|Seeing red over appraisals? (May 2010)|
Low valuations irk bankers. Two experts identify the most common reasons for the downgrades and suggest how to avoid the problem going forward. One tip for right now: Don’t hesitate to ask for values under different assumptions in addition to “as is.”
ABA Community Banking | REAL ESTATE CHALLENGE
By George R. Mann and Larry R. Woodall
Low values drive bankers up the wall. Here’s why there’s a problem and how to improve the appraisal process for the next round
Acommon complaint heard across the nation concerns low values in new appraisals. Is this the result of a real decline in value or appraisers becoming conservative?
First, realize that appraisers are the last people to receive factual information on current price levels. Before an appraiser becomes aware of a property being sold, the owner, real estate brokers, and potential buyers have all been involved in setting and arriving at a transaction price. Thus, the market has caused prices to decline over the past two to four years—not appraisers. Appraisers simply reflect and analyze the market.
We believe the decline in appraised values seen by most banks can be attributed to two factors: The aforementioned decline in market prices, and a change in appraisal quality. Generally speaking, if we look at a 2006 appraised value of, say, $1 million and a 2010 appraised value of $500,000, we find the change is attributed partially to price decline and partially to the original appraisal being poorly supported, unsupported, or the data itself having been analyzed poorly.
Whether acknowledged or not, banks have gone from using marginal appraisers who “hit the number” or quoted the lowest possible fees during the boom days, to using the best appraisers today as they want to know what the property is really worth, so as to make an informed decision.
This same mistake occurred during the S&L crisis. Here are some tips that can help ensure this doesn’t occur yet again. They boil down to two issues: Are you using the right people, and, are you using them the right way?
Update your appraiser roster
The foundation of a solid appraisal management program is a roster of well-qualified, approved appraisers. Begin reviewing your bank’s program by asking:
• Who set up the roster?
• When was the last time the roster was updated?
Red flags should go up if the answer to the first question is: “Loan officers set part or all of the approved roster,” and to the second: “No one has reviewed the roster for many years.”
An important part of the entire appraisal program is independence. Throughout the appraisal regulations, bank regulatory agencies make it clear that loan officers and borrowers can have no say in which appraisers are considered or used for any assignment. As such, an existing roster that had loan officer involvement in which appraisers were approved to work for the bank needs to be revisited by an independent part of the bank such as Loan Review.
The end result may be that many of the same appraisers will remain on the roster. After all, just because an appraiser was recommended by a loan officer does not mean that he or she is not qualified.
To the second point, rosters often are assembled from a group of bank affiliates/regions and bank mergers. The result is a melting pot of names that no one has really looked into for years in regard to appraisal quality, timeliness, etc. In our reviews of rosters we have found appraisers that are in a different profession, retired, or even deceased! On average, the contact information for more than 20% of the appraisers is incorrect. Which leads us to yet another question: When was the last time the bank used these appraisers?
You don’t want a phone book
When you assign someone to review the existing appraiser roster, an area of focus should be the number of approved appraisers: Are there too many? Are there not enough in some markets?
We have seen some approved rosters that contain more appraiser names than a phone book. Consideration should be given to narrowing your roster. A better business relationship can be built if you use an appraiser 10 or 20 times per year than once or twice. Like any business, appraisers will provide their best service to the clients who hire them the most. Building this relationship can be beneficial when the bank needs someone to call to ask about local market conditions.
How to engage an appraiser
We are finding banks frustrated with the appraisals they are receiving as the reports don’t answer the questions that need to be addressed to make a prudent credit decision. Improved communication can reduce the frustration and improve the quality of the appraisal report you receive.
Banks shouldn’t hesitate to ask for specific market information or a variety of values under different assumptions. Regulations require an “as is” value. However, once that requirement has been met, the bank is not prohibited from asking for other values. Here are three situations:
Example 1—“As Stabilized.” Your collateral is a newer, multi-tenant office building that has struggled to achieve 60% occupancy. The appraisal will give you the current “as is” value, but you may need more information. An “as stabilized” value could help you decide whether to commit more funds to this project if it continues to lease up. Also, you should request what is called a “Level C Market Analysis.” In this, you will obtain detailed information on competitive rentals and listings and anticipated market conditions over the next few years. Such information could assist your workout team in choosing a strategy for the subject property.
Example 2—“Liquidation Value.” You have a loan that can go either way—work with the borrower or go ahead and foreclose. Besides an “as is” value, ask for a liquidation value. This downside information should help make an informed decision.
Example 3—“If Completed.” You have a partially finished residential subdivision. Besides getting the standard appraisal, ask the appraiser to show what the lots (and entire subdivision) would be worth if construction were completed. Further, ask them to compare this added value to the estimated cost to complete the project. This should give you some perspective on whether to abandon this subdivision or invest more money in it.
Fee appraisers and bankers need to discuss in detail the property to be appraised and any possible scenarios that might be helpful to value. It is cheaper and more efficient to order one appraisal that answers a variety of questions than to order several appraisals over a period of time. â–
George Mann and Larry Woodall are both managing directors at Collateral Evaluation Services, Cincinnati. Mann is a frequent ABA speaker.
The electronic version of this article available at: http://www.nxtbook.com/nxtbooks/sb/ababj0510/index.php?startid=16
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