Lenders often require appraisals when they need an opinion of market value. Market Value as a type of value, stated as an opinion, that presumes the transfer of a property (i.e., a right of owner- ship or a bundle of such rights), as of a certain date, under specific conditions set forth in the definition of the term identified by the appraiser as applicable in an appraisal. Essentially, its how much a willing buyer will pay a willing unrelated seller, selling at market price, thereby setting market value.
There are several types of appraisals - real estate, business, machinery and equipment, As Is, As Stabilized, Insurable Value, Liquidation Value, As Completed, Fee Simple and Leased Fee. The list goes on. Appraisals are a complicated undertaking and should only be carried out by a certified and licensed professional who meets the competency requirements under the regulating body known as USPAP (Uniform Standards of Professional Appraisal Practice).
The result is the opinion of the appraiser based on their experience and knowledge in the market and the property type as to how much as willing buyer would pay a willing seller and how much as willing seller will accept. So many factors can have an influence on market value including the type of financing. Seller financing might enable a buyer to have a reduced down payment or no down payment, making it easier to buy and that could change how a buyer looks at the opportunity.
Or a project might be in a "fire sale" whereas the property is to be sold faster than the normal time it takes to market a property. Such as if a market has what is known as a 12-month marketing and exposure time, meaning a selling agent will take that amount of time to find a buyer and close the deal as opposed to a selling agent representing a seller who cannot wait and needs cash fast.
These topics are thus about value.
A feasibility study is not about value. Its about a property or business enterprise ability to be accepted in the market known as absorption, what its market share will be, and the risk related to the operations concerning repayment of debt and equity. The equity can come from the owner or their partners or a combination.
To measure the return on equity, a feasibility study will demonstrate pro forma assumptions based on market conditions and reliable comparable source for revenues and operating fixed and variable expenses by showing items known as Cash on Cash, also known a Rate of Return on Investment (ROI), and time valued measures such as Internal Rate of Return (IRR) which takes into account the equity and debt as the debt is amortized over periods of time and an exit strategy such as a sale is taken into account.
Appraisals often show the IRR as well, but this is compared with market indicated equity rates like those published by CBRE (https://www.cbre.com/insights/reports/us-cap-rate-survey-h1-2023), but appraisals are completed based on what is known as "unleveraged" meaning debt is not part of the equation, whereas a well developed feasibility study will show both IRR analyses leveraged, meaning with debt that is specific to the project based on lender provided loan terms and unleveraged like an appraisal to show if the project is within "market" for this type of return.
A clear distinction between an appraisal and a feasibility study is for the feasibility study to calculate and show the lender the Debt Service Coverage Ratio (DSCR), meaning for example if the EBITDA (Earnings Before Interest, Taxes (except real estate and other fixed property or equipment related taxes whereas this means income taxes for the business), Depreciation and Amortization) is $100,000 annually and the annual debt service is $80,000, then dividing the EBITDA by the Debt Service equals the DSCR ($100,000 / $80,000 = 1.20x).
Appraisals do not provide this information to a loan underwriter and its crucial to their decisions.
Moreover, a feasibility study provides details on competitors such as revenue per square foot to test the reasonableness of the manager's projections. An appraisal provides market rents, but only a business appraisal considers this item. So, a feasibility study has this common feature that a business appraisal offers.
The reason why the SBA (Small Business Administration) and USDA (United States Department of Agriculture) require feasibility studies for start-ups, expansion or refinance projects or businesses, is to provide project risk concerning repayment of the loans. For Grants, its required because they want to understand other factors such as job growth in the market.
Appraisals do not touch on the Availability of Trained or Trainable Labor in depth like a genuine USDA feasibility study does. The appraisal will show market factors including job growth and population trends, but is not often so specific to a project. As an example, a project we provided a USDA Feasibility Study for in Buena Vista, Colorado for a Modular Home Factory was to hire about 200 people in a town with a population of about 3,000 persons. We had to illustrate job creation verses job shifting and how far away job seekers were willing to travel to work each day.
In sum, this short explanation provides some examples concerning why lenders need a feasibility study and not only an appraisal. We are pleased to Zoom with you to answer more questions.
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