Appraisal Review and Regulatory Issues
in the Current Banking Environment
A Bank Reviewer Appraiser’s Perspective
Topics
• Brief History of Regulatory Environment
• Most impactful issues with the regulations
• “Best Practices” for Compliance
• Appraisal Review
• Specific Examples from Real Appraisals
Brief Regulatory History
• New “Interagency Appraisal & Evaluation
Guidelines” as of December 2, 2010
• Previous guidance issued in 1994 with
updates on specific topics
• 12/2/2010 combines everything and
emphasizes common themes
Important Points
1. Collateral is an important component of credit decision.
2. Independence of persons ordering, performing, and
3.
4.
5.
6.
7.
8.
reviewing appraisals and evaluations.
Focus on appraiser selection based on competency.
Value Definitions and Scenarios.
Expanded Evaluation Requirements.
Appraisal or Evaluation Required?
Depth of Review/Evaluation
Quick Compliance Suggestions
Important Component of Credit Decision
• The collateral valuation program is an
integral component of the credit
underwriting process and, therefore,
should be isolated from influence by the
institution’s loan production staff.
• A review of valuation information is an
essential component of sound credit
administration and is mandated by the
Dodd-Frank Act.
• Reviewing appraisals and evaluations before
engaging in a loan transaction ensures the
value conclusion is reliable and enables
financial institutions to make informed credit
decisions, manage credit risk, and meet
supervisory requirements.
• Loan repayment sources:
1. Borrower
2. Guarantor
3. Collateral
4. Refinance from another lender
Independence of Process
• Appraisers must be independent of the loan
production and collection processes and have
no direct, indirect or prospective interest,
financial or otherwise, in the property or
transaction.
• USPAP requires disclosure
• Interagency Guidelines simply don’t allow it.
Not Independent
Independent
Very Important Thing to Note:
• “Communication between the institution’s
collateral valuation staff and an appraiser
or person performing an evaluation is
essential for the exchange of appropriate
information relative to the valuation
assignment.”
•
Source: Interagency Appraisal & Evaluation Guidelines, Page 21 of 70
• “An institution should not directly or
indirectly coerce, influence or otherwise
encourage an appraiser or a person who
performs an evaluation to misstate or
misrepresent the value of the property.”
•
Source: Interagency Appraisal & Evaluation Guidelines, Page 21 of 70
• After April 1, 2011, an institution must
report non-compliance with USPAP to
state appraiser boards
• Must also file a Suspicious Activity Report
(SAR) with Financial Crimes Enforcement
Network (FinCEN) when suspecting fraud
• Factual errors are major trouble,
differences in opinion are more difficult to
pursue.
Appraisals from Other Financial Institutions
• Appraisal must meet the Bank’s quality standards (and of
course be compliant with USPAP & FIRREA)
• Must be still valid with respect to changes to the property
and market since date of value
• Should confirm:
• Appraiser was engaged directly by the other bank
• Appraiser had no direct, indirect, or prospective interest, financial or
otherwise, in the property or transaction
• Cannot accept readdressed or altered appraisals with
intent to conceal original client
• A borrower can inform the lender that a current
appraisal exists, and the lender may request it
directly from the other institution
• No “assignment letters” for appraisals from other
financial institutions required.
• Appraiser cannot be engaged by borrower.
– Independence is compromised when:
• a borrower recommends an appraiser or person to
perform the evaluation
• loan production staff selects a person to perform
the appraisal or evaluation
Engagement letters
• Provides paper trail.
• Lenders should use written engagement
letters when ordering appraisals, especially
for large, complex or out-of-area commercial
properties.
• Note: Appraisal Institute offers samples.
• Also, appraisers should have their own.
Preparing Customers for Appraisals
 Let customers know:
 An appraiser will be calling them to set up an inspection
 They will request information needed to complete the
assignment, which may include:
 Site plans
 Building plans
 Capital expenditures (in recent years and planned)
 Historical income and expense statements (3 years + YTD)
 Rent rolls
 Leases
 Title work
 Previous appraisals
 Purchase agreement (if applicable)
Expectations for Appraisers
 In most cases, it’s a good idea for appraisers to contact
the customer within a few business days of engagement.
 If they are going to be late, notification to the client should
occur as soon as possible.
 Learn the regulations to add value to your customers, by
catching things that could get them in trouble.
 Value-in-use example.
Resolving Appraisal Deficiencies
• What can and cannot be asked of an appraiser:
• Can: Consider additional info. about the subject or comps
• Can: Provide additional support for the value
• Can: Correct factual errors
• Cannot: Instruct or require the appraiser to make substantial
changes
• If still not resolved, what options do we have?
• Reject the appraisal and order a new one
• Rely on an appraisal review completed by an appropriately
licensed appraiser, that includes a value opinion – must comply
with USPAP Standard 3
• Adjust underwriting criteria
Focus on Competency
• “The person selected possesses the
requisite education, expertise, and
experience to competently complete the
assignment.”
• Source: Interagency Appraisal & Evaluation Guidelines, Page 22 of 70
• Reviewer qualifications
– Not required to be a state licensed or certified
appraiser
– Must be independent and competent
– Let the appraisal stand on its own merit,
aside from the specific qualifications of
the appraiser.
Value Definitions and Scenarios
An appraisal report must:
1. Conform to USPAP.
2. Be written and contain sufficient
information and analysis to support the
institution’s decision to engage in the
transaction.
3. Analyze and report appropriate
deductions and discounts for proposed
construction or renovation, partially
leased buildings, non-market lease terms,
and tract developments with unsold units.
4. Be based on the definition of market
value set forth in the appraisal regulation.
5. Be performed by state licensed or
certified appraisers.
In regards to #4 from Previous Slide:
• Value opinions such as going-concern value, value in
use, or a special value to a specific property user may
not be used as market value for federally related
transactions.
• An appraisal may contain separate opinions of such
values so long as they are clearly identified and disclosed.
• The estimate of market value should consider the real
property’s actual physical condition, use, and zoning as of
the effective date of the appraiser’s opinion of value.
Expanded Evaluation Requirements
• BPO, AEMV, CMA are out, when by
themselves.
• Also, must consider actual physical
condition.
• What is an “evaluation”?
“A valuation permitted by the Agencies’ appraisal
regulations for transactions that qualify for the
appraisal threshold exemption, business loan
exemption, or subsequent transaction
exemption.”
• See page 31 (of 70) of the Interagency Guidelines 12-2010.
How do the various “valuation products” fit into a banks collateral
program?
• BPO, AVM or other methods may be tools used by a bank for
portfolio monitoring, etc.
• BPO’s, AVM’s, etc. cannot be used as an “evaluation” because they
most likely don’t comply with all of the provisions for development
and content of an “evaluation”.
•
AVM or other methods/ technological tools may be used in the
preparation of an “evaluation”, but probably will need additional
information/analysis in order to comply with all of the provisions of
the Guidelines.
• Who can do evaluations?
– Need not be a licensed or certified appraiser,
but must be competent
– When done by an appraiser, USPAP applies.
See Advisory Opinion 13 (2010-11 Edition).
– Also see AI Proposed Guide Note 13
Appraisal or Evaluation Required?
• A Real Estate Evaluation is Required When:
• „A new real estate-related transaction is $250,000 or less,
• „A new real estate-related transaction is a business loan of $1
million or less and the sale of or rental income derived from real
estate is not the primary source of repayment, or
• A real estate-related transaction involves an existing extension of
credit at the lending institution, provided that:
• There has been no obvious and material change in market conditions or
the physical aspects of property that threatens the adequacy of the
institution’s real estate collateral protection after the transaction, even
with the advancement of new monies; or
• There is no advancement of new monies, other than funds necessary to
cover reasonable closing costs.
• A Real Estate Appraisal is Required When:
• „A new real estate-related transaction exceeds $250,000, unless
another exemption applies,
• A lease is the economic equivalent of a purchase or sale of leased
real estate, or
• „The banking supervisor requires an appraisal be obtained.
• A Real Estate Appraisal is Not Required When:
• „A lien on real estate is taken as an “abundance of caution,”
• „A loan is not secured by real estate,
• „A lien has a purpose other than the real estate’s value,
• „A new business loan is $1 million or less and the sale of or rental
income derived from real estate is not the primary source of
repayment, or
• A renewal, refinancing, or other subsequent transaction of an
existing extension of credit where an evaluation is permitted.
Following are Examples of DecisionMaking Process for Appraisal/Evaluations
(There are separate handouts that show them in bigger font)
Is the loan amount
$250,000 or greater?
APPRAISAL/EVALUATION REQUIREMENT DECISION TREE - NEW CREDITS
Yes
No
Does Transaction Amount
Exceed Supervisory LTV?
Yes
Transaction Amount less than
$1,000,000, for Owner
Occupant, and not dependent
on sale/rental income from
property?
Real Estate Taken as
Abundance of Caution?
No
Is the borrower a high risk
customer (Rated 6 or worse?
Yes
Yes
No
Yes
No
Yes
No
Yes
Is the property outside of the
Trade Area (7 County Metro)?
Is the property outside of the
Trade Area (7 County Metro)?
No
No
Is the subject an atypical
property type?**
Is the subject an atypical
property type?**
No
No
Internal Evaluation Required
Third Party Restricted Use
Appraisal Required
Appraisal Required
Lien unrelated to subject
property's value (e.g. to secure
access to non-real estate
collateral?
Yes
No
Is a Credit Decision Being
made?
No
APPRAISAL/EVALUATION REQUIREMENT DECISION TREE - EXISTING CREDITS
Validation of Prior
Appraisal/Evaluation Allowed
Yes
Does Transaction Amount
Exceed Supervisory LTV?
Yes
No
Is any New Money being
advanced?
Yes
Transaction Amount less than
$1,000,000, for Owner
Occupant, and not dependent
on sale/rental income from
property?
Real Estate Taken as
Abundance of Caution?
No
Is the borrower a high risk
customer (Rated 6 or worse)?
Yes
Yes
No
Yes
No
Yes
No
Has there been any obvious
material changes in the market or
the subject property?
Yes
No
Yes
Is the property outside of the
Trade Area (7 County Metro)?
Is the property outside of the
Trade Area (7 County Metro)?
No
No
Is the subject an atypical
property type?**
Is the subject an atypical
property type?**
No
No
Internal Evaluation Required
Third Party Restricted Use
Appraisal Required
Appraisal Required
Lien unrelated to subject
property's value (e.g. to secure
access to non-real estate
collateral?
Yes
No
Depth of Review/Evaluation –
Should be Prioritized by Risk
• “The institution should consider the risk, size, and
complexity of the transaction and the real estate collateral
when determining the appraisal report format to be
specified in its appraisal engagement instructions to an
appraiser.”
• See page 28 (of 70) of the Interagency Guidelines 12-
2010.
• Although the Agencies’ appraisal regulations allow an
institution to use an evaluation for certain transactions, an
institution should establish policies and procedures for
determining when to obtain an appraisal for such
transactions. For example, an institution should consider
obtaining an appraisal as an institution’s portfolio risk
increases or for higher risk real estate-related financial
transactions, such as those involving:
• Loans with combined loan-to-value ratios in excess of the supervisory
•
•
•
•
loan-to-value limits.
Atypical properties.
Properties outside the institution’s traditional lending market.
Transactions involving existing extensions of credit with significant risk
to the institution.
Borrowers with high risk characteristics.
Quick Suggestions:
• Can’t afford to have staff appraisers?
• Outsource at least some reviews – maybe the most complex
•
•
•
•
•
•
properties.
Outsource some evaluations as well.
Don’t use same appraisers multiple times on the same
property year after year.
Don’t be penny-wise and pound-foolish. You get what you
pay for.
Leverage your appraisers for data and information.
Make it a standard practice to bounce questions off other
qualified appraisers – but keep it confidential.
Rate appraisers for timeliness, quality and responsiveness.
Appraisal Review
• How bank reviewers are scrutinizing collateral
• Real vs. Theoretical
• In-place vs. Proforma
• Provide useful data (not just opinion)
• Convince me.
• Why banks are scrutinizing collateral
• Primarily regulatory and accounting reasons
• Some genuinely care about the collateral component to
their loan.
Appraisal Review
• Of course, there are those banks out there who
are in “Extend and Pretend” mode, trying to rideout the storm until things calm down.
• A low appraised value, even if it is undisputable, can
cause the bank to incur a write-down, and impact
capital reserves.
• To avoid this, they will:
• Delay getting new appraisals as long as possible
• Go back to an original appraiser who appraised it in the
peak of the market.
• Look for less experienced, less competent appraisers who
are hungry for work.
Appraisal Review
• Errors in appraisals can be from:
• Time/effort issues
• Not enough fee
• Not enough time (client or appraiser’s fault)
• Competency - very tricky
• Ethical lapses – usually involves some kind of
coordination/cooperation with lender,
consciously or subconsciously.
• Suggestions:
• Read the appraisal, follow the logic.
• Check the math (at least the most important
sections).
• Tests of reasonableness.
• Watch out for giant leaps in assumptions.
• Think about it as if you were going to buy the
property.
• Who knows, as a lender, you may end up owning
it one day…
• General Warning Signs:
• Spelling/formatting errors
• Leaps of faith
• Core assumptions at extreme ends of a range
• Questionable or insufficient comp data
• Presence of “hedging” words (e.g. “say…”)
• Contradictory logic
• Failure to apply tests of reasonableness
• Value equal to, or exceed costs?
• Value reconciled w/current or historic selling/listing
activity?
• Market Analysis section Red Flags
• Meaningful or meaningless?
• Market participant interviews?
• Request that the appraiser include a section
of the report summarizing interviews of
market participants (realtors/brokers,
developers, city officials, etc.) about not only
the market in general for the subject property
type, but also the specific marketability of the
subject property itself.
• Information related directly to the subject
property?
• Important to be bouncing ideas off other market
participants, including other appraisers, to make
sure they aren’t missing anything.
• To a certain extent, appraising consists of
consensus building, between the appraiser, the
client, and also brokers, developers, borrowers,
etc.
• Cost Approach Red Flags
• Replacement Cost - does it appear reasonable?
• Depreciation – have all forms been accounted for?
• Physical (age)
• Functional (over- or under-improvement)
• External (market forces)
• Entrepreneurial Incentive – is it included? Is it
adequate?
• Without it, why would anyone build it?
• In current market, very rare that cost equals value.
• Sales Comparison Approach Red Flags
• Arbitrary, unless there are “smoking gun” comps.
• Pay attention to range of sale prices per unit (both
unadjusted and adjusted).
• The target should most often harden.
• Use of old, incompletely reported, poorly analyzed
or not truly comparable sales.
• Dramatically different tenant profiles.
• Fee Simple vs. Leased Fee
• Inconsistency in adjustments.
• Income Approach Red Flags
• Direct Capitalization vs. Discounted Cash Flow.
• Stabilized Income vs. Non-Stabilized Income.
• Rate = Risk
• Fee Simple vs. Leased Fee
• Which represents the true “as-is” value of the
subject property?
• Considerations for above- or below-market contract
rent?
• Asking Rents vs. Actual Lease Comps
• Full burden of expenses shown?
• Reconciliation Section Red Flags
• Should lead reader to conclusion.
• Watch for inconsistencies in approaches to value.
• They should rarely be that far off.
• If they are, then there should be a logical,
reasonable explanation.
Examples from Real Appraisals
Example 1
• Summary of Three Approaches to Value for a
purchase of an existing, fully functional retail
building, to be renovated for a unique, special use:
• Cost Approach - $865,000 ($192.22/SF of GBA)
• Sales Comparison Approach - $860,000 ($191.11/SF)
• Income Approach - $635,000 ($141.11/SF)
• Final value conclusion - $860,000 ($191.11/SF)
• FYI, total project cost = $862,050
• Of which, $327,080 is renovation costs.
• Or is it $202,000?
Example 1
• Summary of Three Approaches to Value for a
purchase of an existing, fully functional retail
building, to be renovated for a unique, special use:
• Cost Approach - $865,000 ($192.22/SF of GBA)
• Sales Comparison Approach - $860,000 ($191.11/SF)
• Income Approach - $635,000 ($141.11/SF)
• Final value conclusion - $860,000 ($191.11/SF)
• FYI, total project cost = $862,050
• Of which, $327,080 is renovation costs.
• Or is it $202,000?
Example 1, continued
• Cost Approach
• Cost up as the special use (“as-completed”
condition), but then 100% of renovation
costs were added on top.
• There were conflicting amounts for
renovation costs.
• Actual costs from construction bid lower.
• Functional and external obsolescence not
shown in report.
Example 1, continued
Cost Approach
Source = Marshall Valuation
Classification
Section/Page
Class C - Average
Base Cost
Building (shell)
Heating/Cooling Adjustment
Additional soft cost
Entrepreneurial Profit
Replacement Cost
Adjustment Factors
Perimeter Adjustment
Market Conditions
Location
Architectural
Entrepreneurial
Total Adjustments
0.975
1.020
1.180
1.064
1.000
1.239
Adjusted Replacement Cost
Cost
$317,070
$22,500
$45,000
$45,000
$429,570
$532,237
Example 1, continued
Cost Summary
Shell Cost
Renovation
Less Depreciation
$532,237
$327,080
Age/Life, 10/70 14.30% -$122,882
Depreciated Cost
$736,435
Value Indication
$736,435
Site Value
$190,000
Value Indication via Cost Approach
$925,000
• 100% of Renovation Costs Added to Replacement Cost New.
• No functional or external obsolescence addressed.
Example 1, continued
• Actual Construction Bid is Lower:
Actual Construction Bid
Acquisition
Renovation
Contingency 5%
Sac/Wac
Total
Total/SF
$535,000
$202,000
$36,850
$88,200
$862,050
$191.57
Example 1, continued
• Sales Comparison Approach:
• Again, Functional and external obsolescence
not considered/shown in report.
• Are there any considerations for overimprovement of an existing market-standard
property for a special use?
• External obsolescence present in current
market?
• Is it reasonable to add 100% of renovation
costs on top of “as-is” sales comparison
approach conclusion?
Example 1, continued
Abbreviated for this presentation:
Comparable Sales
Sale 1
Sale 2
Sale 3 (Pending)
Net % Adjustments
Indicated Value
Indication "As-Is"
-15.00%
$119.00
$535,500
-15.00%
$118.06
$531,250
-25.00%
$123.59
$556,146
Cost to Convert
$325,000
$860,619
$860,000
$325,000
$856,368
$855,000
$325,000
$881,269
$880,000
Rounded
Example 1, continued
• Income Approach:
• Can you follow the logic, or is it leap of
faith assumption?
• Interpretation of breakeven rent
analysis?
• Any larger implications relative to other
approaches to value?
Example 1, continued
Breakeven Rent Analysis
Project Cost
$862,500
Overall Rate:
0.0871
Required Net Income:
$75,124
Required Net/SF:
$16.69
Net from tenant space:
$13,500
Net from main space:
$61,623.75
Net required/SF:
$19.04
Example 1, continued
• Market Rent Conclusion, however, is $12.17
per square foot (on a blended basis).
• Appraisal report asserts that “the difference
between the net rent conclusion and
breakeven is significant. The calculation
demonstrates that owner occupancy is
more feasible than rental.”
• Is that reasonable?
Example 1
• Summary of Three Approaches to Value for a purchase of
an existing, fully functional retail building, to be renovated
for a unique, special use:
•
•
•
•
Cost Approach - $865,000 ($192.22/SF of GBA)
Sales Comparison Approach - $860,000 ($191.11/SF)
Income Approach - $635,000 ($141.11/SF)
Final value conclusion - $860,000 ($191.11/SF)
• As a percentage, is this significant? What’s a typical LTV?
• FYI, total project cost = $862,050
• Of which, supposedly $327,080 is renovation
• Or is it $202,000?
Example 2
• “Self-Contained” appraisal report
• Multi-tenant, partially owner-occupied industrial
property.
• No breakdown of individual tenant spaces, nor
office/warehouse percentages.
• Current vacancy 21-28% - as derived by
reviewer.
• Effective date of mid-2010.
From the market analysis section:
• “Unemployment is historically low. It was
4.5% in January 2008 – nearly a full point
below the national average of 5.4%.
• “Median Family income was $66,809 in
2006…”
• “The median price of Twin Cities homes sold
in 2007 was $225,000”
The entire income approach – recreated for this presentation:
Some excerpts:
• “The appraisers’ calculate the
anticipated benefits (cash flows
and reversion) into property
value…” – Though only Direct
Capitalization applied.
• “market rents has been obtained
from the appraisers’ records and
from other sources such as
MNCAR, Colliers, Turley, Martin
and Tucker.”
Example 2, continued
• Ah, the old, one-page Income Approach.
• Mentions that part of the fourth unit is vacant, and all of
•
•
•
•
the fifth, but doesn’t tell us how much space that is and
what impact it could have.
Turns out it is most likely something around 21-28%.
Appraiser uses 11% vacancy and collection loss – is this
reasonable?
No rent comp information.
No expense analysis.
Example 3
• Failed residential condominium development
• Approximately 10% of units sold
• Construction not yet completed
• Regulations regarding “Tract Developments”
apply (See Appendix C of Interagency
Guidelines).
• “Appraisals for these properties must reflect deductions and
discounts for holding costs, marketing costs, and entrepreneurial
profit supported by market data.”
Example 3, continued
Report states that the value scenarios will be:
1) Estimate the “as-completed” value of the condo units
2) Estimate the “as-is” value of the condo units; the cost to
complete the units and the common elements is known.
3) Discount the retail sales estimate to present value based on
current supply and demand in this market.
Are these the appropriate value scenarios?
Example 3, continued
Floor
First
Second
Third
Value Per
SF
"As-Completed" Summary
Aggregate Unit
# of Units
Square Footage
N/A
N/A
N/A
Aggregate
Value
$4,220,580
$5,135,904
$4,770,484
Total: $14,126,968
Rounded to: $14,130,000
*Floor height adjustment of 3% per floor.
• This is essentially the “Gross Retail” value, or the sum of the retail
values of the individual units, once completed.
• As a side note, this amount was greater than the sum of the list prices
of the units at the time.
Example 3, continued
Completion Cost
Cost Per
Type
Line Item
Models
$11,000
Office Unit
$25,500
Incomplete Units
$2,366,000
Total Unsold Units
$2,402,500
Contingency (10%)
10%
Total Cost $2,642,750
Rounded
$2,640,000
Example 3, continued
As-Completed Market Value
$14,130,000
Less: Cost to Complete
$2,640,000
As-Is Market Value
$11,490,000
Rounded
$11,490,000
Example 3, continued
“Consideration of a discount is required by both USPAP and OCC 94/55
when the marketing/holding period of a property is forecast to exceed one
year. Given the timing of the development, a discount to present value is
appropriate. Theoretically, sales should accelerate once the common
elements are complete and occupancy increases. A compounding discount
rate of 5% is used to discount the retail sale estimate. In essence, the sales
per square foot in the third year are discounted 15%. The discount accounts
for holding costs (taxes, insurance, etc.) during the sellout period. The first
table below summarizes the allocation. The remaining charts reflect the
discounting process.”
Example 3, continued
Year 1
Floor #
One
Two
Three
Year 2
Floor #
One
Two
Three
Year 3
Floor #
One
Two
Three
Value per
SF
Aggregate
Present
Unit SF
Value
Value Factor
$1,406,860
$1,712,160
$1,590,112
Value per
SF
$1,339,867
$1,630,629
$1,514,392
$4,484,888
Aggregate
Present
Discounted
Unit SF
Value
Value Factor Value @ 10%
$1,406,860
$1,712,160
$1,590,112
Value per
SF
0.952381
0.952381
0.952381
Total
Discounted
Value @ 5%
0.907029
0.907029
0.907029
Total
$1,276,063
$1,552,979
$1,442,278
$4,271,319
Aggregate
Present
Discounted
Unit SF
Value
Value Factor Value @ 15%
$1,406,860
$1,712,160
$1,590,112
0.863838
0.863838
0.863838
Total
$1,215,299
$1,478,531
$1,373,727
$4,067,557
Example 3, continued
Summary
Year 1
Year 2
Year 3
Discounted Value
Rounded to
$4,484,888
$4,271,319
$4,067,557
$12,823,765
$12,820,000
Example 3, continued
• Holding Costs, Marketing Costs and Entrepreneurial Profit
• Actual signed listing agreement, included 7% market fees
on all units sold.
• The first year of the appraiser’s discounting process only
deducts 5% total, and only for the 1/3 of the units he
allocates during that year.
• If marketing costs aren’t even covered, what about all real estate
taxes for the unsold units, entrepreneurial profit? Construction
costs?
• How much profit would be required for a project like this?
• What is Statement 2 in USPAP about?
• The misuse of the DCF?
• Now which value are we supposed to use?
Example 3, continued
As-Completed Market Value
$14,130,000
Less: Cost to Complete
$2,640,000
As-Is Market Value
$11,490,000
Rounded
$11,490,000
Summary
Year 1
Year 2
Year 3
Discounted Value
Rounded to
$4,484,888
$4,271,319
$4,067,557
$12,823,765
$12,820,000
Example 3, continued
• DCF from subsequent appraisal from a different appraiser:
25%
Example 3, continued
• FYI, the equivalent annual discounts are as
follows:
• Year 1 – 30.7%
• Year 2 – 41.42%
• Year 3 – 52.78%
Example 3, continued
Example 4
• Vacant residential and commercial
land in rural Wisconsin.
• First, the residential land:
Example 4, continued
Abbreviated for this presentation:
Land Sales Adjustment Summary
Location Adjustment
0%
Size Adjustment
0%
Net Adjustment
0%
Adjusted Sale Price:
$240,000
/Acre
$3,310.34
Minimum per Acre (adjusted):
Maximum per Acre (adjusted):
Average per Acre (adjusted):
Concluded Value per Acre:
5%
-5%
0%
$55,290
$3,668.88
0%
-5%
-5%
$64,173
$6,755.00
$2,592.00
$9,052.58
$4,388.00
$4,500.00
5%
0%
5%
$90,720
$2,592.00
0%
-5%
-5%
$59,323
$6,881.99
5%
0%
5%
$170,100
$2,835.00
0%
-5%
-5%
$127,823
$9,052.58
Example 4, continued
• Adjustments are applied to Gross Sale Price, which
•
•
•
•
•
usually only works if the comps are really good.
How about the range in adjusted values?
Grouping of comps by site size shows two clear groups,
one small and one large (subject fits in the large group).
The small site size comps have much higher per acre sale
prices than the larger comps (65% difference).
No adjustment is greater than +/-5% for site size though.
Then it appears that a rounded average of all the comps
is used, even though the subject is clearly part of the
larger site size group.
Example 4, continued
Subject is
52.43 acres
Example 4, continued
Sale/List Price per Acre - Organized by Site Size:
Sale/List Price
Comparable # Sale/List Price Total Acres
per Acre
5
$69,000
8.62
$8,005
3
$70,000
9.5
$7,368
7 (Listing)
$149,500
14.12
$10,588
2
$57,000
15.07
$3,782
4
$90,000
35
$2,571
6
$180,000
60
$3,000
1
$250,000
72.5
$3,448
Subject
N/A
52.43
N/A
Average of 3 Smallest Comps (Site Size):
$8,654
Average of 3 Largest Comps (Site Size):
$3,007
% Difference Smallest to Largest Averages:
65.26%
Example 4, continued
• Next, the commercial land:
Example 4, continued
Commercial Land Sales Adjustment Summary
Sale Date
Nov-10
Aug-08
Unadjusted Sale Price per SF
$0.51
$1.09
Property Rights Conveyed
0%
0%
Financing
47%
0%
Conditions of Sale
0%
0%
Expenditures After Purchase
0%
0%
Time/Market Conditions
-5%
-14%
Location Adjustment
0%
0%
Size Adjustment
0%
-5%
Visibility
0%
0%
Zoning
0%
0%
Net Adjustment
0%
-5%
/SF
$1.04
$0.89
Minimum per Acre (adjusted):
Maximum per Acre (adjusted):
Average per Acre (adjusted):
Concluded Value per Acre:
Feb-08 Listing
$0.62
$1.92
0%
0%
0%
0%
0%
-10%
0%
0%
-16%
0%
0%
0%
-5%
0%
0%
0%
15%
0%
10%
0%
$0.57
$1.73
$0.57
$1.73
$1.06
$1.00
Example 4, continued
• Range of adjusted sale prices per SF:
• $1.04, $0.89, $0.57 (for the three closed sales)
• $1.73 for the active listing
• Don’t be fooled by the per SF analysis – doesn’t sound
like a large difference when talking about a span of $0.50.
• Remember that it’s per square foot. What is it as a
percentage?
• Why the range?
Example 4, continued
Clue from comp 1 write-up:
Comments: Property was acquired by the village from XXXXXX who defaulted
on a deed. The village then turned around and sold the parcel to XXXX for
$43,600 which included TIFF incentives. The village clerk mentioned that the
board estimated that the market value of the land with the TIFF contribution was
estimated at $1.09/SF.
Example 4, continued
Clue from comp 1 write-up:
Comments: Property was acquired by the village from XXXXXX who defaulted
on a deed. The village then turned around and sold the parcel to XXXX for
$43,600 which included TIFF incentives. The village clerk mentioned that the
board estimated that the market value of the land with the TIFF contribution was
estimated at $1.09/SF.
Example 4, continued
Commercial Land Sales Adjustment Summary
Sale Date
Nov-10
Unadjusted Sale Price per SF
$0.51
Property Rights Conveyed
0%
Financing
47%
Conditions of Sale
0%
Expenditures After Purchase
0%
Time/Market Conditions
-5%
Location Adjustment
0%
Size Adjustment
0%
Visibility
0%
Zoning
0%
Net Adjustment
0%
/SF
$1.04
Minimum per Acre (adjusted):
Maximum per Acre (adjusted):
Average per Acre (adjusted):
Concluded Value per Acre:
Aug-08
$1.09
0%
0%
0%
0%
-14%
0%
-5%
0%
0%
-5%
$0.89
Feb-08 Listing
$0.62
$1.92
0%
0%
0%
0%
0%
-10%
0%
0%
-16%
0%
0%
0%
-5%
0%
0%
0%
15%
0%
10%
0%
$0.57
$1.73
$0.57
$1.73
$1.06
$1.00
Example 4, continued
• First, the math on this adjustment. How does a positive
adjustment of 47%, plus then a negative adjustment of
5% turn $0.51/SF into $1.04?
• Also, what about the impact of Tax Increment Financing
on a sale price of a comp?
• What are the terms, and who benefits from the TIF?
• In this case, the buyer got the land for free, and got his
entire site improvement costs covered.
• Which direction should that adjustment be?
Example 5
• Large apartment complex
• No renovation project or stabilization
component part of analysis
• Summary of historical NOI and appraiser’s
forecast summarized in table below:
Net Operating Income:
2006
2007
2008
2009
2010
Appraiser's
Proforma
$173,102
$343,078
$351,783
$272,937
$200,989
$504,587
Example 6
• New construction office/warehouse property
• Land Value Conclusion - $1,000,000
• Final Value Conclusion - $2,435,000
Example 6, continued
Where does the extra $300,000 come from?
Example 6, continued
Range of Sale Price per SF of GBA - Improved Sales:
1
2
3
Unadjusted
$57.87 $104.96
$53.83
Net Adjustments
47%
-17%
59%
Adjusted
$85.07
$87.12
$85.59
4
$67.32
35%
$90.88
5
$41.38
90%
$78.62
• Comp 2 is an office/tech condo, with 80% office finish.
• Subject is not a condo, and has only 16% office finish.
Example 7
• Industrial building, three spaces, two currently leased.
• Engagement letter asked for Leased Fee analysis.
• Good example of what reviewers are looking for these
days.
Example 7, continued
“The third tenant is leased on a month-to-month basis, which expires May 31,
2013.”
Example 7, continued
• Rent comps less than compelling.
• Wide unadjusted range of rents - $5.58 NNN for office
warehouse w/20% finish, $7.19 NNN for a “distribution
center” with 5% office finish, $8.00 Gross for office
warehouse w/58% finish.
• No lease start dates, although one rent comp had expired
in 2010, another one expires/d in 2012, and another one
expires in 2014, which at least suggests that they must
not be too recent indications.
• Report says rents haven’t changed, but doesn’t include
any real way to prove that.
Example 7, continued
• Adjusted range of rent comps was $5.12 to $5.64 on a net
•
•
•
•
•
basis.
Appraiser concludes to market rent of $5.20.
Then applies this market rent to the entire space, as if it
were a fee simple analysis.
Resulting Potential Gross Rent is $129,064, on a net
basis.
Actual Contract Rent is $95,795, on a net, modified gross
and gross basis.
The largest tenant is paying on a Gross basis, and in
total, over 60+% of the total space is paying less than full
expenses.
Example 7, continued
• If evidence were so compelling that contract rent was
below market:
• Why hasn’t the landlord increased rents?
• What has the appraiser assumed by doing it this way?
• Current tenants are actually paying this higher rate already?
• A potential buyer would be able to walk right in and increase the rents
immediately?
• If one of the tenants was not willing to pay, and vacated the space, are
there other tenants lined up to fill the space at the higher rent?
• Who should be taking this risk? The lender? The equity position?
• Would the cap rate change at all given the below market rents?
Example 7, continued
• One last thing to note on this deal:
• Appraiser had full historical income and expense information for the
subject property for the three most recent years.
• Yet, in the income/expense reconstruction section, they were not
included.
Example 7, continued
Potential Gross Income
18,520 SF
6,300 SF
x
x
$5.20
$5.20
=
=
$96,304
$32,760
Total Potential Gross Income
$129,064
Less Vacancy & Collection Loss @
8%
-$10,325
Effective Gross Income:
$118,739
Less: Operating Expenses
Management Expenses (3%)
$118,739
Vacancy Expenses
Reserves for Replacement
x
3%
8%
=
=
=
$3,562
$6,453
$8,687
-$18,702
$100,037
Indicated As Is Market Value
Indicated As Is Market Value
$100,037
$100,037
8.00% =
8.50% =
$1,250,463
$1,176,906
Example 7, continued
• The Appraisal of Real Estate, 13th Edition, pages 466,
482-492,496 & 498.
• On page 483, potential gross income comprises:
• Rent for all space in the property—e.g., contract rent for current
leases, market rent for vacant or owner-occupied space,
percentage and overage rent for retail properties
• Rent from escalation clauses
• Reimbursement income (emphasis added)
• All other forms of income to the real property…
Example 7, continued
• On page 484, operating expenses comprised of:
• Fixed expenses
• Variable expenses
• Replacement allowance
• It is extremely helpful to the reviewer if a full burden
of expenses is shown. Especially if an appraiser is
provided the historical data.
• It makes it easier for the reviewer to
validate/invalidate your assumptions when there’s
adequate detail presented.
Example 8
• New construction office building in an area where most properties are
50-60 years old at least.
• Appraisal report showed market rents equal to the breakeven rent.
Rent comps from other areas.
• Market rent was concluded to be $22 per square foot on a net basis.
• 2% vacancy and collection loss applied.
• Capitalized land-only real estate taxes, but states in the report:
• “as the property becomes fully assessed the tax load will increase significantly.”
• Concluded value was equal to the construction costs - $1,400,000.
Example 8, continued
• Actual contract rent turns out to be $16 on a gross basis.
• Actual vacancy is 20%.
• Actual operating expenses turn out to be triple what the
original appraiser had estimated.
• Subsequent re-appraisal of the leased fee interest -
$500,000 value conclusion.
Example 8, continued
• In between the original appraisal and the new one, the bank had
requested that an appraiser take a look at the situation.
• In a letter to the bank, not an appraisal, the appraiser stated, among
other things, the following:
• “Based on my brief investigation of the property and conditions under
which it is currently leased, I believe that it is reasonable to assume
that the property is likely to fall into a value range somewhere
between $750,000 and $900,000.”
• “I of course cannot provide you with an estimate of market value for
this property without going through all the proper and accepted
appraisal practices and protocol required to do so.”
Example 8, continued
• “Based on my brief investigation of the property
and conditions under which it is currently leased, I
believe that it is reasonable to assume that the
property is likely to fall into a value range
somewhere between $750,000 and $900,000.”
• That’s seven hedging words in one sentence.
Example 9
• An appraisal review ordered by a participant bank (who
was in Extend and Pretend mode).
• Commercial land in outlying area.
• Massively oversupplied submarket.
• Zero new development in past couple years.
• Zero land sales in immediate area for past two years, despite
significant listing price reductions.
• Over 30+ active listings of competing commercial land within 2
miles of subject.
Example 9, continued
• From the review:
• “The appraisers discuss the currently offered listings in
the area and describe a range from $8.00 to $25.00 per
square foot. The subject is listed for $8.50 per square
foot. In other words, brokers in this market believe the
inherent value of land in this market area is $8.00 to less
than $25 per square foot.”
• Is that true? Is that what the brokers believe?
Example 9, continued
• From the review:
• “The appraisers assert that the highest and best [use] is commercial
development, but that the absorption period could be 3 to 5
years…The appraisers indicate that the marketing/exposure period
for the property is 6 to 12 months.”
• “The Interagency Guideline [sic] requires that the appraiser consider if
a discount for absorption holding cost or incomplete construction is
needed. While there is no market basis for the discount, it is common
to apply a percentage that equals the holding cost for a portion of the
absorption period. This does not mimic the behavior of a typical
developer, who would pay the required price and figure the added
cost into the final product. In this case, the appraisers avoid this
issue by selecting a marketing period of less than 1 year (although
this contradicts the 3 to 5 year absorption).”
Example 9, continued
• Is development timing the same thing as
marketing and exposure period?
• Is it reasonable to say that a typical developer
would “pay the required price and figure the
added cost into the final product”?
• Another way of asking that is, do developer’s
have complete control over what they can get for
the “final product”?
Example 9, continued
• From the review:
• “The quality of the…sales comparison approach is average.
Five sales are presented; none are from the competitive market
area…”
• “The preadjusted range is from $4.72 to $7.10 per square foot.”
• “The net adjustments range from -10% to -25%, and each sale
is adjusted downward on a net basis.”
• The appraiser had concluded $4.50 per square foot, based
primarily on the rough market conditions and oversupply.
Example 9, continued
• The reviewer did their own search for comps:
• “A data search of land sales in XXXXX, YYYYY and
ZZZZZ counties revealed 25 sales. Further refining the
data set resulted in an alternate data of five sales. The
sales ranged from $6.68 to $9.36 per square foot. All five
closed during 20XX. All five are zoned for commercial
use. The alternate data set is closer physically
[proximity]…”
• No other information on the reviewer’s comp set provided.
Example 9, continued
• “In summary, three items contradict the appraiser’s conclusions.
First, the assessor values the property at $7.72 per square foot.
Second, the current listing at $8.50 and other listings in the
neighborhood from $8 to $25 per square foot contradict the
appraiser’s conclusion. Lastly, the alternate data set ranging from
$6.68 to $9.36 supports a value closer to the listing.”
• The subject had been listed for $7.87 per square foot for two years,
the broker reporting zero interest at that price.
• The subject has since been listed at $5.00 per square foot for over a
year, still with no interest.
Example 10
• Land appraisal
• Subject was 100% usable (no
wetlands, steep slopes, etc.)
• No adjustments made to Comp 2,
but…
Example 10, continued
Example 11
• “Test of Reasonableness”
• Subject is a busted condo development (24 units)
• Appraiser was asked to re-appraise one year after first
appraisal
• 1st appraisal, he projected an absorption rate of 6 units per year
• 0 units sold between 1st and 2nd appraisal
• Absorption rate projected in 2nd appraisal?
• …6 units per year.
• Doesn’t mean that it’s wrong, just that it will take more
convincing the second time around.
Example 12
• What about expenses on vacant space?
Potential Gross Income
Net Rent
25,000 SF
X
$
6.00 = $
150,000
$
150,000
$
30,000
Effective Gross Income
$
120,000
Operating Expense
"Typical Net Lease"
Reserves for Replacement
Management
$
$
$
2,400
6,000
$
111,600
Total Income
Less Vacancy & Collection Loss
Net Income
20%
2%
5%
Example 13
• Small multi-tenant retail building appraisal
• Appraiser only viewed a rent roll, not actual
leases
• Appraiser assumed all leases were gross terms
• Leases were actually structured in several ways;
net, gross, and semi-gross
• Property was under-valued
Example 14
• The lack of an adjustment IS an adjustment.
• Property was residential development land.
• Effective date was October 2009.
Transaction Date:
Market Conditions
Adjustment:
Sale 1
Sale 2
Sale 3
Jul-08
Aug-07
Feb-08
15 Months
24 Months
20 Months
Sale 1
Sale 2
Sale 3
0%
0%
0%
Example 14, continued
• When did the Credit Crisis occur?
• August/September 2008?
• The sales are from before then.
• How could Market Conditions adjustments be supported?
• MLS data
• Building permit data
• Broker interviews and market reports
• Market participate interviews (i.e. sellers and buyers)
• Analyzing the change in lending conditions
• Other ways?
Questions