On a financed purchase, the appraisal is not a formality. It sets the value the lender lends against, and a low one can end a deal in the last week of conditions. Understanding how it is constructed lets a buyer or seller anticipate the number instead of waiting for it.
Three approaches, weighted by asset size
An appraiser will consider the direct comparison approach, the income approach, and the cost approach, then weight them according to what buyers in that market actually use.
For a duplex or fourplex, direct comparison usually carries the most weight, because those properties compete with owner-occupiers and there are enough comparable sales. From roughly six units upward, the income approach dominates, because that is how buyers price them. The cost approach is generally a check rather than a conclusion.
What the income approach actually does
The appraiser builds a stabilised net operating income — not your NOI, theirs. They will typically apply market rents rather than in-place rents where the two differ, a market vacancy allowance, market expense ratios, a management fee whether or not you pay one, and a structural reserve.
Then they apply a capitalisation rate drawn from comparable sales in that submarket. Small movements here matter enormously: a fifty basis point difference on a building with $120,000 of NOI moves the value by more than $200,000.
Where owners lose value unnecessarily
- Poor records. An appraiser who cannot verify income will use conservative market assumptions. Clean statements and a proper rent roll with lease copies protect the number.
- Below-market rents with no explanation. If rents are low for a reason that will change, say so and evidence it. If they are simply low, expect the appraisal to reflect the income, not the potential.
- Unrecorded capital work. A new roof or boiler affects effective age and the reserve assumption, but only if the appraiser knows about it. Have the invoices ready.
- Deferred maintenance in plain view. It goes straight into the report as a deduction.
What you can legitimately provide
You can give an appraiser information. You cannot give them a conclusion. A useful package is: current rent roll and leases, two to three years of financial statements, a capital improvement schedule with dates and costs, the property tax notice, utility histories, and a site plan or measurement. If you know of recent comparable sales the appraiser may not, providing the addresses is fair.
What you should not do is argue toward a number. Appraisers are required to be independent, and pressure is both improper and counterproductive.
If the appraisal comes in low
Read it properly before reacting. Look at which comparables were used, whether adjustments were reasonable, whether the income was built from your actual leases, and whether any factual error crept in — wrong unit count, wrong area, missed capital work. A factual error is grounds for a reconsideration request. A difference of opinion on cap rate usually is not.
The practical options at that point are to renegotiate price, increase the down payment, or, on a commercial file, take it to a different lender with a different appraiser.
This article is general information, not appraisal, financial or investment advice.
Talk it through with Rimrock
Rimrock Sales & Leasing works with owners, investors and tenants across Calgary, Edmonton and Lethbridge. Get in touch or call 403-910-4611.