The Valuation Trap

Can appraisers avoid the pitfalls of today’s market?

Appraisals in today’s market are not for the faint of heart. Comparable sales are scarce, markets are changing quickly, and rules and regulations are stricter than ever. One false step could imperil even the most solid transactions.

“Today, there can be significant gaps in valuation metrics across property classes and among the various markets and submarkets,” says Von Moody III, CCIM, CRE, MAI, senior manager of Thomson Reuters in Denver, N.C. “These gaps can create hazards.”

And these hazards can create angry brokers.

Mind the Gaps

“Lack of comparables has appraisers using properties that would never have been accepted four years ago,” says Eric R. Rehn, CCIM, vice president of Cassidy Turley in Walnut Creek, Calif. Rehn sees appraisers using comps from other markets, not giving credit if a comp is a “fire sale” or real estate-owned, and underestimating values by as much as 25 percent. But such practices aren’t just common in Walnut Creek.

Russell Byron Webb, CCIM, managing partner with Silver Oak Commercial Realty in Southlake, Texas, notes that an appraisal almost affected one of his recent sales because the appraiser used a 30-year-old class B office building as a comp for a newly built class A building. The bank ordered another appraisal.

In other cases, acceptable comps might not be able to offset rapidly changing markets. For example, James B. Marian, CCIM, of Chapman Lindsey Commercial Real Estate Services in Tucson, Ariz., recently listed an REO land property that had to be continually reappraised because the market was declining so quickly. By the time he got a new list price, the market would already have dropped well below the appraised value, and the bank refused to sell below that value. To avoid these precipitous price declines, Marian says, appraisers should be required to “disclose market trends and communicate possible near-term value adjustments, especially in rapidly declining markets.”

For some commercial real estate professionals, these market conditions have spotlighted a fundamental shortcoming: “Appraisals are retrospective documents, which means they are based on outdated data, especially in declining or appreciating markets,” says Stephen R. Collins, CCIM, executive vice president of Environmental Liability Transfer in St. Louis, Mo. “Investors are prospective, which means they consider factors other than past sales.” Collins suggests that, in most cases, investors can underwrite deals more accurately than appraisers.

A Safer Path

For their part, appraisers know they can’t please everyone. But they also recognize that they have to use all of the tools in their toolbox to make a credible valuation.

When appraising investment properties today, the key factor is net operating income, says Randy Scheidt, CCIM, MAI, FRICS, president of Don R. Scheidt Co. in Indianapolis. “Tenants are asking landlords for concessions or moving out, and these properties might lease up for less,” he explains. “We all need to do a better job giving credible projected income streams to future buyers or current owners.” If current comps aren’t available, an old property with a similar projected NOI might still be useful, Scheidt adds. But appraisers need to clearly document their reasoning in such cases.

Appraisers can also use local listings to bolster a more forward-looking analysis. “We generally use four sale comps and two or three listings that are adjusted for a discount,” says Jeffrey T. Miller, CCIM, MAI, president of Miller Real Estate Advisors LLC in Alpharetta, Ga. “Listings are sometimes the best comps because it’s hard to say a similar property will sell for more than the other’s listing price.”

The current climate also requires a more thorough market analysis. “More attention is being placed upon micro-market-area information reflecting vacancy, absorption, and locational attributes,” says Brian D. Frank, CCIM, GAA, an appraiser for Accurate Services Commercial Property Valuation in Chandler, Ariz. “It has become a mix of current reported data and speculative common sense, with the consideration of future upside potential.”

In Frank’s market, for example, the location of an office condominium property near a major medical facility might offset the current oversupply weighing down office condo sales prices and market lease rates. “As economic conditions improve and absorption increases, this product type would be expected to recover much earlier in the process,” Frank explains. He runs a direct capitalization rate analysis on current market lease rates to illustrate the difference in pricing from sales to potential income.

“I’m finding that properties in outlying areas and older class C properties are again selling for prices relatively in line with direct cap rates of current market lease rates,” Frank says. “This has not been the case for the last two years and indicates that buyers are not willing to take on risk or pay for future upside potential for this property type. In other words, what you see is what you get.”

For REO sales, Frank adds, lender motivation must be considered as well. If appraisers understand lender motivation, they can more accurately assess the current market value vs. the disposition or liquidation value.

Ultimately, however, the client sets the definition of value. “A typical problem is a bank client that requests market value but incorrectly expects a disposition or liquidation value,” Miller says. If the appraiser provides a market value, which assumes a 12-month marketing and exposure time, the broker and bank expecting a sale within a few months will be frustrated.

In addition, listings services are sometimes unreliable, so appraisers need a little help from their broker friends. “Typically, appraisers will interview market participants to confirm data,” says Miller, who uses all available resources to track down the “biggest and best players” in a given market. Recently, he searched the CCIM Find a Professional database to locate experts who could confirm market data for a Colorado land deal. “The CCIMs have a big picture view of the world, are happy to assist, and often share new insights on market activity,” he explains.

Other market participants might need a little more coaxing. “Some brokers say, ‘That’s not my job — you find the data,’” Scheidt explains. “But if brokers want to do the best job for their clients, they need to provide the most credible and up-to-date data available. Greater cooperation among brokers, appraisers, and property managers, along with better data, will result in a more acceptable valuation for all parties.”

Rich Rosfelder is associate editor of Commercial Investment Real Estate.

Who’s Who?

Qualifications to appraise real estate are set by the Appraisal Qualifications Board, an independent board of The Appraisal Foundation, which is authorized by Congress as the source of appraisal standards and qualifications. Under the provisions of Title XI of the Financial Institutions Reform, Recovery and Enforcement Act of 1989, or FIRREA, the AQB establishes “the minimum education, experience, and examination requirements for real property appraisers to obtain a state certification,” according to the Appraisal Institute.

Licensed and certified appraisers have met the qualifications required by their state regulations.

MAI appraisers have earned the MAI designation from the Appraisal Institute, and are considered by AI to have “the necessary commercial property valuation experience and expertise in a property’s relevant geographic area to produce a reliable valuation.” The MAI designation requires 4,500 hours of experience, an undergraduate college degree, and an education program and qualifying exam.

GAA is the general accredited appraiser designation from the National Association of Realtors for state certified appraisers who meet additional experience and education requirements.

The Dual-Designation Advantage

How can MAIs improve their market knowledge? Eric Garfield, CCIM, MAI, director of valuation services for WTAS LLC in Los Angeles, recommends the CCIM designation program. “Incorporation of CCIM sentiments into appraisals is essential to support conclusions and ensure that they’re not based on ‘rear-view mirror’ data,” he explains. MAIs can earn the CCIM designation through the fast-track program, which allows them to bypass the elective credit and Portfolio of Qualifying Experience requirements. Visit for more information.

The Appraiser’s Approach

by Michael P. Hedden, MAI, FRICS, and Marc R. Shapiro, MAI, MRICS

In light of the current economic conditions, valuing real estate has become more complicated, and more attention is being paid to the appraisal process and the appraiser’s opinion of value. Prior to the economic downturn, the volume of transactions made valuing real estate a more transparent process; however, that has changed and recent media reports portray appraisers as purported deal killers.

Buyers, sellers, investors, and brokers, although market participants, do not have the same third-party obligations to support their positions with factual market evidence. The price established by the participants in a single transaction has to be supported by other market evidence in order to be reflective of a market value. Members of the Appraisal Institute and certified appraisers are trained to define the valuation problem, develop a work plan, and collect and analyze the relevant data to arrive at a well-reasoned value opinion. Equipped with knowledge and skill, appraisers apply their judgment to best advise the user of an appraisal with a value opinion that best reflects today’s economic reality.

A comprehensive market analysis is an essential part of the appraisal process and is necessary to render a well-founded opinion of value. The process starts with an understanding of the property’s use or potential use, which creates its value. Armed with that knowledge, the appraiser can form judgments about how a property fits the needs of owners and users in a particular market.

Looking outside the subject property, it is the appraiser’s job to research and understand, on macro- and micro-economic levels, supply and demand parameters as they can impact a specific property. This economic insight forms the basis of the highest and best use conclusion, which is a critical part of every appraisal.

Relying on the Appraisal Institute’s body of knowledge and adequate due diligence, appraisers should bring to each assignment a clear understanding of the potential users/buyers of the property and the likely demand for that property.

Interpreting the Data

Appraisers have a responsibility to understand market trends and advise their clients on whether the continued use of existing improvements is consistent with a property’s highest and best use or whether an alternate use, redevelopment, or remodeling should be considered. Market cycles vary across market sectors and regions, and appraisers must apply their skill in judging a property’s ability to capture its market share of demand and whether its use represents the maximally productive use of the property.

Understanding what’s hot and what’s not in real estate markets is critical to an appraiser’s ability to arrive at a value conclusion that is market-supported. As a reporter of market behavior, the appraiser’s role is to report on market conditions and the activity of buyers and sellers and tenants and landlords and to be an advocate for the value, not to influence market forces or to be an advocate for their client, which distinguishes appraisers from buyers, sellers, investors, and brokers.

As the occasional deliverer of bad news, the appraiser is not to blame. The users of appraisal services should expect a competent and well-founded opinion that is sufficient to solve the valuation question and should demand that their appraiser be knowledgeable and able to communicate their view of market conditions and, most importantly, how these conditions relate to the subject property. The truly professional appraiser contributes a valuable service to clients, as well as the general economy, with the truthful portrayal of the property’s value and extant market conditions whether the news is good or bad.

Michael P. Hedden, MAI, FRICS, and Marc R. Shapiro, MAI, MRICS, are managing directors for real estate valuation in the Real Estate Solutions Group of FTI Consulting. Contact them at and

Rich Rosfelder

Rich Rosfelder is vice president of strategic communications for CCIM Institute.


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