Commercial Real Estate Finance

In the world of commercial real estate, property appraisers are beginning to receive a great deal of attention for their work and accuracy, and the attention isn’t especially positive. Much like the credit-rating professionals before them, appraisers are being singled-out as potential culprits in the drastic devaluations that rocked the real estate world in 2008-2009.

A study by members of Collier’s International and law firm McKenna Long & Aldridge has brought to light some startling discrepancies between the valuations and eventual sale prices of many properties. The study focused on properties backed by securitized bonds that were foreclosed on and liquidated.  A New York Times article explains,

In general, appraisals overvalued the properties, the study found. Of the 2,076 properties it examined, 64 percent were appraised at values that exceeded the sale price, by a total of $1.4 billion, while 35.5 percent were appraised at less than the sale price, by a total of $661 million.

And it gets worse:

At the extremes, in 121 instances, the appraised value was more than double the sale price, and in 132 examples, the appraisal was less than 70 percent of the sale price. It is like “a game of horseshoes and throwing grenades,” the authors wrote of the results. “Close is good enough.”

Commercial real estate transactions are very different from, say, buying an apple at a farm stand. If I’m a few cents short, the vendor may sell me the apple anyway, since the money I have is “close enough.” But in the appraisal of a major property, whether a shopping center, office building, or apartment complex, a tiny valuation discrepancy can hold dire consequences. Sure, $99 million is close to $100 million–unless that missing million dollars is yours. Property values can be extremely unforgiving of errors.

However, in fairness to appraisers, who will readily admit that valuation is an art, not a science, there are numerous factors to a property’s value, many of which are difficult to ascertain. Defending its industry, the Appraisal Institute makes the case that appraisers reflect a market’s behavior, but can’t necessarily predict it. Lacking any point of reference other than properties with similar valuations–which themselves have no stable point of reference–appraisers must make their best guess.

When a property comes to market, its “real value” (as Josh Sapienza has pointed out) is simply whatever someone is willing to pay. If I’m appraising a luxury hotel in Anytown, USA, a town with no other luxury hotel, I’ll have to look at other hotels in demographically comparable towns to get some sense of what the property is worth. The data I collect may or may not apply to the town or hotel I’m actually working with.

Nonetheless, says an expert in the New York Times,

“Appraisals are important in nearly every aspect of a real estate deal, whether it is originating a loan, working out a loan, the decision to buy or sell a property and even bankruptcy.”

So, there you have it. No pressure!

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