Commercial real estate SBA loan appraisal guide

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Anytime a Small Business Administration (SBA) loan includes commercial real estate, lenders are required to obtain an appraisal report to include in the lender’s loan application submission to the SBA. This quick guide will provide you with important information to know regarding the appraisal process for your SBA commercial real estate loan.

SBA real estate appraisal report

The cost of the appraisal report, which may range from $3,000 – $25,000, may be passed through from the lender to the SBA loan applicant. The lender may estimate the value of the real estate for its credit memorandum and state that the appraisal is a closing contingency.

The appraisal report must be dated within 12 months of the loan application.

Rental income or any intangible assets should not be included when valuing the collateral.

If the loan will be used to finance new construction or the substantial renovation – at lease 1/3 of the purchase price or fair market value — of an existing building, the appraisal must estimate the completion market value. After construction is completed, Lender must obtain a statement from an independent party close to the transaction – the appraiser, general contractor, project architect, or construction company that the building was completed with no or immaterial deviations from prior estimates. If no statement can be obtained, the lender can not proceed with the SBA loan.

The appraiser should estimate market value on an as-is basis. If not assessed on an as-is basis, the appraiser must include a narrative why an as-is basis was not utilized (e.g., the property was undergoing substantial renovation at the time).

The appraiser’s will assume in her report that the transaction is arm’s length, meaning the neither is no compulsion on the part of the the buyer or seller to complete the transaction and there are no special relationship between the transacting parties.

If at time of closing the appraised value, is 90% or more of the estimated value, the SBA lender may close the loan but must provide a written explanation why the appraisal is less than the estimated value. If appraised value of real estate is under 90% of estimated value, the SBA lender will need prior written permission from the SBA to close unless the SBA lender is a enrolled in the SBA Preferred Lender Program (PLP). PLP Lenders are permitted to close a loan when the appraisal is less than 90% of the estimated value, but the Lender must include a written justification as part of its file that may be reviewed by SBA at time of guaranty purchase or when conducting oversight.  The justification must lender’s reasons for the low appraisal, and an explanation of steps the lender took to offset the risk to the SBA (e.g., lender required more equity and/or additional collateral).

Appraisal of Other Fixed Assets

If the valuation of fixed assets is greater than net book value (asset purchase price less accumulated depreciation), an independent appraisal by a qualified individual free of the appearance of a conflict of interest is required to support the higher valuation. A valuation of the fixed assets provided as part of a business valuation will not meet these requirements, except as part of a going concern appraisal.

Standard appraisal valuation methods

The three most popular valuation approaches are the income approach, net asset value approach, and market approach. Each approach focuses on different factors and considerations when determining the value of an asset or business.

Income Approach

The income approach calculates the value of an asset or business based on its income-generating potential. This approach is commonly used for businesses and real estate properties that generate regular cash flows. The key idea behind the income approach is that the value of an asset is determined by its ability to generate future income.

There are two primary methods within the income approach – the capitalization method and the discounted cash flow method:

Capitalization Method: This method estimates the value of an income-producing asset by dividing the expected annual net income by a capitalization (“cap”) rate. The capitalization rate is determined based on factors such as the risk associated with the asset, prevailing interest rates, and market conditions. Note that there is an inverse relationship between asset valuation and interest rates: the higher the cap rate, the lower the value of the asset as the buyer(s) demand a higher return on the asset(s) being purchased.

Here are a couple of examples utilizing various cap rates, which demonstrate the huge impact cap rates have on commercial real estate valuations:

Adjusted annual cash flow (EBITDA)$500,000$500,000
Capitalization (cap) rate5%10%
Fair Market Value using Income Approach$10,000,000$5,000,000

The dramatic rise in interest rates by the Federal Reserve in 2022 and 2023 resulted in investors and buyers demanding higher returns for their capital, which equates to much lower enterprise values for businesses and any underlying commercial real estate. Click here for more information on current SBA loan rates, which move in unison to investor’s demanded cap rates, is found here.

Discounted Cash Flow (DCF) Method: The DCF method calculates the present value of the future cash flows generated by an asset. It involves projecting the expected cash flows over a specific period and discounting them back to their present value using an appropriate discount rate. The discount rate considers the asset’s risk, cost of capital, and time value of money.

The income approach is particularly useful when valuing businesses with steady cash flows or income-producing real estate properties.


Net Asset Value (NAV) Approach

The net asset value approach determines the value of an asset or business by calculating the net value of its assets minus its liabilities. This approach is commonly used for businesses with substantial tangible assets, such as manufacturing companies or real estate investment trusts.

The NAV approach involves the following steps:

  • Identifying and valuing all tangible assets (such as property, inventory, equipment, etc.) and intangible assets (such as intellectual property, trademarks, patents, etc.) owned by the business.
  • Subtracting the total liabilities (debts, loans, obligations) from the total asset value.
  • Adjusting the asset values and liabilities to fair market value, if necessary.
  • The resulting net asset value represents the estimated value of the business.

The NAV approach provides an indication of the value of a business based on its underlying assets and is commonly used when a business’s assets are more significant than its income-generating potential.


Market Approach

The market approach determines the value of an asset or business by comparing it to similar assets or businesses that have recently been sold in the market. This approach assumes that the market value of an asset can be estimated by analyzing the prices at which similar assets or businesses have been bought or sold.

There are two main methods within the market approach:

  • Comparable Sales Method: This method compares the asset or business being valued to similar assets or businesses that have recently been sold. Factors such as size, location, industry, financial performance, and market conditions are considered when selecting comparable transactions. The valuation is based on the market prices of these comparable assets or businesses.
  • Guideline Public Company Method: This method is used when valuing a business and involves comparing it to publicly traded companies in the same industry. Key financial metrics such as price-earnings ratio, price-to-sales ratio, or enterprise value-to-EBITDA ratio are analyzed to estimate the value of the business being appraised.

The market approach is useful when there is a well-established market for similar assets or businesses, providing direct transactional data for comparison.

It’s worth noting that each approach has its strengths and limitations, and the most appropriate approach depends on the specific circumstances and nature of the asset or business being valued. Professional appraisers often consider multiple approaches and weigh their respective results to arrive at a comprehensive and well-supported valuation conclusion.


Business valuation

If the amount of SBA financing minus the appraised value of real estate and/or fixed assets is greater than $250,000 or if there is a close relationship between the buyer and seller (for example, transactions between existing owners or family members), the SBA lender must obtain an independent business valuation.


Commercial real estate appraiser’s qualifications

For all 7(a) loans secured by commercial real property when loan proceeds will be used to acquire, refinance or improve real estate, Lenders must obtain an appraisal by a State licensed or certified appraiser. Appraisals must be in compliance with the Uniform Standards of Professional Appraisal Practice (USPAP).

The appraiser, who is hired by the lender and not the buyer or seller, must be independent and have no conflicts of interest, In addition, the appraiser must be state-licensed, or when the estimated value is over $1,000,000, state-certified.

Qualified appraisers are typically Accredited in Business Valuation (ABV) by the American Institute of CPAs (AICPA), Certified Valuation Analyst (CVS) through the National Association of Certified Valuation Analysts (NACVA), or Accredited Senior Appraiser (ASA) accredited by the American Society of Appraisers (ASA).

Because the lender hires the appraiser, SBA borrowers typically do not need to worry about the selection and qualifications of the appraiser. SBA bankers work frequently with the same qualified appraisers. If they chose unqualified appraisers, their loan(s) would not be approved by the SBA, so they carefully select their appraisal vendors.

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SBA Commercial Real Estate Loan FAQs

What is normalized or adjusted EBITDA?

EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. Normalized EBITDA (aka adjusted EBITDA) is EBITDA plus or minus “normalizing” adjustments.

To calculate EBITDA, one starts with net income – the “bottom line” and adds back interest, taxes, depreciation, and amortization. The formulate is:

EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization

Here is a brief description of each:

  1. Net Income: This refers to a company’s net income (aka net profit) after deducting all operating expenses, including cost of goods sold, operating expenses, and depreciation and amortization. Note that capital expenditures – assets purchased with useful lives over multiple years) are not included in net income but rather expensed over the number of years of useful life (see depreciation and amortization below).
  2. Interest: It represents the interest expenses incurred by the company on its debt obligations.
  3. Taxes: This includes income taxes paid by the company based on its taxable income. Note that the taxes addback to calculate EBITDA does not include non-income taxes, such as sales taxes, property taxes, excise taxes, etc.
  4. Depreciation: It refers to the allocation of the cost of tangible assets (such as buildings, equipment, and vehicles) over their useful lives.
  5. Amortization: It represents the allocation of the cost of intangible assets (such as patents, trademarks, and copyrights) over their useful lives.

EBITDA is frequently utilized by capital market participants as well as the SBA because it is a measure of cash flow that is available to pay debt service and taxes. Depreciation and amortization are added back to obtain EBITDA as these expenses are non-cash expenses.

Normalized EBITDA is a modified version of EBITDA that adjusts for non-recurring or one-time items in the financial statements. For SBA loans, the most frequent normalizing

The process of normalizing EBITDA involves identifying and adjusting for non-recurring items such as:

  • Extraordinary gains or losses (e.g., one-time sale of assets)
  • Non-recurring legal expenses (e.g., lawsuit settlement)
  • Excessive rent (e.g., business owner pay himself greater than FMV rent that goes away or normalizes post-acquisition).
  • Excessive owners’ compensation/benefits

The most abused normalizing adjustment to EBITDA, which is often rejected by the lender, is adding back most or all of an owner’s compensation. This is done frequently by business brokers to inflate the “earnings” of the business. EBITDA plus owner’s compensation is called seller’s discretionary earnings (SDE). SDE is not utilized by the SBA or SBA banks. Instead, a reasonable compensation package for the buyer — typically the new owner – of the business. However, excessive compensation may be added back. For example, if the seller was taking compensation and benefits of $300,000 and the buyer will only take $100,000, the “excessive” compensation of $200,000 may be added back to normalize EBITDA since the buyer’s business earnings would be theoretically $200,000 higher given all other variables being equal. We discuss EBITDA versus SDE at great length here.

By normalizing EBITDA, these one-time items are excluded to provide a clearer picture of a company’s recurring earnings from its core operations.


How long does it take to get a real estate appraisal?

Depending on the complexity of the property being appraised, the process may take two to six weeks.

Are environmental studies needed as well?

Yes, in general an environmental study is required for commercial real estate purchases. Lenders often require environmental studies to protect their interests, ensure compliance with environmental laws, and mitigate the risk of potential environmental liabilities. The size of the loan, the industry of the target property, and the lender will dictate the type of Environmental Site Assessment (ESA) required. ESA are commonly referred to as Phase I or Phase II studies. A Phase I ESA typically involves a review of historical records, site inspections, and interviews with relevant parties to identify any potential environmental concerns. If the Phase I ESA identifies potential issues, further investigations like Phase II ESA may be required. These studies can help assess potential cleanup costs, liability, and compliance with environmental regulations.

Can I buy passive rental property with an SBA loan?

No, SBA 7(a) loans may not be utilized for commercial real estate purchases of property that is not 51% + “owner-occupied.” Owner-occupied means the buyers utilize the majority of the square footage of the property for their business. The most common real estate purchase we see are situations where a tenants want to buy the property they are leasing or a business that is looking to expand its geographical footprint. There are some grey areas regarding owner-occupation, so we recommend telling your prospective SBA bankers in detail about your project so they can assist in ascertaining SBA loan eligibility. Note that residential real estate and apartments are not SBA 7(a) loan eligible, but hotels, self-storage, and RV parks are SBA eligible.

What is the term for SBA commercial real estate loans?

SBA real estate loans are amortized over 25 years.

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