Friday, July 20, 2018

My Property Didn't Appraise - But Why?

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Recently, I counseled my sister-in-law. She is selling her house and the appraiser was scheduled to visit.

Although this column is commercial real estate focused, some of the same appraisal principles apply - plus my associate suggested I write something about the process and how slight assumption variations can cause wide swings in value.

So to all y'all out there with a bad number, here's why.

Reason one. Lender review. Since the financial music stopped in 2008, banks have been very careful to ensure appraisers don't have un-tethered reign. Consequently, appraisers are engaged by the lender - not the buyer or seller - and a strict review process is conducted once the appraisal is submitted. I've had appraisers assure me we were OK - only to have the review disagree.

Reason two. Rear view mirror. Comparable sales and leases are tantamount to a fair valuation - and are known in appraiser speak as the market approach. However, past history - done deals - only show you where you've been - not where you're headed. In an up-trending market, a sale that occurred three months ago may dramatically understate the current conditions.

Reason three. Assumptions. Market approach - has a second cousin - the income approach. Necessary for a proper look are recent lease transactions and the capitalization rate investors are paying. You remember capitalization rate - or cap rates, right? - a percentage measure of the net income divided by the purchase price. Well, in order to get there, an appraiser must assume a lease rate - tough to do because lease comps are not readily shared by commercial real estate professionals and a cap rate. As a cap rate is a measure of risk - the higher the risk, the higher the cap rate - the rate used can swing a valuation dramatically. Simple math - Income of $100,000 with a cap rate of 4.5% yields $2,222,222. But increase the cap rate to 5% and we get $2,000,000 - a delta of almost a quarter million dollars.

Last year - in this space - I provided four solutions if find yourself on the short-end of a valuation. In case you missed it, you can quickly catch up by clicking this link. The punch line - Seller reduces the price, buyer ups his down payment, parties cancel the deal, and/or compromise.

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