By Carl Streck, Co-founder and CEO, Mountainseed
In a perfect world, an appraisal would land on your desk free of error. However, as we know, the world isn’t perfect, and as such, neither are appraisals. With the average appraiser completing between 220 and 240 appraisals per year, it’s only natural that mistakes happen. While finding mistakes can be tedious, including a mindful checklist in your appraisal process can help you be aware of some of the common mistakes you should be on the lookout for. MountainSeed is a national AMC that serves several hundred community, regional, national, and international financial institutions and credit unions, and today we will share what we’ve dubbed our “Common Deficiencies Greatest Hits,” or the most Common Deficiencies in back-ordered appraisals. We’ll explain some of the easy-to-understand issues that we might see on a daily basis.
Math errors in DCF (discounted cash flow analysis): Math errors, unfortunately, happen frequently, especially in appraisals that don’t use ARGUS software or similar commercial software. Terry Bowditch, the Chief Appraiser at MountainSeed says, “We do check for math, and while we start with the appraiser's assumptions, we try to confirm or replicate the DCF results that are in the appraisal.” For some clients, that means including the reviewer’s DCF spreadsheet with the review, so the client has an understanding that you have confirmed all of the math. It’s a checks and balances system of sorts.
As-Is Value: Every appraisal, with very, very few exceptions, needs an As-Is Value. As-Is Value is the market value of real property in its current physical condition, use, and zoning as of the appraisal’s effective date. Bowditch explains, “We have confirmed that the As-Is Value is always required with multiple regulators including the OCC and FRB.” In some cases, particularly on the residential side, appraisers try to resist the As-Is Value saying that the financial institution, credit union, or regulations are asking them to do a complete second appraisal, but this is not necessarily true. “In most cases,” Bowditch says, “completing a second, separate appraisal like this would be an improper way of valuing the As-Is Value.” In the case of a renovation or repair, the As-Is Value is usually a cost to cure, whereby the appraiser completes the As-Complete Value, and then subtracts out the cost to repair value. In new construction, it’s usually the value of the site or the value of the vacant land. “If the appraiser is doing the proper job, they should be valuing the land or the site and supporting that value,” Bowditch asserts. He continues, “Either way, this part of the work should be completed anyway, and it’s just a matter of reporting it.”
Leased Fee/Fee Simple: When it comes to the Leased Fee or the Fee Simple, there are a few distinctions to look for. If a property is encumbered by a long-term lease, the proper As-Is Value is the Leased Fee, but sometimes a financial institution or credit union will ask for what is called a Fee Simple. “If the appraiser only presents the Fee Simple, and the property is encumbered by a lease, then he or she hasn’t provided the As-Is Value; it’s perfectly acceptable to provide both values,” Bowditch clarifies. The appraiser would provide the Leased Fee Value, and then do a second value under a hypothetical condition in order to produce the Fee Simple Value. One more item of note: When a property is encumbered by a non-market lease, the appraisal must clearly state the ownership interest, and if the contract rent is less than the market rent (if the Leased Fee value is less than the Fee Simple value) then for loaning purposes, the financial institution or credit union must use the Leased Fee (the lower value).
Extraordinary Assumptions & Hypothetical Conditions: While different, these two common deficiencies are best explained hand in hand. An Extraordinary Assumption is an assumption, directly related to a specific assignment, as of the effective date of the assignment results, which, if found to be false, could alter the appraiser’s opinions or 69 conclusions. In contrast, a Hypothetical Condition is a condition directly related to a specific assignment which is contrary to what is known by the appraiser to exist but is used for the purpose of analysis. First, when it comes to Extraordinary Assumptions and Hypothetical Conditions, always be aware of the use of each one and understand their potential effect on the appraisal. Second, consider if they are reasonable. Bowditch says, “Sometimes, the appraiser will use an Extraordinary Assumption or Hypothetical Condition to obviate something which he should be doing because either he is being lazy or doesn’t understand how to do it. If it’s not reasonable, it could have a major impact on value.” Consider, for example, the presence of asbestos. Don’t assume that it’s not present in a building whereby the abatement of asbestos could cost more than the building is worth. When it comes to new construction, this is where Extraordinary Assumptions and Hypothetical Conditions really differ. For example, if an appraiser uses a current date, they would use a Hypothetical Condition because the improvements don’t yet exist. If an appraiser uses a future date, he would use an Extraordinary Assumption because logically, he assumes that the improvements will be there in the future.
It’s important to keep in mind that these are just a few of the common deficiencies. When completing these reviews, use the results of your own appraisal process to then give feedback on your panel management process. As MountainSeed President Nathan Brown says, “At the end of the day, the best way to ensure that you’re getting good appraisals is to use good appraisers.” As such, it’s key to use these issues in your review process to determine your quality scoring.
Carl Streck is Co-founder and CEO of MountainSeed. He oversees all aspects of new and existing clients.