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CRE Finance World, Winter 2012

Valuing Appraisals: Evidence from the CMBS Industry Chart 4d Chart 5b Lodging AV/GP; N=130; Average Gap=31.5% UPB> $10MM; N=289; Average Gap=23.9% Appraisal Accuracy by Unpaid Principal Balance (UPB) Implications The final analysis considers the appraisal accuracy by the unpaid One of the greatest challenges facing the real property community principal balance. It is worth noting that the value size variable today is over definitions of value and how to adapt an “As-Is” market could be examined by either unpaid principal balance, appraised value appraisal to the subsequent accounting and servicing value value or liquidation proceeds. These tests may yield different perspectives once the loan goes bad. Appraisers aren’t accountants. results. The principal balance tested below divides UPB above and below $10 million. The vast majority of loans — 1,787 out of 2,076 Accountants aren’t appraisers. And special servicers are just or 86% by number — are in the smaller category.6 caught in the middle with investors tempted to believe that someone got the value wrong. Indeed, the financial, accounting bank regulatory The smaller balance category shows relatively higher dispersion, and loan servicing industries place the appraiser in a precarious including 113 loans exceeding 2.0:1, and a materially higher Average position of asking for a “one-size” opinion of value that meets Gap at 44% versus the larger loans’ 23.9%. Only 8 out of 289 of all parties’ needs. And, because of a crisis of confidence in the the larger loans exceeded an AV/GP of 2.0:1. In the over/under appraisal industry today due to regulatory turmoil, accounting classification, small balance loans are split 500 under 1.0, and complexities and the evolution in financing structures in which 1,287 loans over 1.0 which heavily skews to overstated values. appraisers often fail to appreciate the importance of concepts The larger loan category splits in favor of more conservative values like “interest appraised,” “highest & best use,” and “fair value,” trust with 150 under 1.0 and 139 over. and reliability in real estate values has eroded. Without restoration of both, capital will be slow to return to real estate. This volatility is captured prominently when comparing the standard deviation of the AV/GP ratios: the larger loans produce a standard Why is clarity over opinions of property value so vital? On one hand, deviation of 36%; the smaller loans produce a standard deviation the real users of appraisals have lost faith in their reliability and of AV/GP of 319%. The data support the hypothesis that appraisals credibility. On the other hand the “value police” (bank regulators, on smaller balance loans are less reliable. auditors, SEC, etc.) have elevated appraisals in rule making and policy to a point of unquestioned gospel. The “value police” take Chart 5a whatever appraisal is on hand and unilaterally rely upon it to make UPB<$10 MM; N=1,787; Average Gap=44.0% consequential, sometimes irreversible decisions. It is difficult to overstate the importance of appraisals on commercial property financing. Lenders are regulated, mortgages are serviced and creditors’ rights are pursued all with heavy support from appraisals. In one recent CMBS transaction, the term “appraisal” is used more than 150 times in the deal’s pooling and servicing agreement. The problem is that definitions of value and property interest to be appraised often lack clarity. In the new world of CMBS 2.0, Appraisal Reduction Amounts that arise when mandatory appraised values are applied against certificate balances can and A publication of Winter issue 2012 sponsored by CRE Finance World Winter 2012 39


CRE Finance World, Winter 2012
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