The Ross Rant

About the Author

Joel Ross

Ross began his career in Wall St as an investment banker in 1965, handling corporate advisory matters for a variety of clients. During the seventies he was CEO of North American operations for a UK based conglomerate, and sat on the parent company board. In 1981, he began his own firm handling leveraged buyouts, investment banking and real estate financing. In 1984 Ross began providing investment banking services and arranging financing for real estate transactions with his own firm, Ross Properties, Inc. In 1993 Ross and a partner, Lexington Mortgage, created the first Wall St hotel CMBS program in conjunction with Nomura. They went on to develop a similar CMBS program for another major Wall St investment bank and for five leading hotel companies. Lexington, in partnership with Mr. Ross established a hotel mortgage bank table funded by an investment bank, and making all CMBS hotel loans on their behalf.  

In 1999 he formed Citadel Realty Advisors as a successor to Ross Properties Corp., focusing on real estate investment banking in the US, UK and Paris. He has closed over $3.0 billion of financings for office, hotel, retail, land and multifamily projects. Ross is also a founder of Market Street Investors, a brownfield land development company, and has been involved in the acquisition of notes on defaulted loans and various REO assets in conjunction with several major investors. 

Ross was an adjunct professor in the graduate program at the NYU Hotel School. He is a member of Urban Land Institute and was a member of the leadership of his ULI council. In 1999, he conceived and co-authored with PricewaterhouseCoopers, the Hotel Mortgage Performance Report, a major study of hotel mortgage default rates.

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The quoted appraisers noted that the appraisals are pictures of the current market. We are asked to value the current market value of an asset based on what a well-informed investor would pay. And, as Mssrs. Greenspan and Prince noted last week, nobody (or at least very few) saw what was coming. When I track purchases in a market and see investors paying 5.0% cap rates on properties, my responsibility is not to tell the bank that 5.0% is not a reasonable rate (with that partially defined as a rate where the purchaser does not have to reach into his pocket every month to make a payment), but to tell the lender that, yes, in this market at this time this is what investors are paying.
I agree that 10-year cash flows go well beyond the foreseeable future. I apply a multi-year cash flow only when the projected cash flows are uneven and only until the cash flows show stability (when a property is either encumbered by long-term leases or the current leases are generally reflective of the market). And yield requirements are not that hard to guess; there are numerous competing investments with quoted yields that benchmark my projection.

Now when Tishman-Speyer bough Stuy.Town & Peter Cooper, they based their projections on forecasted "market" rents (assuming existing tenants would move out and allow market-based tenants to move in), not projected rent-controlled rents. In so doing they, the investor whose actions appraisers are supposed to predict, made a colossal blunder. However, the sales comparison approach would suggest that at that time I use their highly-inflated per unit purchase price in valuing a competing facility. If I use my standards of reasonableness, the loan does not get made, even though the property would have sold at a higher price than my conservative estimation allowed. Hence, I short-changed the client.

A lot of good institutions that I work for did not lose their shirt in the last crisis. They used solid underwriting. They made sure that the loans were well-collateralized. The lent on a reasonable LTV, with a good DCR. On other words, I did my work well and they did their work well, and they limited the troubled assets on their books.

The only reasonable conclusion is that appraisal are as "deeply flawed" as the investment community. Neither of us has a crystal ball. And I can tell you that appraisers who use their personal, conservative criteria in fast-moving, expanding market need to find a new line of business, because no bank will use them. As noted, market value reflects what a reasonable purchaser would reasonably pay for a property as of a given date. We reflect the market; if something is deeply flawed, look in the mirror.
Posted by comment_user_451374 | Monday, April 12 2010 at 4:12PM ET
I take exception to the two comments by appraisers.. this is more reflective of their personal circumstances rather than the profession. Apparently, they picked the wrong clients for whom to work!! And, this is how they think the profession should be which is a very distorted view.

As in every profession and industry including real estate promoters, packagers, rating agencies, etc. there are bad apples. I think it is disingenuous to be blaming the problems on the appraisers. I find it very hard to believe that because the credit agencies were so reliant on appraisals that they totally missed the boat. We all know why they blew it because they are hired by the same party that is getting the rating.

Wall St. and the rest of the industry that depends on OPM and debt, want what they want. Just like attorneys who forum shop and junkies who shop for docs that will give them the scripts they want, those that retain the appraisers want what they want. They want to do the deal, borrow the max, lend the max, get high credit rating, etc. Real simple solution, use competent, honest appraisers, don't predicate their employment on dishonest work or overly optimistic assumptions. With any service business, cash flow is king and to put the burden on the valuation industry is nonsense. Yes, appraisers should hold the line, turn down the work, walk the assignment, etc. BUT way too many times in the recent past, clients did get what they wanted, high numbers to make their deals work and the valaution companies that did this type of work were able to stay in business.

The problem is not the methodology but the use of it and application of realistic assumptions. Those that do that frequently many times are not doing work for the parties that you reference in your email for the same reason.... aren't providing what the clients want in terms of numbers. The problem is with the real estate industry-- the norms, the ethics, the means of compensation and emphasis on short term results and pushing the envelope.

As I'm sure you would agree, a very important ingredient in any service business is having the luxury of picking the right clients and ditching the ones that nothing but trouble. I submit, that this goes for the rest of the industry not just appraisers.
Posted by comment_user_451375 | Monday, April 12 2010 at 4:16PM ET
You've obviously had bad experiences with appraisers and appraisals. A ten-year cash flow is utilized by appraisers as it reflects what the market typically uses for investment properties. Sure, anybody predicting what the market will do in ten years is required to make a number of educated guesses. However, these assumptions are based heavily on historical data, investor perspectives, and both micro and macro-economic factors. Income and expense forecasts can be quite reliable with long-term leased properties. While renovation costs may significantly vary over the cash-flow period, appraisers do take into consideration the age and quality of various building components. They additionally rely upon property condition reports and cost estimates provided by reputable sources.
Terminal capitalization rates and discount rates may be subjective, as you opine, but no true alternative exists. Appraisers carefully study various survey sources - which are typically reflections of active buyers and sellers. They also seek the opinions of these same parties. Additionally, cap and yield rates consider the reliability and characteristics of the income stream - something which can be fairly well estimated based on the leased status of the property.
Get yourself a better appraiser, one who is not swayed by a buyer or a seller, but considers the true factors of market value. Your wide brush stroke of all appraisers/appraisals suggests you have been dealing with too small a canvas.
Posted by comment_user_451376 | Monday, April 12 2010 at 4:18PM ET
Thanks for the article ... not sure it should surprise anyone ... but these days lots seem to be surprised by things I think are pretty obvious ...

I think that the deeper layer that could be an interesting piece as a follow-up to this one ... could be a look at the Fund management side of things ... where the firms make money by buying and running the assets ... and participate without a downside in residual ...


Where do those allegiances run? ...

How realistic an appraisal do they want? ...

IS the "Made As Instructed" appraisal a tool for them?
Posted by comment_user_451377 | Monday, April 12 2010 at 5:12PM ET
Just like all lenders are not "loan sharks", all appraisers do not just pull numbers and projections out of thin air. Market participants - by that I mean those who buy and sell commercial real estate - are what drives the demand for lending and appraisal services. As a valuation analyst with FirstService PGP Valuation, I put emphasis on prevailing insights and anticipations of market participants. What cap rates are they buying at? What returns are they looking to achieve on an investment? It just so happened that between 2005 and 2007, market participants had a high appetite for risk that turned out to be unsustainable. But markets are seldom static.

An important part of an appraisal to consider, especially when contrasting to a BOV (broker's opinion of value), is the disinterested third party aspect. Whereas a BOV is more of a marketing tool to court a listing with an owner or asset manager.

I would suggest to those ordering appraisals to talk to appraisers and ask questions about market conditions. You may be surprised how knowledgeable they are outside of a structured appraisal document. But if you want to just file them away, that is fine with us too.
Posted by comment_user_451378 | Monday, April 12 2010 at 5:15PM ET