I recently looked at a warehouse property that was just purchased for 500k. They only needed 200k. I thought the loan should be a no brainer until I started digging and found out the property was only worth around 200k! How could there be this large of a discrepancy? The appraiser made the most common mistake I see in valuing an industrial building. 5 tips to ensure you don’t make the same mistake.
This begs the question, is all square footage created equal? Does some square footage actually depreciate the value of the property? The broker called me in a panic, how can the property be worth so much less than they paid?
On this particular property, the assessor’s office showed a square footage of 2500 feet, the appraisal showed 5000 square feet. This was an industrial condo so the footprint could not have changed. The difference turns out to be the creation of a mezzanine space. What happened? The purchaser overpaid substantially for the space since they factored in the mezzanine space. Why should you not count mezzanine space?
The appraiser made a very common error. He was giving the same value to ground floor space as mezzanine space. This is very common. I have looked at two properties just this week where the same mistake was made. Why is this an error? Before getting into the actual error, it is important to define what mezzanine space is, if it adds value, and what you should do if looking at a property with a mezz space
What is Mezzanine space?
A mezzanine is an intermediate floor (or floors) in a building which is open to the floor below. It is placed halfway up the wall on a floor which has a ceiling at least twice as high as a floor with minimum height. A mezzanine does not count as one of the floors in a building, and generally does not count in determining maximum floorspace. In essence it is traditionally used in industrial applications to add a second floor while at the same time reducing the height of the first floor. I’ve also seen this occasionally used in retail applications in older buildings with high ceilings
Does Mezzanine space add value?
Mezzanine space should not be counted in floor space when calculating the income or sale approach. The governmental contracting office takes it a step further with their guidance on mezzanine space:
“It is also important to realize that the Warehouse Model only allows for single-floor space, and all space must be on the ground floor. Therefore, any mezzanine or other space not on the ground level will not be counted toward the square and cubic footage. This should not pose a problem, as in most markets mezzanine space is not counted in square footage, regardless of the method of measurement. Lastly, even if mezzanine space is offered free of charge, the Government cannot use it without an elevator to meet accessibility requirements. This will generally not be economically feasible, so any mezzanine space should typically be either demolished or sealed off.” Source: GSA
In essence the mezzanine space adds little value and can actually be a liability for many users. A traditional warehouse user is buying or renting a warehouse for the purpose of a warehouse, if they wanted an office building they would buy an office building.
What should you do when evaluating a property with a mezzanine space?
Factor all mezzanine space out of your calculation. There is little if any incremental value as a result of this space. This space could be considered a nice “bonus” if you have a use but should not be counted like ground floor square footage.
How do you know if you have a mezzanine space? It is readily apparent as soon as you typically go into a building. Look at the ceiling heights and construction. Also if it were intended to be a second story more often than not there would be an elevator for ADA requirements on any newer building.
5 tips to ensure you properly value a building with a mezzanine space.
- Go to the source: i.e. look directly at the county records. For new buildings, many counties have plans, see if you can look at the original building plans to calculate the actual square footage
- Large disconnects are a flag: look at the property history, have there been multiple transactions with increasing prices over a short period? Is the tax assessment drastically different, when you look at prior listings are their differences in square footage?
- Remember all square footage is not equal and mezzanine space should not be counted in ground floor square footage
- Ceiling heights matter: In an industrial setting, min ceiling heights should be 15+ foot clear height, this is drastically reduced with any mezzanine space
- Look at both methods of valuation, look at the sales approach using the ground floor space only. Also look at the income approach, you can look on sites like Loopnet to see what market rents are in the area and use this number to “check” that the sales price is reasonable
Valuing a commercial property is more challenging than a plain vanilla residential property. Many factors must be considered to properly value a commercial building. The above five tips should help ensure that you are not “taken” by an unscrupulous appraisal that makes a very common error.
Sources:
US government contracting office: https://www.gsa.gov/portal/mediaId/191855/fileName/LDG-Chapter21_Warehouse_FINAL_ISSUED_2014-05-05_rc.action
Written by Glen Weinberg, COO/ VP Fairview Commercial Lending. Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in the Colorado Real Estate Journal, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.
Fairview is a hard money lender specializing in private money loans / non-bank real estate loans in Georgia, Colorado, Illinois, and Florida. They are recognized in the industry as the leader in hard money lending with no upfront fees or any other games. Learn more about Hard Money Lending through our free Hard Money Guide. To get started on a loan all they need is their simple one page application (no upfront fees or other games).