What Makes an Appraisal Report Questionable for Your Underwriters


In our previous blog, Rising Interest Rates: Critical Benchmarks in the Commercial Real Estate Valuation Process, we discussed a few critical benchmarks used in the commercial real estate valuation process.

In this blog, we will discuss some ‘questionable’ things to look out for as part of an appraisal review process. Ultimately, an appraisal report is an unbiased opinion of a property’s value based on interior and exterior conditions, location, and surrounding market conditions. It is an appraisal reviewer’s role to drive the report to a standard where underwriters will not question the property appraisal for commercial and residential lending purposes. At LCS, we help lending institutions and their internal underwriters understand the appraisal as well as the opinion of the real estate value.

Of note, it’s important to remember that, according to appraisal guidelines, the definition of market value states “both parties are well informed or well advised, and each acting in what he or she considers his/her own best interest.” Noelle McDonald, Vice President of Valuations Services, outlines items that can deem an Appraisal Report as ‘questionable’ for use as part of the loan approval process. If the items outlined below are identified, it is likely that additional steps will be required to remedy the issues in order to make sure that all parties are well advised in order to act in their own best interest.

Appraisal of an Incorrect Property

It is imperative that the property being appraised is the correct property being used as collateral for the loan. As silly as it may seem, the appraisal of a wrong property can happen. Details such as property addresses, approximate acreage, and number of buildings included as part of the transaction should always be clearly stated and confirmed.

Significant Value Indication Variances

While it is not uncommon for value indications from different approaches to vary, significant variances may indicate errors in the valuation. A common guideline is to be mindful of value indications showing variance of greater than 10% without explanation. These variances can be present in assumptions used in the appraisal process, errors in methodology, mathematical errors, and incorrect adjustments; just to name a few. If a final property value is determined by averaging value indications by approaches that have large disparity, the credibility of the appraisal report may be reduced.

Comparable Properties Located Outside the Market Area

The use of comparable sales should be limited to the immediate market area of the subject property. In some cases, notably when valuing special use properties, the use of comparable sales from larger markets may be necessary. For properties such as marinas, hotels, senior living facilities, or golf courses for example, the market may encompass an entire state or be a national market. However, for most properties, and depending on the complexity of the appraisal assignment, there should be significant market data within a reasonable distance from the subject.

Value Based on Unsupported Investment Criteria

Examples of unsupported investment criteria include selection of capitalization rates, discount rates, and/or vacancy projections. The use of unsupported low capitalization rates can artificially inflate the value of a property affecting the credibility of the appraisal. The same holds true for low vacancy estimates and discount rates in a discounted cash flow model. All of these parameters must be reasonable and well supported by market data.

Inconsistencies in Adjustment Grids

Adjustments to comparable data needs to be consistent for a specific line item. For example, if an adjustment is made at 10% per acre of land, then a comparable with two more acres than the subject should be adjusted by -20%. Conversely, if a comparable has two acres less, the adjustment should be 20%.

Appraised Value Lower Than the Contract Price

If the appraised value conclusion is lower than the contract price of a proposed purchase, the loan process is likely to not move forward. In order for the loan to continue, typically the seller would have to reduce the sales price to the appraised value. Or the buyer would need to make a larger down payment to obtain the appropriate loan-to-value ratio.

Appraised Value Higher Than the Contract Price

When the appraiser receives and reviews a sales contract as part of the appraisal assignment, there may be good explanation for why an appraised value is higher than the reported contract price. However, this information should be clearly conveyed in the appraisal report. Exceptionally high appraised values, compared to the contract price, can sometimes indicate there are undisclosed issues with the subject.

Items such as foundation issues may not be readily apparent. A depressed contract price may also indicate a buyer that is taking advantage of a naïve seller and/or the seller may be under duress to sell. With these examples, a higher appraised value may indicate that the seller is not well informed nor well advised.

Structural Concerns & Maintenance Items

Deferred maintenance items should be discussed, with appropriate adjustments made to critical benchmarks. Roof repairs are an example of a commonly deferred maintenance item. If the roof appears to be in poor condition in the appraisal pictures, then a certification from a roof inspector may be prudent.

Other common deferred maintenance issues include broken window panes, leaking water lines, outdated HVAC systems, and noticeable electrical problems.

Structural issues or inhabitable property concerns should also be discussed. Structural issues such as cracks in the foundation, can significantly affect property value. Cracks can suggest unstable settling of a property which should be further investigated by an engineer or other qualified expert. Foundation repairs can be costly and are sometimes unfeasible to repair.

Non-permitted Improvements or Additions

If the property has had additions to the original structure or additional structures built, it is essential to confirm if improvements were properly approved with permitting. If a subject building was originally 5,000 square feet, with a later 5,000 square foot addition, the total square footage would be 10,000 square feet as of the appraisal date.

However, if the appraiser based the valuation on 10,000 square feet and the addition did not have the proper permitting, this could result in an inflated market value. Often, the municipality will require the unpermitted addition to be razed, or appropriately reinspected to obtain retroactive permits.

Environmental Contamination

Older properties may still contain asbestos in building materials. Common asbestos-containing materials (ACMs) include insulation, ceiling and floor tiles, siding, roof shingles, and pipe insulation. If damaged or friable suspected ACMs are noted in the appraisal report, the underwriter may request further investigation by an expert in that field.

Lead paint is another possible contaminant, especially for properties built before 1974. If the appraiser indicates the suspected presence of lead-based paint, the underwriter may request further investigation by an expert in that field.

Any suspect mold growth apparent in appraisal pictures should be discussed. Unabated mold can effectively eat away at building materials like wood and drywall and permanently damage the structural integrity of a building. Mold is also a health hazard, as it has the potential to produce allergens and irritants. If mold contamination is suspected, a mold remediation expert may be consulted.

Lastly, ground contamination is a potential concern to be aware of. While it is not the purpose of an appraisal report to complete a preliminary review of potential environmental concerns in soil or groundwater (as compared to a Phase I or Transaction Screen Environmental Site Assessment), an expert should be consulted if current or historical operations of increased-concern are observed. Operations such as filling stations, dry cleaners and industrial facilities are common sources of subsurface contamination – which can negatively impact the current property value and potential for future sale if not properly assessed.

Racial Bias

As part of the Congressional Bill: H.R.2553 – Real Estate Valuation Fairness and Improvement Act of 2021, an interagency initiative known as the PAVE (Property Appraisal & Valuation Equity) Task Force directed by President Biden was launched to address racial bias in appraisal reports. As a rule, any racial and ethnic references in an appraisal should be immediately investigated.

While appraisal bias can happen consciously or unconsciously, it’s a violation of fair housing laws to discriminate in the appraisal process based on protected factors; including race, color, national origin, religion, sex, gender identity, sexual orientation, familial status, or disability. After examining millions of agency property valuations, the Federal Housing Finance Agency released a report in December 2021, that found thousands of potential bias cases related to neighborhood descriptions written by appraisers.

Examples of references contained comments regarding the percentages of racial and ethnic makeup of the area; foreign birthplaces of residents noted as part of the neighborhood descriptions; amenities specifically geared to a race, ethnic, or religious group; and even languages spoken in an area.

The Review Process

As part of the appraisal review process, LCS uses the above criteria above to determine if the appraisal supports the opinion of value for a property proposed for lending, or if additional steps are needed to correct identified concerns for underwriting purposes.

And as always….

LCS listens to your needs to develop products that are right for your lending transaction. Whether that be an individual appraisal, environmental or construction report, or a combination of services; LCS will meet your needs in the most efficient, effective way possible.

To learn more, reach out to Liz Mahoney, Director of Sales & Business Development today.