Why they are so expensive and what to watch out for when working with private capital lenders

CRE appraisals can differ greatly from the residential appraisals with which most of us are familiar. They take more into consideration than simply the value of the property itself, including its income generation and location, so they are more subjective to the appraiser’s interpretation. Appraisals can be important for a variety of reasons: establishing valuation for mortgages or other loans, determining an appropriate sale price, helping to settle an estate in the event of a death or divorce, or assessing property taxes.

1. The inspection is not the appraisal. The physical inspection of a commercial property is only a small part of the larger appraisal process. The inspection of the physical property usually takes at most a few hours, but the additional research that an appraiser must make into the property’s records and other documents can take several days or even weeks. An appraiser’s research will usually encompass public records of ownership, zoning records, location and demographic information, comparable sales, replacement costs, as well as rentals.
2. What determines the Scope of Work for the appraiser. There are six key parts that appraisers are required to identify in order to determine the scope necessary: client and intended users; intended use of appraisal and report; definition of value (this could be market, foreclosure, investment, etc.); hypothetical conditions or extraordinary assumptions; the effective date of the appraisal; and the property’s salient features. At a minimum, the appraiser must meet the expectations of the client and the actions of other appraisers who have similar assignments. The scope of work is not affected by the type of report requested as any additional information obtained will remain in the appraisal file even if it is not included in the final report.
3. The three methods used for appraisal. There are three traditional methods of appraisal: cost, sales comparison, and income capitalization. The cost method is the least common of these as it assumes that the value is equal to the cost of replacement minus any depreciation. Sales comparison is the method that is used with residential properties, comparing similar properties within the appraised property’s market which have sold in a particular time period. The final method, income capitalization, is most useful for commercial real estate appraisals because it considers the value of how the property is used in addition to its underlying physical asset.
4. Be honest and upfront with your appraiser. If you misrepresent facts about your property to your appraiser, it will likely only succeed in lowering your own credibility in their eyes. It is also important to provide any documents which your appraiser requests. Providing additional information at this juncture can save you the time of having to dispute the accuracy of assessment at a later time.
5. There is a strict code of ethics for appraisers. This is known as the Uniform Standards of Professional Appraisal Practice. This protects both you and your appraiser by requiring them to render an unbiased opinion on your property’s valuation.
6. Identify the use of appraisal and any intended users. The appraiser is required to maintain client confidentiality, so the report can only be released to the party which ordered it. This means that if you are a borrower and your lender orders an appraisal, the report will be given to the lender, not to you. This also means that if you request an appraisal as part of a property tax appeal, the report will not be provided to the property tax board without your permission. If you are the appraiser’s client, then it is up to you to inform them of the intended use for the appraisal and to name any other parties who should be authorized to access or use the report.
7. Choose one: the three types of reports. There are three types of reports, which go from least to most expensive: restricted use report (client-use only); summary report (available to all intended users); and self-contained report (contains all details and data, rarely used). The intended use of your appraisal will determine which type of report is desired.
8. When you need a Highest and Best Use appraisal. An HBU determines the use which will produce the highest value for a property. This is done in two situations: when a property is vacant or undeveloped and when a property is being improved or repositioned. It involves the appraiser determining, first, all the legally permissible uses, then eliminating those which are not physically possible. Next, this list is narrowed to those which are financially possible or economically supported. Once this is done, the appraiser identifies which one of the remaining options will result in the highest production.
9. Establishing the date of valuation. A property’s value can be appraised as of the date of inspection or can be done as either a retrospective or prospective appraisal if a past or future date is selected. This can be a crucial decision for a CRE appraisal since the date chosen determines the economic and other factors that can influence the property’s value.
10. Identify which property interest is appraised. There are three main interests that an appraiser can value. Fee simple values the property outright and is best if you are interested in the value of the property itself and any developments that have been made. Leased Fee will tell you how much a property is worth to its landlord as this considers the value of any leases (whether they are above or below market value) and adds this to the fee simple value. Finally, Leasehold interest will determine the value of a lease to its tenant based on its cost relative to market value.

The commercial real estate appraisal is one area in which both traditional lenders like banks and life companies and private capital hard money lenders are on the same page.  Banks are required by the Federal regulators (FDIC & OCC) to obtain appraisals that meet very specific standards.  Many, but not all, hard money lenders also require appraisals.

The hard money lender can be more flexible in the type of appraisal they order since no agency oversees their underwriting.  Some lenders are able to close on a verbal valuation and obtain the full written appraisal after closing.  This enables them to close much more quickly than traditional lenders. Other hard money lenders tell their borrowers they don’t need an appraisal and will visit the property themselves and make their own estimate.  Although this may sound good initially it has may have a negative consequence for the borrower.  When the hard money lender offers to do a quick personal valuation they frequently come in at a very low valuation number, often far lower than a full professional appraiser would determine.

This saves the borrower an appraisal fee up front but may result in the borrower getting a drastically lower loan amount when the amount of the loan can be critical for the borrower.  Borrowers are advised to have a serious discussion with their lender on this issue.  Borrowers are also strongly advised to discuss with their hard money lender whether their property is being appraised at “quick sale” value or at “fair market value”. For the difference between these two methods of appraisal see Montegra’s Blog titled Quick Sale Value vs. Fair Market Value Appraisals

This blog was written by Bob Amter, President of Montegra Capital Resources, LTD., a Colorado hard money lender.  [google_authorship] has been in the private capital lending business for 41 consecutive years.