3 Myths You Need to Know About CRE Appraisal Reviews

 

Dispelling myths is a concept that modern society is fascinated by. After all, there’s an entire show dedicated to busting these phenomenons. While MountainSeed isn’t taking our myth-busting skills to the airwaves just yet, we are here to dispel some of the common myths associated with commercial reviews and commercial appraisals. Our appraisal management company prides itself on knowing everything we can about appraisal reports and beyond, so we can confidently say we’re debunking commonly held myths one at a time.

Myth #1: In a typical bank review, the reviewer is concurring with, or agreeing with, the value conclusion.

This is not true. According to Richard Sorenson, MAI and author of Appraising the Appraisal: The Art of the Appraisal Review, “The essence of an appraisal review is to investigate, analyze, and verify the logic and procedures used in appraisals, and to ensure the preparation of confident and thorough reports that result in sound value opinions.” He further says, “Ultimately the purpose of an appraisal review is to reinforce the client’s confidence in the credibility of the appraisal and the conclusions it presents.” Simply put, while the appraisal provides an opinion of value, the appraisal review provides an opinion of the quality of the report in question. If the review appraiser agrees, or concurs, with the value in the appraisal, they are performing their own appraisal subject to all of the requirements of Standards 1 and 2 of the Uniform Standards of Professional Appraisal Practice (USPAP). A review, on the other hand, falls under Standard 3, which addresses the appraiser’s responsibilities when reviewing a report. While many banks believe that need a reviewer to concur with the appraiser’s value, what they really need to know is that the original report is credible. If the report is not perfect, what is the extent of the deficiency? When the appraisal review clearly communicates the level of confidence, and the extent of the deficiencies, in the appraisal report, the bank has all the information they need to make an informed decision.

Myth #2: Since the appraiser is an expert in estimating construction costs, they can easily include an “Insurable value,” in the appraisal report.

It is fairly common for financial institutions to request an insurable value (more appropriately called insurable replacement cost) in every appraisal report. On the surface, this appears to be a prudent and savvy practice. The appraisal includes a market value for making the lending decision, and the appraisal includes an insurable value for determining how much property insurance should be set aside to protect the bank’s collateral position. Adding an insurable value doesn’t seem to increase the appraisal fee either! However, a closer look reveals that it may be time for the industry to rethink this practice. Not only does this create a dual purpose appraisal, most financial institutions are unaware that the vast majority of appraisers are not trained in construction. In fact, there is a limiting condition in most appraisal reports that states the appraiser is not a construction expert. Another downfall of this practice is that there is no standard definition of insurable value. If the financial institution does not provide a definition, there will be no consistency from one report to the next. So how should an institution determine the appropriate amount of property insurance? Doesn’t it make more sense to obtain an insurable value estimate directly from an insurance company? Insurance carriers are the ones that will eventually provide the insurance. So why not obtain the estimate directly from one of the providers? Financial institutions should rethink obtaining an insurable value during the appraisal process. If they decide to include an insurable value, it should be a second estimate to test the estimate from the insurance company. Beware of falling into this myth’s trap.

Myth #3: Good quality appraisal reports always include an extensive regional and local market overview.

While the regional and local market discussion may be informative, the appraisal should focus on analyzing the pertinent data that relates to the “appraisal problem.” It is easy to obtain and regurgitate information obtained from demographic or commercial data websites. However, it is the analysis of the data that creates the quality appraisal. Too many appraisals fall short on the analysis. If the appraisal assignment involves a spec office building, then the appraisal problem is determining how long will it take to achieve stabilization. It follows that a significant portion of the appraisal should focus on the pace of the lease-up. What is the current and future office supply? What is the current and future demand? Based on the interaction of this supply/demand of office space, how should a “typical” building lease up? Is the subject property typical? These are the types of questions that, if addressed thoroughly, create a quality report. The inappropriate attention to data, not analysis, ripples through many reports. In the sales comparison approach, what is the current and future demand? Based on the interaction of this supply/demand of office space, how should a “typical” building lease up? Is the subject property typical? These are the types of questions that, if addressed thoroughly, create a quality report. The inappropriate attention to data, not analysis, ripples through many reports. In the sales comparison approach, emphasis is often given to describing the comparables, not explaining their dissimilarities relative to the subject property. In the income capitalization approach, too much time is spent presenting the rent comparables and expenses, not analyzing how they compare to the subject property. Estimating market rent or expenses by selecting a number in the middle of the range is not an appropriate analysis! While it is important to include detailed information in an appraisal report, it is the analysis of the data that creates a quality report. While the regional and local discussion is nice, it is the analysis of the data, focused on the appraisal problem, that creates the quality report. Myth busted!

These common myths surrounding commercial appraisals should make you feel more empowered and confident about what to expect from a commercial review. If you’re looking for even further clarification, let’s talk. We’re happy to walk you through the process even more.