctor in a small town who simply cleans out his office and retires.  By nature the entire database is biased upwards, meaning that any value derived from a market approach is higher than what the value of the business should be.  

Many appraisers tend to pull statistics from the selected (filtered) database and apply them to the subject property.  I tend to use regression analysis to apply the comps to the subject business.

In the end, business appraisers typically give little to no weight to the results of the market based methods due to the poor data to start with.

Asset Approach in Business Valuation

The asset approach usually does not yield credible results in professional service businesses (accounting firms, doctor’s offices, consulting firms, etc.).  The main reason is that professional businesses rely on their employees to turn a profit not expensive machinery.  

However, a huge factory relies on equipment and not necessarily people to generate revenue and profits.  In businesses that don’t rely on people, an asset approach is an appropriate method to use.

The asset approach involves calculating a market value for all of the plant, property and equipment in use by the company.  An appraiser may also consider the brand value of the item that the factory produces and sells.

Business Appraisal Vs. Real Estate Appraisal Conclusion

Business appraisal is:

  • More complicated
  • More time consuming
  • Heavily reliant on the Income Approach
  • More expensive
  • Harder to shop for
  • Not regulated
  • Businesses are portable, possibly worldwide

Real estate appraisal is:

  • Less expensive
  • Local, location, location, location!
  • Less time consuming
  • Heavily reliant on Market Based Comps
  • State Regulated
  • Easy to shop for (banks select appraisers from a pool)
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Ross Landreth is an Accredited Senior Appraiser with a MBA in Finance.
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