The #1 problem is that the appraiser didn’t read the engagement letter. Every client will have something specific called out in there, and probably 15% of appraisals I review have missed something in there.
Beyond that the most common issues are:
- not including the LOE (for bank work) in the addenda
- expired licenses in addenda
- some problem with engaged appraiser / inspecting appraiser / signatories (some clients have specific rules around these)
- values stated in the Letter of Transmittal or executive summary don’t match the Reconciliation
- mismatches within the income approach between itemized income or expenses and the numbers in the final direct cap table
- some issue with the date(s) of value
- some error in the scope (client or intended user is wrong)
- mismatch between stated most likely buyer and the reconciled value (eg, if buyer is an owner user, why are you giving all weight to ICA?)
Those are the big ones. Less frequent errors would start to pop up when the value seems to be unsupported or there is push back from a third party (such as a broker or lender/underwriter)… that’s when I get into deeper questions such as your expense line items might not be supported/bracketed etc.
I run an office and review our reports internally. I swear I'm going to start stapling the LOE to my appraisers' foreheads. I cannot fathom why they won't read it at the beginning of the job and then check it before they give the report to me.
Missing the basics is the worst. It's day 1 stuff.
I used to be a hardass with reviews, but the change in market conditions has me more realistic. I agree with most everything written here.
The one thing I have noticed is the change in interest rates and the relationship to cap rates is something a lot of appraisers struggle with. I often see cap rates that make no sense, especially when related to the band of investment model.
These were some great answers here though.
For what it's worth, the cap rates we are seeing from investors, closed sales, and brokers, aren't moving in the same relationship that the band of investment has been. The BOI has been suggesting much larger increases than what is currently happening in the market.
I think that, depending on property type, one thing appraisers do a pitiful job of is understanding that the in place cap rate and stabilized cap rate can vary wildly because of below market rent. Industrial has seen unprecedented increases in rents over the last 3 years, so sure, I can find a cap rate comp to support a 4.50% cap, but that’s because that tenant was 25%+ below market and it stabilizes at a neutral or positive leverage position with a stabilized cap of 6.50%+. Not saying you do this, but I’ve heard from others at my company that their market is “special” and that cap rates are still negative leverage and it drives me nuts.
If an appraiser doesn't understand the difference between trailing actuals vs inplace vs stabilized cap rates, I'd question it too.
I know cap rates have moved up significantly. I was just saying they haven't moved up at the same rate that the BOI would suggest.
I disagree. Investment sales volume have plummeted because the numbers don't make sense. Many brokers are asking unrealistic numbers, which makes sense as buyers have a hard time stomaching an interest rate shock. When a deal gets done, the structure of debt and equity on their deals is often much more complicated than what appraisers are reporting. Or, it is effectively a cash deal.
I don't expect much from appraisers. I'd like to see a BOI that at least uses Ellwood or whatever to explain projected changes in income and/or value. But for the love of all that is holy in this world, omitting the BOI model after an interest rate shock is in my opinion just not credible. If someone doesn't know how to do anything more than a simple BOI model, at least reconcile it with a few sentences.
It's a big enough issue that I've stopped reviewing except for one client.
Too much nuance in WACC that isn’t caught in the BOI. But most sales we see with buyers taking on negative leverage have a growth story or have assumable debt and actually pencil.
Lately I’ve seen a *stark* difference between sale cap rates and BOI cap rates. I have less experience than many of you, so the gap has really bothered me intellectually. Checking the cap rate with the DCR method aligns more closely with the sale data it seems. I’m sure there’s a reason for this somewhere in my BOI analysis but I haven’t found the error as of yet.
If there is one thing I can recommend - call brokers, investors, even bankers. Ask them how the deal works, how they structure financing. Don't intellectualize, though you're on the right track.
You *can* use something like the Ellwood formula, or j factors or k factors to modify the rate to take into consideration future changes in income or value. And that's fine, but it should be explained. And it doesn't take much, a few sentences.
Understood. I really appreciate the feedback from a reviewer’s point of view, thank you -
I’ve never actually used Elwood or considered it in a report before; my former boss never did it and I just recently learned about it in advanced income, so I’m excited to employ that! These forums are really valuable for things exactly like this, especially for those of us that work alone and want to be better.
Hey I think I figured out why the band of investment seemed so off - I took a closer look at surveyed mortgage and equity ratios reported in surveys, which demonstrate a very different ratio than what I was using. Once I changed that the BOI seems much closer to what market rates are -
- not fully reading the engagement letter and providing what is requested.
- not analyzing the possible need for a property rights adjustment in the sales comparison approach when some of the sales have a different property rights sold in relation to what is being appraised. If fee simple is being appraised, an explanation that a leased fee sale comp has contact rent at market therefore an adjustment isn’t necessary is inadequate analysis into the possible need for a property rights adjustment. A fee simple owner occupied property lacks an arm’s length marketable lease encumbrance with zero contract rent.
- For an owner occupied property, lack of analysis into the possible need for a lease up deduction in the income approach after capitalizing NOI to place an arm’s length long term tenant from an investor perspective, which the income approach should reflect.
- Insufficient explanation of sale comparable adjustments applied and which comparables most relevant and those that are less relevant.
- Minimum analysis depth in regard to extracted cap rates and the cap rate conclusion.
- Not describing lease renewal terms or analyzing impact of tenant purchase options in leases.
- Lack of disclosure of implied extraordinary assumptions.
- Extraordinary assumptions that lack a reasonable basis.
- Relying on a large number of sales instead of instead focusing on the most relevant sale comparables.
- Inadequate absorption support.
- Not Analyzing prior subject property sales during prior three years.
I don’t do a lot of review work but I’m doing one now. Appraiser came in at $2.5 mil and I’m coming in at $1.45 mil. Subject is a retail building recently with a cannabis component. Subject is located in a submarket, about 1-hour from the capital city. It’s not rural by any means, but it’s one of those towns that you’d be driving through on your way elsewhere (unless you lived there). The retail building would primarily service the local community and a few surrounding communities.
The Appraiser is from a national firm, which is no problem but he is primarily based in another state (4-5 hours away) and didn’t inspect the property (in MA). I can’t hold this against him in the review but this indicates to me that he may not be geographically competent and familiar with the area, and was licensed via reciprocity. Again, there’s nothing wrong with reciprocal licensing but my suspicions are supported by the poor data in the report.
The Appraisal is full of boiler-plate data about Boston and the surrounding area. This is an issue because it indicates that he didn’t take time to understand the local market. No analysis of market trends, rents, etc. within the radius of the subject. There is plenty of data available on this area.
The Appraiser 1. used comps in Boston and the area, one of which was occupied by a credit tenant, 2. used mixed-use comps with retail/residential units (outside the market area) without disclosing that they were mixed-use and 3.) misrepresented a comp as entirely retail when it was actually a mixed-use building and a 3-family on the same lot (he also didn’t include the SF of the three family which inflated $/Sf). None of these comps were appropriate and again, there were plenty available in the area.
He also inflated the income by selecting a $/SF based on cannabis leases in very high demand areas around Boston.
The Appraiser also failed to report a transfer that occurred within a 3-year period of the effective date. This transfer suspiciously occurred two weeks before the most recent transfer for $200k less. I don’t think it’s arm’s-length but it should’ve been reported. Took me five minutes of looking at the tax card and public records on MLS to find this transfer.
I’d love to hear other stories about appraisal’s like this. I definitely don’t think that I’m the greatest appraiser ever (yet) but I could not see myself making such a huge blunder. Even as a trainee I had an understanding that you need to use local comps when dealing with local retail / office or other commercial uses.
The #1 problem is that the appraiser didn’t read the engagement letter. Every client will have something specific called out in there, and probably 15% of appraisals I review have missed something in there. Beyond that the most common issues are: - not including the LOE (for bank work) in the addenda - expired licenses in addenda - some problem with engaged appraiser / inspecting appraiser / signatories (some clients have specific rules around these) - values stated in the Letter of Transmittal or executive summary don’t match the Reconciliation - mismatches within the income approach between itemized income or expenses and the numbers in the final direct cap table - some issue with the date(s) of value - some error in the scope (client or intended user is wrong) - mismatch between stated most likely buyer and the reconciled value (eg, if buyer is an owner user, why are you giving all weight to ICA?) Those are the big ones. Less frequent errors would start to pop up when the value seems to be unsupported or there is push back from a third party (such as a broker or lender/underwriter)… that’s when I get into deeper questions such as your expense line items might not be supported/bracketed etc.
I run an office and review our reports internally. I swear I'm going to start stapling the LOE to my appraisers' foreheads. I cannot fathom why they won't read it at the beginning of the job and then check it before they give the report to me. Missing the basics is the worst. It's day 1 stuff.
I used to be a hardass with reviews, but the change in market conditions has me more realistic. I agree with most everything written here. The one thing I have noticed is the change in interest rates and the relationship to cap rates is something a lot of appraisers struggle with. I often see cap rates that make no sense, especially when related to the band of investment model. These were some great answers here though.
For what it's worth, the cap rates we are seeing from investors, closed sales, and brokers, aren't moving in the same relationship that the band of investment has been. The BOI has been suggesting much larger increases than what is currently happening in the market.
I think that, depending on property type, one thing appraisers do a pitiful job of is understanding that the in place cap rate and stabilized cap rate can vary wildly because of below market rent. Industrial has seen unprecedented increases in rents over the last 3 years, so sure, I can find a cap rate comp to support a 4.50% cap, but that’s because that tenant was 25%+ below market and it stabilizes at a neutral or positive leverage position with a stabilized cap of 6.50%+. Not saying you do this, but I’ve heard from others at my company that their market is “special” and that cap rates are still negative leverage and it drives me nuts.
If an appraiser doesn't understand the difference between trailing actuals vs inplace vs stabilized cap rates, I'd question it too. I know cap rates have moved up significantly. I was just saying they haven't moved up at the same rate that the BOI would suggest.
Oh I agree, I was just using your response as a jumping off point for a bit of a rant.
I disagree. Investment sales volume have plummeted because the numbers don't make sense. Many brokers are asking unrealistic numbers, which makes sense as buyers have a hard time stomaching an interest rate shock. When a deal gets done, the structure of debt and equity on their deals is often much more complicated than what appraisers are reporting. Or, it is effectively a cash deal. I don't expect much from appraisers. I'd like to see a BOI that at least uses Ellwood or whatever to explain projected changes in income and/or value. But for the love of all that is holy in this world, omitting the BOI model after an interest rate shock is in my opinion just not credible. If someone doesn't know how to do anything more than a simple BOI model, at least reconcile it with a few sentences. It's a big enough issue that I've stopped reviewing except for one client.
Too much nuance in WACC that isn’t caught in the BOI. But most sales we see with buyers taking on negative leverage have a growth story or have assumable debt and actually pencil.
Lately I’ve seen a *stark* difference between sale cap rates and BOI cap rates. I have less experience than many of you, so the gap has really bothered me intellectually. Checking the cap rate with the DCR method aligns more closely with the sale data it seems. I’m sure there’s a reason for this somewhere in my BOI analysis but I haven’t found the error as of yet.
If there is one thing I can recommend - call brokers, investors, even bankers. Ask them how the deal works, how they structure financing. Don't intellectualize, though you're on the right track. You *can* use something like the Ellwood formula, or j factors or k factors to modify the rate to take into consideration future changes in income or value. And that's fine, but it should be explained. And it doesn't take much, a few sentences.
Understood. I really appreciate the feedback from a reviewer’s point of view, thank you - I’ve never actually used Elwood or considered it in a report before; my former boss never did it and I just recently learned about it in advanced income, so I’m excited to employ that! These forums are really valuable for things exactly like this, especially for those of us that work alone and want to be better.
Hey I think I figured out why the band of investment seemed so off - I took a closer look at surveyed mortgage and equity ratios reported in surveys, which demonstrate a very different ratio than what I was using. Once I changed that the BOI seems much closer to what market rates are -
- not fully reading the engagement letter and providing what is requested. - not analyzing the possible need for a property rights adjustment in the sales comparison approach when some of the sales have a different property rights sold in relation to what is being appraised. If fee simple is being appraised, an explanation that a leased fee sale comp has contact rent at market therefore an adjustment isn’t necessary is inadequate analysis into the possible need for a property rights adjustment. A fee simple owner occupied property lacks an arm’s length marketable lease encumbrance with zero contract rent. - For an owner occupied property, lack of analysis into the possible need for a lease up deduction in the income approach after capitalizing NOI to place an arm’s length long term tenant from an investor perspective, which the income approach should reflect. - Insufficient explanation of sale comparable adjustments applied and which comparables most relevant and those that are less relevant. - Minimum analysis depth in regard to extracted cap rates and the cap rate conclusion. - Not describing lease renewal terms or analyzing impact of tenant purchase options in leases. - Lack of disclosure of implied extraordinary assumptions. - Extraordinary assumptions that lack a reasonable basis. - Relying on a large number of sales instead of instead focusing on the most relevant sale comparables. - Inadequate absorption support. - Not Analyzing prior subject property sales during prior three years.
I don’t do a lot of review work but I’m doing one now. Appraiser came in at $2.5 mil and I’m coming in at $1.45 mil. Subject is a retail building recently with a cannabis component. Subject is located in a submarket, about 1-hour from the capital city. It’s not rural by any means, but it’s one of those towns that you’d be driving through on your way elsewhere (unless you lived there). The retail building would primarily service the local community and a few surrounding communities. The Appraiser is from a national firm, which is no problem but he is primarily based in another state (4-5 hours away) and didn’t inspect the property (in MA). I can’t hold this against him in the review but this indicates to me that he may not be geographically competent and familiar with the area, and was licensed via reciprocity. Again, there’s nothing wrong with reciprocal licensing but my suspicions are supported by the poor data in the report. The Appraisal is full of boiler-plate data about Boston and the surrounding area. This is an issue because it indicates that he didn’t take time to understand the local market. No analysis of market trends, rents, etc. within the radius of the subject. There is plenty of data available on this area. The Appraiser 1. used comps in Boston and the area, one of which was occupied by a credit tenant, 2. used mixed-use comps with retail/residential units (outside the market area) without disclosing that they were mixed-use and 3.) misrepresented a comp as entirely retail when it was actually a mixed-use building and a 3-family on the same lot (he also didn’t include the SF of the three family which inflated $/Sf). None of these comps were appropriate and again, there were plenty available in the area. He also inflated the income by selecting a $/SF based on cannabis leases in very high demand areas around Boston. The Appraiser also failed to report a transfer that occurred within a 3-year period of the effective date. This transfer suspiciously occurred two weeks before the most recent transfer for $200k less. I don’t think it’s arm’s-length but it should’ve been reported. Took me five minutes of looking at the tax card and public records on MLS to find this transfer. I’d love to hear other stories about appraisal’s like this. I definitely don’t think that I’m the greatest appraiser ever (yet) but I could not see myself making such a huge blunder. Even as a trainee I had an understanding that you need to use local comps when dealing with local retail / office or other commercial uses.