Joel D. Gonia, ASA – ARM, MTS
Senior Appraiser, KATS M&E, LLC.
Abstract: Lenders need the assurance that the value of collateral represents “real world” market conditions. Lenders need an appraisal they can depend on. Understanding and correct application of the intended use and scope of work is paramount to a credible appraisal. Within commercial lending, the review appraiser is tasked with understanding both regulatory compliance issues and specific market attributes. This article will discuss best practices to correctly review a report where the original intended use is for commercial lending.
When approaching an appraisal review for any reason, a review appraiser will want to consider a comment in Standards Rule 3-3(a)(iii), repeated in (b)(ii), that states:
Consistent with the reviewer’s scope of work, the reviewer is required to develop an opinion as to the completeness, accuracy, adequacy, relevance, and reasonableness of the report …
This direction, which underlies much of ASA’s Appraisal Review classes, is excellent guidance in reviewing reports for commercial lending.
Lenders don’t want questions, they need answers. While you may think your review is insignificant and just represents a checked box, most likely it is paramount to closing the loan. The lender may not be a professionally trained valuation expert and is relying on your judgement and expertise to tell them what they’ve got! As part of the review process, we opine on the quality of work and if we believe the value conclusion is credible. We only mention an actual opinion of value ourselves if that appraisal service has been requested in addition to the upfront review.
The lender is relying on your review for several key factors, all relevant to the lending process:
Within the scope of work, you should identify the elements that allow the review to address all of these.
As a review appraiser for lenders, I have reviewed all sorts of appraisals, most are pretty good and in full compliance with USPAP, but not all. Some appraisals are contracted by the lender directly while others are provided by the potential borrower or possibly a co-lender with little to no consistency regarding qualifications and standards.
Appraisal Reviews provided by ASAs must be USPAP compliant, in accordance with Standard 3, but our review process does not automatically assume the original appraisal must adhere to USPAP. Remember to check if the original engagement letter required the appraiser to comply with USPAP. If the original appraisal does not claim to be USPAP compliant or was not required to comply with specific standards such as USPAP or IVS, you will probably review that report differently than one that is intended to comply with USPAP.
Your client may have accepted the original appraisal regardless of whether it complies with any specific standards or not. Say the collateral is a fleet of over-the-road (OTR) trucks and trailers and the original appraiser is a local dealer with many years’ experience but is not a professionally trained appraiser. Their values may be accurate, but are not adequately supported within the report, if there is one. What to do? Start by requesting a copy of the original engagement letter to confirm what, if any, requirements the appraisal was to be performed under, then proceed with the review. While we cannot hold the original appraiser to a higher standard than they were required to perform, any appraisal report should be credible and provide supporting narration and documentation as referenced in the Comment in Standard Rule 3.
Whether or not the original report is required or not to be USPAP compliant, an important question is whether it contains sufficient data to support the appraisal results. In the situation of the OTR trucks and trailers, are the values — which may be accurate — adequately supported within the report? Credible appraisals are complete and can be understood by their intended users whether or not they are technically USPAP-compliant. Does the appraisal report have all the information and explanation a lender would need to understand the value conclusion?
Credible appraisals do not contain errors. The lender will depend on the data to determine collateral positions. We are really addressing two significant concepts: data accuracy and value accuracy. Data accuracy relates to the actual asset data (make, model, serial or VIN, and so on) necessary to secure the loan. Junk in – junk out! The lender will place a lien against the collateral and may use the asset listing within the loan documents without additional verification. If the data is incorrect, the lender may not be secured – big problem!
Value accuracy is equally important to determine an appropriate loan-to-value position. Each lender has their own unique formula to determine the amount, but it all begins with the estimated value by the appraiser. It’s not good enough to be in the ballpark. Appraisals need to accurately reflect the market for subject property.
Within your review process, you are attempting to determine the quality of work and if the conclusions are credible and supported. You are determining if the conclusions appear to be accurate based on the data and methodology used within the original appraisal. Appraised values represent a specific date in time (effective date of value) and we should consider all data as it relates to that date and the scope of work. Remember you are not yielding an opinion as to the value of subject property, unless requested within a separate agreement.
The original appraisal report must be adequate for the intended use and should align with the stated scope of work. Simply put, the appraisal services and subsequent report should address all assignment elements within the scope of work, nothing more, nothing less. Possibly more if the report is intended as a USPAP compliant report though the client did not require it.
Adequacy is a judgment call made by the review appraiser. We know the original appraisal was to be used within commercial lending, so if the listing of collateral does not contain sufficient detail then that may become an issue. VIN (vehicle identification numbers) and serial numbers are often used to identify assets within loan documents. According to your review analysis of the overall quality of work, it may be questionable if this information is not provided.
The concept of value is also of concern. Most lenders do not base their loan-to-value ratios on a continued use concept, rather a removal or in exchange concept. What does the original scope of work require? Maybe the original appraiser was required to provide a specific concept, or not.
Lenders want to rely on the original appraisal for the basis of their collateral requirements. They need to know if the original appraisal is sufficient, or not, to move forward with the loan process.
If the contents of the work are not applicable, the lender may question if sufficient effort was performed. Boilerplate discussing details beyond the appraisal problem and the scope of work may be a red flag. Many appraisers utilize a template for their report, and many include data and information that may not be immediately relevant to the assignment. How much is too much? This is another judgment call made by the review appraiser when considering the type and extent of discussion within the original report. The reviewer should notice if the original appraisal stays on point or interjects a bunch of data and discussion that really isn’t necessary.
For example, think of a commercial real estate appraisal of a significant property with full development of all three approaches to value. This report will typically be 60 – 100 pages long plus numerous addendums addressing overall market analysis, macro- and micro-neighborhood analysis, rent and occupancy trends, and so on. Rather extensive to say the least. Now compare that to an appraisal of a machine shop with 20 – 30 CNC machines of common type and manufacture. This appraisal will typically only include the sales comparison approach due to the abundance of data currently available and the report may be 10 – 30 pages long.
Each report is relevant for the stated purpose! However, what if the M&E appraisal included full development of the cost approach and discussion of both direct and indirect replacement cost new values, yet clearly states that there is an abundance of used market data currently available similar to subject property? Is it necessary, or is it relevant to the overall appraisal to include the extra commentary and analysis to determine RCN? Probably not.
Within your review, try to determine if the original report was excessive, or conversely if it may not contain adequate supporting documentation.
Does the work performed and conclusions reached make sense? Given the scope of work, is it reasonable that others would reach a similar result? This is actually my favorite part of the appraisal review – I call it the sniff test! After I’ve read the original engagement letter and scope of work, after I’ve read the report, after I’ve reviewed the analysis, and after I’ve read the report again, I ask myself some questions: What do I think—Is the argument supported? Do I believe it? Yes, no, maybe. And then I go back and read the report for the third time, now making notes and comments according to my particular scope of work for the review.
The lender is asking the reviewer, either directly or indirectly, do we agree with this appraisal, and if not, why. If we think it is reasonable, then we need to relate that opinion to the client. If we don’t think it is reasonable, then we need to point out exactly where and why we believe it is inadequate. Sometimes an appraisal just doesn’t make sense, like maybe the appraiser didn’t understand the industry. Or maybe they didn’t address the scope of work elements or provide a proper concept of value. Or maybe the appraiser used the wrong effective date of value. Maybe the effective date of value represents a retrospective appraisal, yet the market data reflects current comparables! What does this thing smell like?
Providing review appraisals to commercial lenders is an important part of the lending process. Appraisal reviews are considered to be the additional support to justify collateral value and firm up the loan-to-value ratio so the loan can be booked. Of equal importance is to confirm compliance with standards so the original appraisal doesn’t get rejected down the road.
An appraisal review that has been performed well, that has addressed all assignment elements within the scope of work, will allow the lender to proceed with loan funding, or identify where the original appraisal failed so they can request a new appraisal. It is far better to know now that the collateral value is inadequately supported than find out later when the lender thought they were adequately protected.
About the Author
Joel D. Gonia, ASA - ARM & MTS,
Senior Review Appraiser, KATS Machinery & Equipment Appraisals, has
spent his entire career within the valuation industry – 35 years and counting! Joel
received his MTS ASA from the American Society of Appraisers in 1989 and his
ARM in 2016. At KATS, Mr. Gonia is responsible for all work performed by the
firm, including value accuracy and consistency, USPAP compliance, internal
policies and procedures, and continuing education. The clientele consists
primarily of professional service providers for middle market firms, providing
valuation and consulting services for financial reporting, commercial lending,
insurance, tax, and litigation purposes.