Appraisals take on greater importance when the real estate market has a downturn. The appraisal profession grew out of the Great Depression of the 1930s and since then appraisals have been more closely scrutinized in every downturn, including this one.
In a steadily rising market, appraisals may provide discipline to the system, as observed by one chief credit officer, but are otherwise not given much circumspection. As long as everything is rosy, appraisals are file-fillers. But now?
In addition to the self-evident purpose of establishing loan-to-value ratio, commercial property appraisals can and should have invaluable information for the underwriter. The appraiser’s estimates and projections of rent, vacancy and expense will indicate the likelihood of the borrower’s making debt service from cash flow.
The underwriter should be stress-testing the appraiser’s forecasts with what if scenarios. If vacancy rises to 20 percent, what will the cash flow look like? If rents drop 10 percent on renewals, will debt service still be covered?
The strength of the appraiser’s income approach, in particular, will mean everything for the lender.
When the market turns down, the bigger banks and lenders are usually in pretty good shape. They have a chief appraiser or staff appraiser who has been performing quality reviews all along. So when the scrutiny increases, the lender has a panel of seasoned appraisers who can perform well in all market conditions.
But what about mid-sized and smaller lenders? Without the volume to warrant staff appraisers or reviewers, these lenders may not have the kind of infrastructure their underwriters, directors or regulators would like to see. Even lenders doing a good job of ordering sound appraisals can improve their procedures to get appraisals better, faster and cheaper to have a leg up on their competitors.
Outsourcing
Commercial real estate lenders can simply take a page from the book of our residential lender and appraiser colleagues. For some time now, appraisal management companies have been able to handle all appraisal matters for their lender-clients on a turnkey basis. It really is the outsourcing of an appraisal department, or at least the outsourcing of the chief appraiser’s function.
This concept can make great sense for economy and quality control. Many lenders – mortgage bankers, medium and smaller banks, as well as specialty lenders – can have the advantages of an in-house appraisal department at quite reasonable prices per appraisal.
Having an independent appraisal manager who can order and review appraisals removes that burden from lending or credit officers. It also adds a level of independence and comfort to the process that is sure to be popular with regulators, investors or stockholders, particularly when the market climate may give them doubts about commercial real estate lending.
To begin the process, a contract appraisal manager can provide policies, procedures and a panel of qualified appraisers or review and fine tune current practices by a lender. The outsourced chief appraiser can effectively match appraisers to assignments and negotiate fees.
An appraisal manager can lower the cost of the appraisals. There is centralized purchasing power. By receiving clear appraisal specifications and by knowing what to expect from the reviewer, many appraisers are willing to lower fees to reflect the resulting time savings.
In addition, an independent appraisal manager can develop good working relationships with both fee appraisers and the line officers. In a down market, disagreements about value or income levels become more prevalent. The appraisal manager can solve problems and reconcile differences in thinking as a disinterested third party.
Even in the best lender-borrower relationships, there is an inherent tension between the borrower and the lender and, by extension, between the borrower and the lender’s appraiser. There’s no surefire way to solve all problems that might arise, but an independent appraisal manager has a better chance to neutrally focus on the appraisal issues without a vested interest in the transaction.
Mortgage bankers can benefit from these and other advantages. An insurance company or other investor can be assured that the fee appraiser was selected for competence and expertise. The contract appraisal manager can write specifications for appraisal reports that would emphasize the important elements and discourage boilerplate.
A crisp format can be customized to an investor’s particular needs, such as providing a tenant rollover table for CMBS lending. A standardized format always has the information in the same places which facilitates review for users. And a succinct appraisal format costs less.
The outsourced chief appraiser needn’t be expensive at all. A large part of the cost can be recaptured through cost savings in the appraisal process. Some part of the appraisal manager’s fees may be passed through to the borrower. Any other cost an institution might have would pale in comparison to staff salary and benefits. And staffing overhead is like the Energizer bunny – it just keeps going.
There are many economies and improvements in the appraisal world that can be developed. Changes are occurring rapidly and someone who is working full-time in the appraisal industry is in the best position to keep a lender or investor in the soundest position at the least cost.
