One very important service Valuation Management Group provides its client partners is the review of residential and commercial appraisals prepared by independent appraisers. Appraisers must apply critical thinking in the writing of the report and VMG review appraisers must do the same during the review process. Applying critical thinking and asking the question “Does it make sense?” should result in a better reasoned and thus more credible appraisal report and review.
To illustrate the importance of critical thinking, we gathered examples from recently conducted commercial reviews. The answer(s) to the following questions could potentially affect the value conclusions and perhaps the client’s ability or desire to lend on the subject collateral. Preface each of the following points with “Does it Make Sense” –
- to rely solely (or predominantly) on the value indicated by the income approach when the subject is owner occupied, all the sales comps were owner occupied, the most probable buyer would be an owner user, and the rent comps and the cap rate sales comps were not very similar to the subject? The predominance of the data seems to suggest that the most applicable approach to value would be the Sales Comparison Approach.
- to conclude to a Highest & Best Use (H&BU) of commercial use when surrounding uses are rural single family residence, wooded acreages, and agricultural fields, but there are no commercial uses for miles and the subject is on a dead end street? The characteristics of the immediate subject area and subject location seem to suggest that the subject is more suited for agricultural or residential use as there is no evidence presented that supports commercial demand and use.
- to apply an unusual technique (Example – doing a discounted cash flow analysis as opposed to a direct capitalization method when there is an anticipated steady income and expense stream) without explaining why the use of the generally accepted appraisal method is not applicable? Using a technique that is typically relied upon for the collateral type can lead to more reliable variable input, and thus a more credible value indication.
- to conclude that a proposed improvement is financially feasible when the cost approach says $430,000 and the other sales and income approaches average $120,000? Does it make sense that a lender would typically want to lend based primarily on the cost approach? If the cost to reproduce the real estate far outweigh the amount a typical buyer or investor is willing to pay for the property, it is likely that the project may not be financially feasible to the typical user. If the loan were made based upon the cost approach and the borrower were to default on the loan and the lender had to take the property back, the asset holder would not likely achieve a sale price commiserate with the cost approach value conclusion.
- to use the current real estate taxes for a poorly-occupied (below market-indicated occupancy level) income property that is being renovated? The direct cap method incorporates a stabilized income and expense structure in deriving a value indication of the Prospective Value Upon Stabilization. Would it make more sense to use a forecasted, stabilized tax liability? What do investors do when analyzing similar properties? An investor would most likely use a forecasted, stabilized tax figure in assessing subject NOI and value. The investor would anticipate an increase in value once occupancy and renovations are stabilized and complete. Any change in value, should reflect an increase in tax liability, even if only on paper, and not yet recognized by the governing body. The investor and lender would expect to know how that change in value impacts taxes and the bottom NOI line.
Getting in the habit of thinking critically when performing and/or reviewing an appraisal report should result in more credible appraisal reports – the primary goal of all parties. Please keep an eye out for our Part 2 blog on this topic with another handful of examples.
Valuation Management Group is a national, full service appraisal management service company that manages the appraisal process, including the required review, for financial institutions, banks, mortgage bankers, and credit unions. We offer the full array of commercial and residential appraisal products and services, taking the appraisal process from ordinary to extraordinary.