Appraisal Matters

We’ve had some interesting round table discussions about reserves in the office. The big question is why don’t we see reserve line items on income statements or as a separate deposit/bank account on the balance sheet? For marinas, this is an even more important question because it seems that lenders don’t understand how much of a reserve to put on this property type.

The reason is simple, as suggested by my title - real estate owners refinance their properties when they have to make major capital expenditures that should be taken care of via an annual reserve allocation. If the reserve were, say, 4 percent, that’s 4 percent of gross profit that cannot be returned to the owners. More importantly, this is a much higher percent when you consider how much that is compared to cash flow (net operating income less debt service), which often goes into the pocket of the owners. We’ve seen this a lot with marinas that get second mortgages to pay for bulkhead repairs and dock reconfigurations.

We’ve also noticed a slight trend with marina reserves. Some of the larger national and regional banks are specifying how much of a reserve a marina owner must allocate and it’s written into the loan documents. They also require a separate reserve account to be held at their bank. One lender we know of specifies a 4 percent reserve (very few appraisers even dare to put a reserve above 2 percent in their appraisals). It makes sense because the majority of repair expenses in a marina are to the docks and sometimes bulkheads (if they are not stone/rip rock); this is also a weathering asset. I won’t quote reserve ranges because labor costs vary substantially between union and non-union labor and they also vary by region of the country.

Not including a reserve is also conceptually so much easier for marinas owners.

• They don’t have to calculate how much they’d have to spend to replace the items above
• They get more money to reinvest in the business or to take home as entrepreneurial reward
• Many of them figure they’ll have to refinance anyway if the interest rate is favorable or they run into their balloon payment
• It can be hard to justify setting money aside when a marina has multiple owners (frequently family members) who may feel differently about setting money aside
• There are no tax incentives for them to do so

Since this is how market participants think, I’d say that the items above make the case that owners don’t reserve Given the current mortgage status, lenders should start thinking about requiring it.

Right now, lenders want proper ties that have no problems at all.  If there is a slight functional problem or any creative back end financing.  Calls from reviewers are up too because the criteria for lending is tight for not just for the person.

There are lots of special financing deals.  Cash back is becoming more common, short sales(selling less than owed are being approved and below market owner financing is increasing.  I’ve had to update my excel spreadsheet for  adjustments for  special financing.  In the past, the  lenders were giving the  money away.  Now other have to step in.

Lenders are very nervous about using comparables with special financing, but soon that is all that will be available in the market.  Without extra incentives, buyers are just not biting.

Bar and restaurant appraisals are interesting assignments. Unless you are going for an SBA loan, the lender only wants to lend on the “bricks and sticks.” They are not interested in the bar equipment (AKA FF&E), business value or good will. The hardest part of this type of assignment is how to separate business value from real estate.

Rarely in a loan transaction are we given balance sheets for the business. In order to comply with the Uniform Standards of Appraisal Practice, we must allocate between real estate value and business value. This is much harder than it sounds.

In urban areas, it is often easy to find similar type buildings without restaurant uses. Our “backyard” is the DC/Baltimore markets and it is generally easy to find sales without businesses being sold with the property. Where it gets hard is in rural or suburban locations where the design of the building only lends itself to a restaurant use.

Very often owners don’t have equipment lists, don’t separate real estate expenses from business and generally do not understand that although the restaurant down the road sold for “X dollars” that included the business and the real estate without allocation between the two. Very often, sellers hold the note for the business or a separate loan with different terms is written for the equipment.

For estate appraisals we do usually get balance sheets and can value the business and allocate between business and real estate, but obtaining this information on comparable sales is almost impossible. Some smart real estate agents do allocate between business and real estate but how much of this is real and how much is fabricated?

Technically, as hard as we try, do we ever comply comply with USPAP given the market data available? We certainly do all the due diligence we can, but since the market participants do not understand WHY we are asking the questions, it is difficult to obtain these allocations. The buyers of bars do not allocate. Why do we?

I’m open to all comments on this one.

So many people in real estate think there is only one cap rate. Did you know there are at least 3 real cap rates and a bunch of “estimated” cap rates? Let’s count the real ones.

1. Using the seller’s last year income (like what assessors use) and current year sale price
2. Using the seller’s proforma 12 month or partial current year income projected for 12 months
3. Using the buyer’s proforma 12 month projection

Now let’s count the “estimated” ones:

1. The cap rate shown from a data source that you buy your comparable from (the tip-off is they show rounded vacancy and expense numbers like a 5 percent vacancy and a 40 percent operating expense ratio or dollar expenses that are perfectly round like $10,000 for real estate taxes)
2. In non-disclosure states where sale prices are not shown on deeds, the buyer can give you one sale price and the seller another, so no matter how you estimate income and expenses, the sale price could vary and hence the cap rate.

So, how do you know what cap rate is best? Obviously, the first is more reliable than the last two, but sadly most people always want to take the easy way out. They don’t want to call the participants to find out the cap rate - they’d rather buy the comparable and use the cap rate reported in the sale data verbatim. I’m amazed that in many of my tax appeals, the assessor whips out the cap rate from a third party data source, it’s just “estimated” as discussed above, and they rely on it without question. They’ll even defend someone else’s work tooth and nail.

The sad thing by all this, and the point I wish to make, is that reality usually mirrors perception. You assume the cap rate is right from the data you buy even though there are all these disclaimers associated with its purchase (like they don’t assume liability for any of the data reported). You do remember the old Odd Couple episode when Felix Unger said that when you assume, you make an ass out of u and me?

When enough people believe it, it becomes the cap rate. Perpetuate a lie long enough and you start to believe it. That’s when the cap rate becomes the crap rate.

http://www.msnbc.msn.com/id/23676448/

Where exactly IS the bottom?

Looking at the latest round of resumes, I have to ask how some prospective employees figure their appraisal trainee licensing classes are worth the cost, about a thousand dollars. Remember the book “What Color is Your Parachute”? It should be required reading in the first appraisal trainee class.

What a job search boils down to is just answering four questions. It’s a lot like highest and best use analysis - you start with the entire range of possibilities (kind of like an inverted cone) and then work your way down to a single conclusion.

1) What is it I like to do? If you like to analyze and especially like to write, commercial appraising is a possible career path. If not, move on.

2) What are my strengths and weaknesses? You need to know yourself before you can answer #4 below. In our industry, sales skills help, but demand is always greater than supply, so analytical skills and lots of common sense are paramount.

3) What have I been good at in my life? If you’re the type that likes to write and you got “A”s on papers in school, commercial appraising is still possible.

4) Lastly, what are the key success and key failure traits in an industry? For commercial appraising, again you need analytical skills but you also need a tireless work ethic, the ability to work independently and be creative. These are the key success traits. Failure traits include the opposite of these plus the ability to work effectively in a group environment (at least until you start your own firm).

So let’s say you’re happy with your answers to the four questions above. Time to sign up for the trainee license class? Not so fast, tiger. Relying just on your instincts isn’t enough. When I got started, I answered these four questions and then called other commercial appraisers in the area. I begged them for help and offered to take them to lunch. You guessed it - some people weren’t so kind, but one person was. He gave me 90 minutes of his time and answered every question I could think of, including his answers to the questions above.

If you do this and you’re answers are right on target, stop reading and sign up for the trainee license classes!

Although most appraisals are done well, from time to time I’m called on to review a report that misses the mark. I started thinking - what is the one thing that makes getting the value right or wrong? What is the one thing the separates a poor appraisal from a good appraisal?

In a word, it’s the ability of the appraiser to learn the “market”. Everything else does not matter if the appraiser picks the wrong comparables, and why does he or she do that? They didn’t understand what the market is thinking and how it is reacting, so they picked comparables that were not a part of the market. The best appraisal in the world is garbage without comparable data that reflects the market.

As the number of sales and contracts dwindled from the current recession, there was only one good way to prove that the market was changing. By examining listing activity, days on market and price reductions, the trend in the demand decline became fairly obvious. Withdrawn listings were another signal. As things became softer, for-sale listings became for-sale and for-rent. So the way to make the point was to include a simple table showing statistics such as the increase in for-sale and for-lease listings, increase in days on market and other items that I mention here. A few simple phone calls to popular brokers can detail if concessions were being offered. All this gives factual evidence that markets were changing.

This type of data is important in another way. It indicates that even data in the same market could be outdated. Whereas
we could use data that is one, two or even three years old (depending on the quantity of such data, of course) when market values are flat, now data that is even six months old can be outdated.

Lastly, sometimes it’s only one factor that defines a market and it is very easy to miss it. I appraised a regional mall in Ohio that was stigmatized from crime and riots and without doing newspaper research, I would never have caught on that there was stigma. A second example is K Street in Washington, D.C., more famously known as “lobbyist’s row”. Even a comparable one block away not on K Street would be at a serious disadvantage because the market recognizes this as a premium address.

So getting the definition of the market correct and picking data that was reflective of the market (even if it requires reporting listings) is the key to getting the value right.

Every week we get resumes from persons who have completed their trainee license. Sometimes they even call us. Universally, they express a great deal of frustration with the difficulty in getting a job in our industry. The other day, someone asked me why it’s so hard to get a job.

Well, there are lots of reasons, but in my opinion, there are 5 that answer the question.

1. Commercial appraising is one of the hardest jobs out there. Oh, I don’t mean physically or mentally - it’s one of the most dynamic and creative. You could be doing an office building in downtown D.C. today, a shopping center in Northern Virginia tomorrow, a mixed-use building in Baltimore the next, a subdivision the following day, etc. The product is frequently different, the range of knowledge is different and the twists and turns in analyzing a market take years to learn. Even the same property type in different markets can be result in a very different level of analysis. Lastly, sometimes one single market dynamic is so important in an area that if you don’t know it, you’ll get the value wrong (there are lots of examples of this). The reasons I mention all this is, unfortunately, our school systems do not teach students how to think dynamically and how to “improvise, adapt and overcome”, as the Marines are so fond of saying.
2. I remember reading years back in a study of the appraisal industry that the average size of 96 percent of appraisal firms is 5 people or fewer. To train an apprentice for 3 years requires tons of time on the part of the owner and/or senior appraiser. Small firms have lots of financial pressure (i.e. dis-economies of scale), so many senior level appraisers view training as too time consuming. For this reason, they just don’t hire trainees. Many view it as training their future competitors too.
3. Many commercial appraisers view skilled residential appraisers who are seeking to convert to commercial as stigmatized. They’re used to filling in forms using canned comments and they do that long enough, many of them lose the ability to be creative and adaptive.
4. You have to know how to write. Period. So often, we’ll see a resume with spelling errors, no creativity in the layout, the cover letter does not sell and none of the jobs the prospective employee had show any skills that match up well with those of the appraisal profession. We’ve hired Ph’ds, persons who graduated with an MBA in Real Estate Appraisal, you name it, and I am amazed at how poor writing skills can be.
5. You’ve really got to want that job and this career. It has to show through on your cover letter, on the phone and in the interview. When you’re asked why you want to be a commercial real estate appraiser, you’ve got to nail that question. It’s not good enough that “the appraiser who came to my house spent 15 minutes at my property and I thought it would be a great job” (i.e. read “easy job”).

This is a great profession if you hate being bored and like a mental challenge. Just make sure your strengths and abilities match up with the industry and keep plugging away.

John

Oh, there are so many things I could say about this. It actually is a smart business move, but goodbye to independence in the residential field! Consolidation has come to most industries, has it finally come to ours? We do commercial and I believe it will be years before something like this hits us, but the residential guys must be feeling like they are losing control.

Will they too try to control the numbers to satisfy clients? Only time will tell!

February 12, 2008

Press Release: Zaio Acquires Appraisal.com Assets

Buffalo, NY, February 12, 2008 – Zaio Corporation (TSX-V: ZAO) announced it has acquired the technology assets of Appraisal.com, one of the nation’s largest firms serving lenders and appraisers. Appraisal.com technology is used by more than 100 lenders, 7,500 Day One appraisers and 9,184 appraisers in their nationwide appraisal network. Download Zaio_Acquires_Appraisal_com.pdf

Zaio is offering Appraisal.com lender customers a 20% discount on all appraisal orders they place over the next 60 days to introduce them to the quality, service and nationwide coverage offered by Zaio. Lenders may continue to use the www.appraisal.com website to place orders. Zaio currently serves nearly 500 lenders in the USA with a full range of appraisal and valuation services.

Zaio is also offering Day One appraisers a substantial price discount in the form of a free 3 month extension for 1-year software renewals and free 6 month extension for 2-year software renewals. Day One and United Systems Appraisers may purchase Zaio Zones at a 10% discount through April 30, 2008. Zaio currently owns the nation’s first and most established appraisal technology known as United Systems and manages a network of about 9,000 appraisers. Zaio recently reported that its revenues paid to its elite local “Zone” appraisers were up 107%, demonstrating Zaio’s commitment to helping appraisers increase their revenues.

Jim Kirchmeyer, Chief Marketing Officer said: “We welcome Appraisal.com lenders and Day One appraisers. Simply continue to use the Appraisal.com and Day One technology as you have in the past, with the full confidence that Zaio, and its two national service centers in Buffalo, NY and Tempe, AZ are here to ensure you have a positive experience.”

“The Appraisal.com brand is known by lenders and appraisers throughout the USA”, said Thomas Inserra, CEO. “These technology assets provide us with the means to continue serving the needs of a large number of lenders and appraisers.”

Zaio has obtained possession of select technology assets necessary to serve appraisers and lenders on a go-forward basis. Customers will be served by Zaio’s Buffalo, NY office.

Rod Mitton, CFO said: “No stock or deferred fees were granted in this cash transaction. Zaio’s overhead costs will remain virtually unchanged since we are not obligated to retain any of the Appraisal.com staff or assume any of their liabilities. With our cash and investments of over $12 million, the Company has sufficient resources to continue executing its business plans.”

We are constantly being asked for “comp runs.” Lenders and buyers don’t want to spend money for an appraiser’s expertise. They want to KNOW what a value will be before engaging our services. Although I can appreciate that the cost of an appraisal fee is significant, we just cannot take assignments with value conditions.

I do know of many firms that do this. There are several problems with this:

1. Until we inspect the property, how do we know what is a comp?

2. USPAP does not allow contingent assignments. Once you make the choice of hiring an appraiser, you are paying for the report and advise, not a rubber stamp.

3. Do you work for free? Free consultations cannot be part of a business model.

4. Although with certain parameters, sales data can be provided independently, we feel that then doing an appraisal assignment can show bias.

There are assignments that do not involve providing an appraised value that are legal and correct. There are also limited assignments that can be performed with less due diligence to arrive at a value, but the user must know that any change in scope (more research) could change the value conclusion. Very often we are asked to provide research within a market without any conclusions for lenders, especially hard-money lenders. There is nothing wrong with that.

What we cannot do is provide comps and say we think it is worth “X” before taking an assignment. It’s illegal and completely diminishes our role in helping our client’s make informed decisions.

Eileen

Many moons ago, I started a little project where I wanted to find a way to carry all my field gear with me on inspections. Specific items I had in mind were my large 100 foot measuring tape, an electronic indoors measuring tape, cell phone, business cards, pens, a bottle of water, extra batteries for my camera, flashlight, sanitary hand wipes and gloves… at the least. Ah, but we only have two hands.

So my first thought was to get a police belt and add various attachments to the belt. Sounds good in theory, but trying to find all the right carrying containers to fit a 2 inch belt was almost impossible. They’re usually all leather too, so you could wind up spending lots of money.

Then I stumbled on the Tactical Jacket sold by scottevest http://www.scottevest.com/v3_store/40_Tactical_Jacket.shtml (no, unfortunately the model in the photo is not I). What a find! I now have a black jacket that holds all these items plus I can put my clipboard and sketch paper in a pocket behind my back. It’s really warm, too. I can also it with the fleece or in the Spring, just use the fleece by itself. I just love this jacket. Yeah, with all my gear I look like a cross between a cop and the Terminator, but that works in my favor.

I can’t recommend their jackets any more highly. Now if only someone on ebay would buy all my cop gear;)

We had a great dinner with Jim MacCrate, MAI who graciously gave us three hours of his valuable time while visiting Baltimore to teach a class. I had met Jim while taking two classes and I have been impressed with his honesty, knowledge and desire to give back to the community.

Although court work has been part of our practice, most have settled so the number of times we have been on the stand is small in comparison to Mr. MacCrate. There is an art to testifying so he was kind enough to share his thoughts and insights about his experiences on the stand. It has become so natural to him to know what to do, that I’m not sure he realizes all the wonderful advice and guidance he gave John and I last night. The main thing we came away from the table with is we need reach out into the appraisal community and collaborate more.

We look forward to future debates, discussions and perhaps some joint work on some new cases we are booking. We always look to provide the best to our client’s and adding Mr. MacCrate’s knowledge and advise to cases would benefit our clients. If you are in the NY metro area and need a great appraiser, his website is below.

http://www.maccrateassociates.com/

Thanks Jim for your time!

Eileen Simpson

In this market, it is getting pretty tough out there for people. On the commercial side, many loans have balloon payments and the owners NEED their values to keep rising. Right now values are at best flat. Over and over I see owner occupied real estate investors who banked on their values rising. Very often appraisals during the “go go” period were even too high for then! Now investors are upside down.

What to do? Well, never borrow more than it is worth. Did you know that the appraiser works for the bank, not the borrower? The only time the appraiser is working for the owner is when they are directly engaged by them. If that happens, it can’t be used for financing! Sound confusing? Here is the bottom line:

In a refinance or purchase, we are only a closing cost. Even if you pay the lender for the appraisal or even hand a check to the appraiser, you don’t own it. The appraisal is done according the the scope of assignment that the lender requests, which can vary. If you are unsure about a value, hire your own appraiser! Yes, it cost more, but when you are spending hundreds of thousands, even millions of dollars, does it matter? Did your loan officer push the appraiser to get that higher value, and thus a higher commission? Bet your loan officer didn’t tell you that!

We just got done with a case we appraised 3 years ago. We came in at our value conclusion and another appraiser appraised it for the “requested value.” Now the balloon payment is due and the owner cannot refinance. At the time of the first appraisal, great pressure was put on us but we stood our ground AND lost the lender as a client. Now the borrower is in trouble.

Something to think about during the next “upswing” in the market. It always ends!

Eileen Simpson

As always, Mr.Mac Crate always is right on the mark about our industry. This article is one of the best out there and we are now having a terrible time with being honest and actually saying a market is declining. Why is that? It’s because the lender’s still want to make loans. Most are not the direct investors, so we are constantly being cut from lists for telling the truth.

Can a loan be placed in a declining market? Maybe. It is hard and it should be hard. Investors need to know the risk involved in lending in a declining market. Don’t they have the right to mitigate their losses.? It is hard when you have a mortgage payment to hear that you will lose a large client to “not marking the check-box.” How many good guys have fallen to needing to feed their families?

All should read this article.

http://soapbox.millersamuel.com/?p=370

Eileen Simpson

Some of you may know that I’ve authored 4 books with the Appraisal Institute and 12 Appraisal Journal articles, but that’s just a part of my monologue. I help run an appraisal firm, I’m an active day-to-day commercial appraisal and I’ve been in the industry for almost 2 decades. To put it simply… I’m a writer. This is my medium of choice and where I’m most comfortable.

Now that the intro stuff is out of the way, I hope to bring a commercial appraiser’s perspective to real estate on this blog. Typically, we’re the only unbiased, third-party part of a real estate transaction and that’s precisely what I intend to provide… an unbiased, third-party perspective of what’s going on. I’ll also be throwing in a sprinkling of other topics shown in the Categories pane just to round-out the perspective.

Lastly, blogging gives me an outlet where my opinions are not round-tabled by review editors, my examples are not watered down for appraisal industry political correctness and I’m not misquoted by the press. For me, that’s refreshing.

Stay tuned.

Well, I’m a geek. But even a geek can hate computers. My server is DOWN. I am forced to just clean and wait for my computer people to fix it.

Anyone else have a love/hate relationships with computers? Why so hard? How come I can’t leave Microsoft for Apple?

Eileen

So often when we appraise properties where the business is tightly held with the real estate, it is very difficult to separate the business from the real estate. This is most common in restaurants, bars, marinas and hospitality properties. When a business is dependent on its real estate to function (an office could be anywhere in theory) and is owner occupied,the business owner does not divide the business income and expenses from the real estate.

Even if the property is owner occupied, these need to be divided. The best way is to pay yourself market rent and separate the business and the real estate into two entities. Real Estate taxes should not be on the same statement with cost of goods! This has advantages for your accountant and makes financing the property much easier.

Remember, unless specifically stated, your lender is NOT providing financing on the business and equipment. SBA loans can be an exception to this rule, but we always have to report business and real estate income separately. Talk to your accountant about how to do this. It will make tax time and financing much easier for you. It will also not be a shock when your appraised value (for just the real estate) is much lower than anticipated. I’ve seen liquor stores doing millions in sales, where the real estate was worth almost nothing.

Eileen

Well, I made it here first. There is going to be two of us at this blog and maybe more in the future. We are a husband wife team with two very different approaches to commercial valuation and life in general, who always seem to come to the same location in the end.

My husband, John Simpson, graciously has given me the first post. Who am I? Well, professionally I would say I am a “street appraiser”. I don’t have my MAI, but I’ve sold, brokered loans and I’ve been an appraiser for 13 years. For the last five I’ve only been doing commercial with my husband as my mentor. I’m best with small commercial properties (AKA blue collar properties) and John’s expertise is miles above mine on investment grade properties.

John on the other hand is an MAI who IMHO is brilliant, but never was good at promoting his abilities. People are generally not good at sales when they are analytical. He has been my hero and mentor for many years and I hope you enjoy our posts and debates on this blog. We’re new at this but are very fortunate to have 21 year old Bethany with us. As her email byline states: Troubleshooter Extraordinare. We’re hoping that we’ll convince her to join us full time after college. You may see posts from her from time to time too as she starts down the “apprentice appraiser” path.

You’ll be seeing posts about our day to day practice, our opinions on Real Estate related matters and appraisal theory and practice in general. We look forward to your comments and hope that your enjoy our posts.