Commercial appraisers, who did record business during the sales binge of 2007, are once again seeing a spike in business. This time around, the traffic is coming from lenders holding debt on shaky commercial properties.
“Loan delinquencies are up exponentially,” said Karen Hanlon, an appraiser at Colliers Meredith & Grew. The feeling in the industry is “there’s a tidal wave [of defaults] coming,” she said.
When lenders are deciding between working out a defaulted loan and taking a property back through foreclosure, they’ll normally start with an appraisal. Lenders are looking to quantify how much a borrower’s property might fetch on the market, and how badly underwater loans are.
“In a short amount of time, there may not be enough MAIs to handle the work,” Hanlon added.
Webster Collins, an appraiser at CB Richard Ellis, said his department is suddenly very busy, with a work backlog of three to four weeks. That’s a marked change from the past 12-18 months. In 2008, he said, work was off 22 percent, and 2009 began another 20 percent below that.
“Since then, it’s started to come back strongly,” he said. “We’re seeing portfolios from lenders and bankruptcy courts. There’s been a huge increase in recent business as a result of the downturn in the economy.”
A potentially troubling pattern is developing, though. Appraisers are seeing plenty of traffic from traditional lenders like banks and insurance companies, but comparatively little from the servicers of commercial mortgage-backed securities (CMBS), which hold a substantial slice of commercial mortgage market share.
“The last [downturn], we sat by the fax machines, and the appraisal orders came in faster than we knew what to do with them,” said Steven Foster, an appraiser at Lincoln Property Co., referring to the blitz of appraisal orders that poured in during the early 1990s.
The difference in volume, he believes, is because “CMBS wasn’t around. We know the problem exists. So why aren’t we seeing more of it?”
CMBS represented a massive segment of the commercial lending market, accounting for $707 billion in debt issued from 2004-2008, according to figures from the Commercial Mortgage Securities Association.
Now, huge chunks of that debt are tumbling into trouble. A recent Deutsche Bank report found the face value of securitized commercial loans in special servicing is nearly triple what it was a year ago. Fitch Ratings expects the overall CBMS default rate to exceed 5 percent by the end of 2009.
Many real estate professionals have joked that the typical CMBS loan originator didn’t pay particularly close attention to appraisals when packaging mortgages during the market’s massive surge upward, so appraisers shouldn’t waste time waiting by the phone now. Collins is hearing that some special servicers have taken to calling local brokers, asking them to handicap cap rates and probable sales prices.
“The problem we’re seeing is, when we are asked to look at something, the errors we’re finding are huge,” he said.
If servicers are relying on their internal numbers, “They’re making decisions blind,” Collins argued. “And they might have to take a discount to compensate for those errors.”
Even as commercial appraisers’ business picks up, their jobs have become more complicated. The upheaval in the credit markets has all but shut off commercial property sales, leaving buildings incredibly difficult to value. Most local real estate executives are working off an assumption that values have declined anywhere from 20 percent to 40 percent. However, a 20 percent to 40 percent haircut is little more than a guess, said Mary Sullivan Kelly, director of research at Colliers Meredith & Grew.
“None of it’s based on data,” she said, as the market hasn’t logged any “real price-clearing transactions.”
Foster said that, in the absence of sales data, appraisers are drilling into rental streams.
“Investment properties still have income, leases, cap rates and mortgage rates. You can still take the components and get to a reasonable value.”
The trick is that rental rates are falling, and income that is coming in from peak-market deals will burn off. Appraisers are loath to capitalize above-market income, and that’s driving down the value of non-distressed assets, to owners’ chagrin.
Another area of concern is the “quality of the income stream,” said John Fowler, executive managing director of the commercial finance firm Holliday Fenoglio Fowler LP.
“You have to assess the quality of the tenancy. If you’ve got six law firms, one of them’s going down. If the income stream is stressed, you’ve got to discount that.”
Fluctuations in cap rates are also causing havoc.
“There’s been a major change in cap rates,” Collins said. “If you take a hypothetical building, the rents are down 20 percent and the cap rate is up 30 percent, so the values are basically cut in half.”
Foster said: “If the cap rate changes from 8 to a 10, the value’s down 25 percent, even if the income’s the same. If you borrowed 80 percent on the property, just the cap rate change would put you underwater. Never mind lower rents.”
It’s precisely math like that that may be keeping some lenders from reappraising collateral assets until they absolutely have to, Foster said. “As long as the note has been paying, and the rent is in place to support the debt service, [lenders] have been letting it play without a valuation. It’s as the 2006 and 2007 rents burn off, and the incomes go down, that people won’t be able to carry the debt.”
