Fee Simplistic is a regular post by Martin Tessler, CRE whom after 30 years of commercial fee appraiser-related experience, gets to the bottom of real issues by seeing the both the trees and the forest. Marty has never been accused of being a man of few words and his commentary can’t be inspired on a specific day of the week.

…Jonathan Miller

From illiquidity to insolvency, to default, to unemployment, to declining demand for space and consumer spending, to falling rents, growing vacancies and overall economic gloom coupled with looming mortgage refinancing in the face of a continued credit market freeze-up. Is it time to realize that this might well be the perfect storm? What lessons have we learned? It does not take Advanced Appraisal 501 to have foreseen that the frenzied market produced by low interest rates, CMBS securitization that off-loaded risk, easy credit and lax underwriting standards, if not their complete absence as in the residential sector, was a disaster waiting to happen (archival Soapbox postings would confirm).

The appraisal world however, true to its role in reporting what the market was experiencing as of the valuation date, could only report back market metrics of sales prices/square foot, going-in cap rates, cash-on-cash yields, expected investor yields, rental growth, and vacancy trends. And if the appraisal lived up to its fundamental requirements, it would include a section on supply and demand metrics for the particular use of the subject property. Anecdotally, I can count on the fingers of one hand the number of appraisal reports reviewed in my previous financial institution days that truly measured supply and demand factors in apartment sale and rental scenarios, shopping center appraisals where share of the market sales ratios were calculated, office space supply and absorption vs. employment growth. This is not to say that these metrics were not presented in the appraisal report but the manner of presentation was generally “boilerplate” filler to convey the feeling that these factors were being addressed.

We have gone from a capital driven market back to what will be prevailing supply and demand metrics in the specific geographic market of the subject property. In essence we will be forced to return to market analysis as the basis of valuation rather than rely on the frenzied deals of the past created by easy credit. Nowhere is this more evident than in an overview of the capital markets where in 2007 commercial property sales generated $500 billion in financing that declined to $150 billion in 2008. For 2009, loans projected for maturation refinancing total between $80-90 billion. The present closure of the securitization market will mean that valuations are going to have to be dead-on in their opinion of value and absent bonafide market analysis measuring supply and demand the appraisal will likely not be worth the paper it is written on.

This brings to mind the question of estimating value in a market that is virtually shut down and is stuttering along to find itself in volatile economic circumstances. Should the FIRREA/USPAP protocols be amended to mandate that every appraisal look at a downside risk scenario? Thus not only would the appraisal report the opinion of value as of the date of value but it would also include the lower end of value if economic and market assumptions did not pan out. If investors and lenders are exposed to the downside would it enable a thawing of the credibility and credit freeze prevailing today? My opinion is-yes it would at least help.

The Wall Street Journal, in a recent article reporting on the mezzanine debt that financed the acquisition of the John Hancock Tower, quoted a lawyer specializing in real estate that “tranche warfare” is starting in the battles over who will sustain losses or retain equity from overleveraged debt and how these are going to be battles never previously encountered. The article went on to point out how mezzanine debt was sliced and diced among different investors similar to the tranching of CMBS debt. Compounding the problem is the fact that if there was a default an appraisal was to be undertaken to determine which investors retained equity and who were wiped out. Needless to say, arguments over the appraised value have started. A major factor contributing to the cash flow shortfall was that in the two year period from the time of the purchase vacancy in the building went fro 0 to 15%. Whether this was on the radar screen of the appraisers or attributable to the market would have been something that turned up in a definitive market analysis. This will be a very interesting period for lawyers if not appraisers who may well discover that the slicing and dicing may well have produced values (or prices) greater than the sum of the tranched parts.

All hands on deck man your battle stations


  1. Edd Gillespie January 25, 2009 at 12:58 pm

    “Thus not only would the appraisal report the opinion of value as of the date of value, but it would also include the lower end of value if economic and market assumptions did not pan out.”

    This sounds like prediction, which neutralizes the effective date included in the concept of market value.

    The lenders and investors who have been willing to discuss the matter seem to be comfortable with their ability to predict value and part of the freeze up seems to have something to do with them looking through a glass darkly. Of course, most lenders and investors also think they know what something is worth without an appraisal. Would it not be as helpful and more in keeping with the abilities of appraisers to require market analysis to the actual date of valuation rather than choose some date in the future or just report the assumption that the sky will continue to fall?

    Why not include the upper end of value just in case positive market assumptions pan out?

    In this time, it is critical to report market supported time adjusted values and stop with that. Nobody knows where this is going. We are only now becoming aware of where it has been. Date of value with well supported time adjustment is the way to go. I’d vote for more in depth market analysis and reporting in all appraisals always to the extent reliable, relevant and meaningful data is available. Leave the predictions to the economists, start training appraisers to analyze the market and give them week long tests that require them to analyze the market and then cogently report what they analyze. If they can’t do it then don’t give them a license until they can.

    We are required to know USPAP inside and out, and that is good. Shouldn’t we know the market inside and out?

  2. marty tessler February 12, 2009 at 5:26 pm

    Edd-your challenging & inspiring commentary is noted and date is critical to estimating value. But if we have 10 year horizons on DCF’s & get wrapped up in growth rates as of date of value (mkt.rents, new supply, demand, employment, absorption, etc) coupled with IRR’s we are ending up with “numbers” not values brought forth by the Argus, Project & Excel computer programs. What I’m leading to is that assumptions as of the date of valuation are only as good as the current thinking in the market and there is no violation of USPAP protocols if the appraiser comes up with a range of value from high to low based on the market analysis which is already crystal balling into the future.
    Presumably you are retaining an appraiser for his knowledge and opinion as to how markets & cash flows are going to evolve over the projection period discounted back to the date of valuation. It is my contention that you want an experienced appraiser to call the value based on all tha tis not only happening at that date but what is likely to evolve over the “holding period” and this is where experience & expertise come in-not just calling out a “number” produced by a DCF. In the battle between borrower & lender or buyer & seller it is each side’s right to fight for their share of the value range. Could a selling price be higher or lower than an appraiser’s market value-certainly. That’s where I was going in my commentary although I was looking back at the overheated market of the 2005-2007 period when even then I could not believe that the market would be sustained at that level and that the numbers were exactly that -numbers and not values despite the sales activity.

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