As year-end is approaching, we reflect on the past year and look ahead to the future. We’re grateful to work across several states and with so many great clients!
In 2022, Simonson Appraisals completed a steady stream of financing assignments with planned new construction or significant proposed renovations. On several occasions, we were presented information about construction or renovation plans well after the initial assignment was started.
Having worked with many different lending institutions completing new construction and planned renovation assignments, think of this article as a “best practices” reference to be shared with new lenders, credit analyst team members and borrowers navigating the commercial appraisal process for the first time.
Below are are several key points from my presentation titled Navigating the Appraisal Process that’s been presented several times to the U.S. Small Business Administration and Minnesota Bankers Association. The goal of this article is to help lenders, banks reviewers and appraisers.
Lenders, what’s in it for you?
We believe it’s important for appraisers to communicate with their clients to avoid surprises and ensure the appraisal process is as smooth as possible. Our goal is helping our clients make sound investment decisions and solve real estate problems to achieve their financial and business goals.
Understanding the perspectives of the appraiser and bank appraisal review department helps lenders communicate with the borrower at the onset of the real estate financing process.
Lenders work with real estate investors and owners of small, medium and large businesses (borrowers) to help them secure financing to purchase and refinance real estate that fit their investment criteria and fulfill their business needs. As investors and owners of businesses, these individuals carry many responsibilities, of which financing real estate is one component. The lender can help the borrower ease this process in several ways.
Lenders have a desire to get the appraisal completed in a timely manner to assist the borrower in focusing on their business or other investment needs. Lenders are in communication with the bank reviewer/credit analyst from the onset and want to ensure the appraisal is proceeding without any major setbacks. If something comes up that may impact delivery or information is missing, it is important for the lender and appraiser to inform the bank reviewer/credit analyst.
Defining the Appraisal Scope of Work
This is a decision where the lender can help the bank appraisal review department and appraiser hired for the appraisal. In solving any appraisal problem, there are three basic steps to the process:
- Identify the problem,
- Determine the solution (or scope of work), and
- Apply the solution.
What property should be appraised?
Does the collateral match what’s included in the appraisal? The borrower may own multiple properties, sometimes in close proximity to one another. It is very helpful and can save time and avoid later questions and scope of work revisions to identify the actual property to be appraised. It is important to clarify if adjacent parcels are owned by the borrower and if they are to be included in the appraisal. Helpful information includes tax parcel numbers, legal descriptions, number of buildings, building size, etc.
Key Appraisal Items to Communicate
Fee Simple Interest – The fee simple interest is the most complete form of property ownership. Fee simple interest is defined as absolute ownership unencumbered by any other interest or estate, subject only to the limitations imposed by the governmental powers of taxation, eminent domain, police power, and escheat. Under fee simple ownership, a property owner may occupy the property and also has the right to sell, lease, mortgage or give an interest away.
Examples: Owner occupied properties don’t have a lease in place and so the property is appraised based on market rents. Some building owners may structure a lease with a separate related entity that operates the business. However, these leases are not considered arm’s length because they are between related parties, can be cancelled or revised at any time, and generally not relied upon.
Sometimes, a building will have all short-term (less than 12 month) leases. Most lenders will request the fee simple interest be appraised. The understanding here is the tenants could vacate and a more reliable value is provided by the fee simple analysis based on market rents.
Leased Fee Interest – Defined as the ownership interest held by the landlord, which includes the right to receive the contract rent specified in the lease plus the reversionary right when the lease expires.
Examples: A building owner has a single lease or multiple leases with tenants. When a property has longer term leases in place, even at market rates and terms, the interest appraised is typically leased fee. The value may be the same as fee simple, but the interest is identified as a leased fee. Common scenarios include single tenant buildings with leases exceeding 12 months and multi-tenant commercial buildings with lease that have varying lease expirations.
Helpful Items to Provide for the Appraisal
- Site and Building Details
- Title work
- Environmental Information
- Purchase Agreement
- Income Information
- Arm’s length vs. related party leases
- Historical Income & Expense Statements – Verify the owner’s consolidated statements match up with tax returns
- Signed lease documents, detailed rent roll, etc.
- New construction or planned renovations – Actual construction cost statements, plans, material specifications, etc.
Clarify What Value or Values are Needed
Market Value As Is – The estimate of the market value of real property in its current physical condition, use, and zoning as of the appraisal date. (Interagency Appraisal and Evaluation Guidelines) Note that the use of the “as is” phrase is specific to appraisal regulations pursuant to FIRREA applying to appraisals prepared for regulated lenders in the United States. The concept of an “as is” value is not included in the Standards of Valuation Practice of the Appraisal Institute, Uniform Standards of Professional Appraisal Practice, or International Valuation Standards.
(Source: The Dictionary of Real Estate Appraisal, Sixth Edition, Appraisal Institute, Chicago, Illinois, 2015)
What is the actual occupancy of the property? Lenders, prior to sending the loan request to the review appraiser, find out what the building occupancy is. If a building has significant vacancy (above market), more than one value is generally required. This simple step ensures the proper bid request is made.
Prospective Market Value As Completed and As Stabilized
A prospective market value may be appropriate for the valuation of a property interest related to a credit decision for a proposed development or renovation project. According to USPAP, an appraisal with a prospective market value reflects an effective date that is subsequent to the date of the appraisal report. Prospective value opinions are intended to reflect the current expectations and perceptions of market participants, based on available data. Two prospective value opinions may be required to reflect the time frame during which development, construction, and occupancy will occur.
The prospective market value—as completed—reflects the property’s market value as of the time that development is expected to be completed. The prospective market value—as stabilized— reflects the property’s market value as of the time the property is projected to achieve stabilized occupancy. For an income-producing property, stabilized occupancy is the occupancy level that a property is expected to achieve after the property is exposed to the market for lease over a reasonable period of time and at comparable terms and conditions to other similar properties.
Particularly on new construction and renovation projects, getting this information upfront in a timely manner helps everyone win and ensure a smooth appraisal process to get completed in a timely and efficient manner! What has your experience been navigating the appraisal process?