Appraisals Are Deeply Flawed
Appraisals Are Deeply Flawed I recently wrote a column on HotelNewsNow stating that appraisal methodology was deeply flawed and that appraisals are essentially fairy tales based on a bunch of unsupported wild guesses by appraisers. They claim to be able to project cash flow, interest rates, discount rates, terminal value cap rates, and renovation requirements for 10 years and then they use some unsupportable discount rate to determine present value. It is all nothing more than wild guess compounded by more wild and unsupportable wild guesses. It short, appraisals to me, have no value, and were clearly proven to be nothing more than propaganda to support unrealistic loans in the 05-07 period. In response to the column two appraisers commented that"appraisers are required by our standards and regulations to reflect the market. If the market is being optimistic we are required to reflect that. It is not the appraisers role to adjust projections or cap rates or values or opine if anticipated net income is not sustainable. We are merely reporters on the sidelines. If you want us to tell you what we really think then have us put our consulting hat on instead of asking us to do an appraisal." Another appraiser said "we are required to reflect the froth". That says it clearly. Even the appraisers say their appraisals are nothing more than make believe to reflect what the clients wants them to say. In fact one appraiser responded to my column by saying "who are we to question the view of the borrower or the lender". Why do appraisers even bother with the make believe of 10 year cash flows, alleged terminal cap rates and all the rest. What they are admitting finally is they are merely making all that up in order to get the answer their client wanted in the first place. This is why when I created the first hotel CMBS programs in 1993 we refused in our underwriting to use any numbers or values the appraisers came with. We got appraisals just to fill the rating agency file folder. Everyone would be much better to ask appraisers to provide real numbers and projections as the appraiser I quote above has suggested. Phony appraisals was one of the contributors to how we had the crash. They were used as excuses to make stupid loans. The rating agencies are the ones to drive this change. The servicers tell me they are relying much more on broker opinions of value than appraisals and they only get appraisals because they are required to by the PSA docs. In 1993, our underwriting manual required the use of historic cash flows and then current cap rates to determine loan proceeds. Loan to value was only used to make sure we did not exceed a percent of the appraised value since we knew the appraised value was in excess of reality, we always wanted to below that test. My intent here is to get the capital markets, the rating agencies, and the real estate industry to start to use appraisers properly, and to use their knowledge in a way that is helpful, and not to support excessive lending and stupidity. If the truth hurts as to projections and value, then loan proceeds should reflect truth and not bull. If we redo how loans are underwritten, and if we use the talents of the appraisers properly, we may just help save ourselves from the next crisis in the capital markets. Excessive lending and over inflated values always lead to a crash-that is reality, so let's not repeat this costly history.