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Over the past decade, new products and services coming out of Silicon Valley have profoundly altered — and often improved — how we live, work, and play. But commercial real estate (CRE) is one area in which widespread adoption of advanced technology has lagged. Until recently, industry players have focused almost exclusively on refining the efficiency of already existing processes. In doing so, they have given short shrift to the digital disruptions rippling through residential real estate, from Zillow’s serving of aggregated housing data through its freely accessible website to Opendoor’s cutting multiple middlemen out of the home buying and selling processes.

But a group of up-and-coming startups is aggressively targeting CRE. Their aim is to dismantle existing infrastructure — the policies, procedures, ownership models, and basic materials that have made CRE a prohibitively expensive, illiquid, and relatively opaque asset class for many investors — and replace it with entirely new systems geared toward speed, scalability, and peak profitability. Collectively, these new systems constitute what is known as proptech, a unique and ever-shifting amalgamation of commercial real estate expertise and technological innovation.

What are those innovations, and how are they significantly changing how CRE is bought (or leased), at what price, and from whom?

Big Data

In its original context, the “big” in “big data” meant “astronomical.” That’s because the term was first coined by NASA scientists in 1997 as a way to describe collections of information so vast and dense that they can only be manipulated with machine assistance. “Big data” has since come to refer to the quantification of even the most everyday activities and interactions. If you’ve ever found yourself structuring your daily routine around breaking the 10,000-step threshold, then you’ve experienced “big data” firsthand.

In today’s CRE market, big data is producing unprecedented insights into building utilization. Landlords are monitoring and gathering data about everything happening in (and, in some cases, around) their properties. Once subjected to analysis, such real-time data on how people interact with buildings can inform systems that facilitate predictive maintenance, track energy consumption, manage vacancies, and bolster tenant retention using true customer relationship management (CRM) functionality.

With respect to valuation, big CRE data could be mined to reveal hidden portfolio risks and empower more proactive market strategies. It might also guide decisions regarding renovation and redevelopment, hypothetically increasing the revenue potential of any given property. Does more foot traffic pass through your clothing boutique on an east-west or north-south axis? Using people counters as well as indoor mapping and location services, retail property managers could conceivably optimize individual floor plans to achieve the highest possible sales volume per cash register — and thereby maximize the space’s rental value.

The Internet of Things (IoT)

The next (or fourth) industrial revolution is underway. On its front line are devices that aren’t robots per se but which come equipped with sophisticated computerized components. Thanks to inexpensive yet powerful processors and 5G wireless networks, practically any physical object can now be made “smart” — capable of independently transmitting streams of data about its status and the environment in which it is situated on an Internet of Things (IoT). Such devices currently outnumber the human residents of our planet, and their population is expected to climb to a staggering 20.4 billion by 2020.

Smart elevators. Smart HVAC systems. Smart building security systems that incorporate biometric recognition. Even smart plumbing systems whose pipes can alert property managers before they freeze and burst. These solutions are all currently available and, as they attain greater market penetration, will cease to be seen as premium. (Longtime CRE observers have seen this pattern before with green buildings.) Yet, whatever cool features these tools have to show off, can they pay for themselves? Can they even boost any given property’s market value?

The short answer is that it may be too soon to tell. However, according to a recent report issued by Memoori, “the combined global market for the Internet of Things in Buildings (BIoT) will grow significantly over the forecast period, rising from $26.65 billion in 2015 to $75.5 billion by 2021, at a CAGR [Compund Annual Growth Rate] of 20.7 percent.” Meanwhile, owners of multifamily properties should be aware that more than 75 percent of respondents to a survey conducted by Coldwell Banker and T3 Sixty indicated that they would be willing to pay more to live in a smart home. Property type considerations and tenant preferences aside, landlords may still realize significant cost savings by making smart, efficiency-generating upgrades and renovations.

Blockchain

Although synonymous with headline-grabbing cryptocurrencies such as Bitcoin, Ethereum, and Libra, blockchain technology has applications and implications far beyond the transactional. A comprehensive overview of the blockchain and how it works is beyond the scope of this article, but suffice it to say that virtually any CRE process that has traditionally relied upon a paper trail may ultimately be migrated to this automated and hacker-proof digital space. That’s because, unlike other forms of digital data, the “blocks” in any given blockchain can be distributed but not duplicated.

Smart CRE contracts that utilize the blockchain are already in use. These contracts are replacing customary lease agreements as well as transfers of title. In fact, title management may stand to benefit the most from the blockchain. The American Land Title Association estimates that fully one-quarter of all title records contain erroneous information, resulting in costly title resolution proceedings. Smart contracts could also be the key to eliminating title fraud.

From an appraiser’s perspective, the blockchain could combine with big data to make the verification of all property details both faster and more accurate. Everything from ownership history to repair records could be collocated in a centralized, blockchain-secured repository. And, as the blockchain propels CRE toward a future of fractional or tokenized ownership, valuation experts will likely have to rely more and more upon such repositories.

Of course, any investor who has ridden the Bitcoin rollercoaster might view the blockchain with healthy skepticism. Many unanswered questions about the technology and the consequences of its widespread adoption remain. As Data Nerds and Estated CEO Joshua Fraser writes in Forbes, the blockchain may “get rid of the need for banks, lawyers and other intermediary figures and instead validate transactions purely using digital encryption.” Whether that is a desirable state of affairs for investors, lenders, developers, contractors, property attorneys, appraisers, and the communities that rely upon a thriving CRE marketplace remains to be determined.

The Best of the Rest

Artificial Intelligence (AI). The Age of AI may still be dawning, but machine learning is already being profitably leveraged by CRE professionals. Computer programs that perform tasks that typically require human intelligence are already being used to normalize data (e.g., leases, nondisclosures, available inventory), locate key clauses or phrases in CRE-related documentation, identify incomplete or missing data, and simplify fiscal reporting. By automating and optimizing specific tasks that can be redundant and prone to error when handled by a human operator, AI is also providing a better foundation for decision-making. In the long term, software-based “robots” may indeed replace these human operators outright. In the short term, however, the process augmentation AI-powered systems provide is one factor in CRE’s recovery from the financial crisis of 2009.

Virtual Reality (VR). Despite the failure of the ‘90s-era VR products, VR’s time may have finally arrived courtesy of the CRE market. (VR sales are expected to reach $40.26 billion by 2020.) VR is a natural fit for the industry, as it enables investors to tour properties without time-consuming, expensive, and environmentally unsustainable travel between distant locations. Moreover, recent innovations in VR promise to make the technology more accessible to smaller, less high-end CRE developments.

Drone Technology. The extraordinary aerial imagery we enjoy today has been made possible through the use of drones. These remotely piloted devices can photograph everything from high-rise office buildings to coastal properties to sports stadiums. Visually impressive flyover videos can be instrumental in closing CRE sales, but they can also communicate valuable information — for example, surrounding due diligence.

The Texas State Legislature convenes only every two years. Such a schedule ensures that each session is a busy one, and the recently adjourned 86th regular legislative session was no exception.

According to one estimate, during that 140-day assembly (which began January 8 and ended May 27, 2019) legislators filed 7,795 bills and resolutions. Of those, only about 19.5 percent (1,525) reached Governor Greg Abbott’s desk, with slightly over 1,400 now scheduled to become law.

Of these 1,400 enacted measures, several pertain to real estate, both residential and commercial. Among them are four laws whose provisions could significantly influence how real property is valued, traded, and developed across the state.

Read on to learn more about the new real estate laws on Texas’ books, how they got there, and what their presence could mean for your business.

House Bill (HB) 2439: Prohibition of Local Government Product Mandates

• This legislation prohibits cities from using building codes or other local ordinances to require the use of construction products that exceed national standards.
• HB 2439’s bipartisan authors, sponsors, and supporters hope this measure will curtail a domino effect in which one requirement leads to the direct or indirect prohibition of otherwise approved construction products, thus creating significant compliance challenges for contractors — or effectively forcing them to work with a vendor they might not otherwise prefer.
• For example, authorities can no longer mandate masonry material percentages in new construction or limit contractors to using a single type of insulation, piping, or tubing if national model building codes permit other options.
• Elected officials representing several municipalities across Texas (including Dallas and McKinney) urged a veto of HB 2439, saying it fails to strike an adequate balance between financial and aesthetic considerations. They argue that the law penalizes communities by limiting their ability to designate conservation districts and preserve the character of their local architecture.
• However, the law does contain exceptions for neighborhoods officially registered as historically or culturally significant. This exception also includes commercial buildings located in downtown areas participating in the Texas Main Street Program (TMSP).
• Will the enrolled version of HB 2439 contribute to a decline in the quality and safety of construction, as its opponents fear? Or will it deliver on its chief promises: to provide consumers more choice when selecting building materials and make housing, especially multi-family dwellings, more affordable? Answers to these and other questions may be soon in coming, as the law has been in effect since September 1, 2019.

HB 2496: Historic Landmark Designation

• The stated purpose of HB 2496 is to protect individual property owners from what its authors deem to be unfair and inconsistent rules around the establishment of historic landmarks.
• HB 2496 stipulates that a municipality in Texas cannot name a property a historic landmark unless:
  1. the owner of the property consents to the designation; or
  2. the designation is approved by a three-fourths vote of the governing body of the municipality as well as the municipality’s zoning, planning, or historical commission.

• HB 2469 further stipulates that owners whose properties are subject to historic designation be issued a “historic designation impact statement.” Upon reviewing this official document, owners may withdraw previously granted consent.
• HB 2496 received the backing of the Home Builders Association of Greater Austin, among others. These proponents claim that historic designations unjustly strip property owners of their rights and devalue their real property investments. They cite the fact that even though landmark status does offer owners property tax relief, it may obligate them to undertake expensive repairs and saddle them with burdensome regulatory obligations.
• Organizations such as Preservation Austin, Preservation Texas and the National Trust for Historic Preservation contend that HB 2496’s requirements do more than make it difficult to save specific historic structures from either the wrecking ball or a landlord with a vision for modernizing such properties. These organizations believe the law all but prevents the creation of new historic districts, citing the virtual impossibility of securing approval under its strict provisions.
• Is a historic landmark more or less attractive to prospective buyers? The answer to this question varies by location, market (residential versus commercial real estate), and even property type. Whatever the case, the Texas Legislature has, with this law, clearly sided with current property owners and targeted what they consider overreach by local governments.
• HB 2469 was signed into law by Governor Abbott on May 25 and is effective as of September 1, 2019.

HB 347: Annexation

• This 2019 legislation revises SB 6, which was enacted in 2017.
• With SB 6, the 85th Texas Legislature separated the state’s counties into two tiers. Tier 1 counties — defined as having a population of less than 500,000 — were allowed to annex land at their sole discretion. However, Tier 2 counties — with a population of over 500,000 — could annex land only after holding an election in the area proposed to be annexed and winning the approval of a majority of the landowners.
• HB 347 abolishes this system. Now, all Texas counties are effectively Tier 2. Any municipality that wishes to annex land must put the proposal to a vote as specified above.
• Passed by super-majorities in both houses, this measure went into effect immediately after Governor Abbot signed it on May 24, 2019.
• Both the Texas Association of Realtors and grassroots supporters throughout the state hailed the law for putting an end to what they called “forced annexation.” One of the bill’s authors, Rep. Phil King, was encouraged to act by residents of a neighborhood is his home county (Parker) unwilling to be incorporated into the city of Weatherford, itself located just 25 miles west of Fort Worth.
• HB 347 has the potential to alter the pace of urbanization in Texas. Since 2010, Texas has welcomed over 1 million new residents from the other 49 states. Writing for The Dallas Morning News, Lloyd Potter, Texas’ official demographer, reveals that “the state’s metro regions garnered 94 percent of the total domestic migration between 2010 and 2014.”
• Urbanization has helped fuel Texas’ economic expansion over the past decade as well — as the health of the state’s CRE market indicates. For example, retail occupancy rates in Texas’ four largest metropolitan areas (Austin, Dallas-Fort Worth, Houston, and San Antonio) currently average 94 percent.
• The passage of HB 347 should serve as a reminder that property rights in Texas can be a particularly sensitive issue, especially as more of the state’s traditionally rural areas are faced with the choice of becoming suburbs and exurbs.

SB 2: Property Tax Reform

• This law, dubbed the Property Tax Reform and Relief Act of 2019, provides an automatic property tax rollback election if cities, counties and other local entities propose an increase of more than 3.5 percent.
• These increases cannot be scheduled for a special election and must be included on ballots issued during the state’s November general elections.
• Under previous legislation, voters could petition for a property tax rollback only if a proposed revenue increase exceeded 8 percent.
• The law also obligates the state’s Central Appraisal Districts (CAD) to conduct their business more transparently. Each CAD must now maintain a property value database that allows for public comments on proposed rate increases.
• Additionally, these databases must contain public hearing information so property owners can more easily appeal (or protest) the assessed (or taxable) value of their property.
• City officials in the state’s larger metropolitan areas expressed considerable opposition to SB 2. They fear that the measure, while a potential boon to individual taxpayers, will lead to critical budget shortfalls that will significantly limit their ability to maintain and expand essential services. They argue that those limitations could, in turn, slow future development and retard the growth of Texas’ economy.
• Supporters of SB 2 insist the lower rollback rate will help ease economic strain experienced by both homeowners and business owners.
• Leaders in the state’s CRE market have by and large championed SB 2. Considering that commercial property appraisal values in Houston (to take but one example) increased by nearly 40 percent in a five-year period ending in 2017, this should come as little surprise. But the financial implications of such a surge go beyond property tax bill sticker shock.
• Upward-trending property values become an issue for landlords when a property’s profitability cannot keep pace with its taxable value. Owners then have little choice but to pass the tax hike down to their tenants. When those tenants are businesses, they may choose to absorb that rent increase by cutting costs elsewhere — for example, by instituting hiring freezes or postponing (or even canceling) planned expansions.
• Nevertheless, cities such as Dallas and Houston have become desirable places to live, especially among millennials, due to their having made concerted urban revitalization efforts. While that revitalization does not happen without the private capital needed to build and renovate, it also takes the cooperation of local governments solvent and functional enough to maintain roads, collect garbage, and ensure public safety.
• The bulk of SB 2’s provisions will take effect on January 1, 2020.

They’re long. Their language is characterized by highly specialized (and sometimes unfamiliar) terminology and legalese. They’re bursting with tables, charts, maps, and photos. But they demand to be pored over, and from cover to cover. The question remains, however: What’s the best way to read a commercial real estate (CRE) appraisal report?

Let’s begin by pinpointing the exact object of our inquiry. A commercial real estate appraisal (or a commercial real estate valuation) is a professionally calculated assessment of the value of a commercial property. A broad category, “commercial property” encompasses everything from office buildings to condominiums to industrial sites and vacant land. If commercial property is being bought, sold, taxed, insured, or developed, that activity can trigger an appraisal.

Appraisal Report Types

Appraisal (or valuation) is a process and therefore to be distinguished from appraisal reports, which are the outcome of this process and can take one of several forms.

• Appraisal Report. Think of the Appraisal Report as a bread-and-butter narrative document. The required scope and level of detail in each Appraisal Report is determined by the appraisal professional and can vary widely depending on market and property complexities. Formerly known as a “Self-Contained Report” or “Summary Appraisal Report,” this new Appraisal Report format gives valuation experts extra discretion with regard to the amount of data, description, explanation, and analysis they include in their final write-up. Additionally, appraisers are required to “summarize” their findings for each Appraisal Report, meaning supporting documentation now may be kept in a separate work file.
• Restricted Appraisal Report. As its name suggests, this report is much more abbreviated than its counterpart above. Its primary purpose is to provide the party requesting the appraisal (the client) an opinion of value. Many topics covered in depth in the Appraisal Report may only be “stated” rather than “summarized” (the latter being applicable only to the Appraisal Report) herein. Finally — and crucially — the Restricted Appraisal Report does not meet the criteria for descriptive detail set by most lenders and adjudicating bodies.

Furthermore, it should be noted that the market is now demanding many Evaluation Reports. According to federal banking regulations, an evaluation may be issued instead of a formal appraisal if:

• the “transaction value” (generally the loan amount) is $500,000 or less;
• the transaction involves certain renewals, refinances, or other transactions involving existing extensions of credit; or
• real estate-secured business loans with a transaction value of $1,000,000 or less and the sale of, or rental income derived from, real estate is not the primary source of repayment for the loan.

Many appraisers are now producing Restricted Appraisal Reports and submitting them as Evaluations. This is permissible as long as appraisers are careful to label the appraisal a “Restricted Appraisal” and comply with the specific USPAP requirements and quality assurances (see below) related to the composition of formal appraisal reports.

Quality Assurance for Appraisal Reports

Whatever its type, and regardless of the audience for which it is intended, any worthwhile appraisal report must adhere to a set of professional guidelines known as the Uniform Standards of Professional Appraisal Practice (USPAP). By order of Congress, USPAP compliance is required for state-licensed and state-certified appraisers involved in federally-related commercial real estate transactions.

USPAP Rule 2-1 stipulates that each written appraisal report must:

• Clearly and accurately describe the appraisal in a manner that will not be misleading.
• Contain sufficient information to enable the intended users of the appraisal to understand the report properly.
• Clearly and accurately disclose all assumptions, extraordinary assumptions, hypothetical conditions, and limiting conditions used in the assignment.

Evaluation reports must comply with the Interagency Appraisal and Evaluation Guidelines as defined by the Federal Deposit Insurance Corporation (FDIC).

The Most Critical Features of Any CRE Appraisal Report

You’ve confirmed the report type. You feel confident that the document you are consulting adheres to USPAP’s best practices. What next? Look first to these sections or elements of your appraisal report to begin extracting the most value from its valuations.

1) Definitions. Does the appraiser define such key terms as “cap rate”and “damages?” Do they also provide sources and context for their definitions? An illustrative example serves to highlight the weight these definitions carry.

• In cases of eminent domain, where only part of the property is condemned and appropriated by a government entity for public use, the terms “the value of the uncondemned land before the taking,” and “the value of the uncondemned land after the taking” are often a source of confusion.
• Essentially, the use of these terms involves determining the value of an entire tract of land and then the value of the part being condemned and taken. The difference between those two figures yields the value of the uncondemned land before the taking. Next, the value of the uncondemned land after the taking is determined. The difference between these two figures — before and after the taking — is added to the value of the condemned tract of land, and the sum of the two yields the compensation due to the landowner.

2) Explanation of methodology. The previously described formats are the bones of a CRE appraisal report. The methodology the appraiser uses to determine the fair market value (FMV) of the property being evaluated can be likened to the report’s soul.

The three most frequently applied valuation methods are:

• Cost Approach. Here, the appraiser focuses on the cost to rebuild the structure from scratch, factoring in the current costs of associated land, construction materials, and other expenditures related to replacing any existing structures.
• Sales Comparison Approach. Also called the market approach, this method relies heavily on recent sales data for comparable properties. “Comparable properties” here translates into sold buildings with similar assets in the same market area. One drawback to this method is that, depending on market conditions, it can sometimes be difficult to find data sufficient to support the appraiser’s analysis.
• Income Capitalization Approach. This method is based primarily on the income an investor can expect to derive from a particular property. Said expectations can be based, in part, on a comparison with similar properties. They may also be based on optimizations made to the existing property, such as improving the efficiency of maintenance services to realize cost-savings or adjusting rental rates to reflect current market conditions.

It should be emphasized that, for the professional appraiser, appraisal method selection is not necessarily an either/or proposition. Appraisers can and often do mix and match methods to provide the most accurate appraisal possible for the property in question. Either way, the report should speak to the rationale behind the appraiser’s choices.

3) Ownership history. Real estate properties, while material assets, are not immutable. They change over time, being put to different uses by different landlords. When assessing an appraisal report, look for the following items.

• Identification of the property’s owner(s) of record (also known as the record owner).
• Any questions regarding the title or state of ownership.
• Relevant encumbrances (e.g., easements, liens, deed restrictions, etc.).
• Enumeration of any recent sales, listings, offers, and/or options.

4) Market conditions.What a meteorologist is to the weather, the appraiser is to the economic forces affecting real property transactions. After reading through this section of an appraisal report, you should be able to answer the following questions.

• How does the appraiser describe the prevailing market trends leading up to and as of the valuation date?
• Has the appraiser reviewed relevant market indicators of value such as vacancies, competing projects, and available inventory? At LPA, our commercial real estate valuation experts constantly strive to track the pulse of the market using the very latest market analytics.
• What information has the appraiser used to justify their adjustments?

5) Property interest appraised. Ultimately, the appraisal report should directly address the client’s — that is, your — stated interest in the property. If, for example, you want to move your business into a shopping center, the appraisal you receive should report on the fee simple interest, or the total value of the building and the land on which it is situated. If, on the other hand, your goal is to lease the property to a tenant or tenants, you want to know what it is worth to a landlord. The appraisal should therefore report on leased fee interest.

It is crucial for clients to specify this interest before property inspection commences. If the property interest is not identified (or has been misidentified), the valuations issued may not be absolutely accurate — or relevant.

In the decade since the last major financial crisis, commercial real estate (CRE) prices have experienced a historic recovery. By some measures, valuations for CRE property types as different as office towers and warehouses are as high as they have ever been.

Meanwhile, one year ago, the Office of the Comptroller of the Currency (OCC), the Board of Governors of the Federal Reserve System, and the Federal Deposit Insurance Corporation (FDIC) published a final rule officially raising the appraisal threshold for CRE transactions.

Specifically, this new regulation:

1. Raised the appraisal threshold level at or below which appraisals are not required for CRE transactions from $250,000 to $500,000.
2. Required the use of state-certified appraisers for CRE transactions above $500,000.
3. Mandated that regulated institutions must obtain an evaluation of the real property collateral “that is consistent with safe and sound banking practices” for exempted transactions at or below $500,000.
4. Made the use of appraisals for exempt CRE transactions at or below $500,000 optional, as appropriate, as in the case of higher-risk transactions discussed in OCC Bulletin 2010-42.

By and large, lenders have welcomed this change. The appraisal community, on the other hand, has expressed mixed feelings on the subject. To understand why — and to appreciate what the federal government’s decision could mean for your business — it’s first necessary to establish the proper perspective.

Appraisal Thresholds: A History Lesson

The regulations regarding CRE appraisal are a result of the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA), enacted in 1989 in the wake of that decade’s savings and loan crisis. One of the law’s primary purposes, as laid out in Title XI, was to ensure that future real estate appraisals adhered to uniform standards as enforced by certified (or licensed) professionals.

Congress amended Title XI in 1992, authorizing the appropriate federal agencies to establish a threshold level at or below which an appraisal by a state-certified (or -licensed) appraiser would not be required. In response, those agencies (the OCC, Federal Reserve, and FDIC) set the appraisal level at $250,000.

That figure endured, unchanged, for 24 years. For some representatives of the financial industry, that stasis had by 2018 hardened into a form of rigor mortis. Since the number of CRE transactions occurring above the $250,000 threshold had grown exponentially, they felt, regulatory requirements were now placing an undue burden on buyers, sellers, and loan originators.

In considering this change, the agencies had initially proposed raising the threshold to $400,000, while the National Credit Union Administration (NCUA) urged a $1 million threshold. In the end, the agencies negotiated a $500,000 threshold. In so doing, they exempted an additional 15.7 percent of CRE transactions from mandatory appraisal.

Finally, revising the appraisal threshold was also partly an outgrowth of a larger effort to streamline federal regulation. The Economic Growth and Regulatory Paperwork Reduction Act of 1996 requires regulators to conduct a review every 10 years to identify outdated, unnecessary, or onerous rules.

What Does the New Threshold Accomplish?

Arguments advanced for raising the CRE appraisal threshold neither end nor begin with the observation that the federal government had failed to keep pace with rapidly evolving market conditions.

Consider the rise of debt funds and mortgage real estate investment trusts (REITs) over the past decade. Data collected by Green Street Advisors shows that these funding sources were responsible for 42 percent of the growth in CRE lending volume from 2016 to 2017.

In the same timeframe, banks were still responsible for roughly a quarter of all lending volume, but that share was down from 2014 — a trend projected to continue. Many banks hope that raising the appraisal threshold will allow them to be more competitive with these other lenders.

A nationwide shortage of qualified appraisers created additional friction under the old $250,000 rule. In particular, many regulated institutions in rural areas were struggling to secure prompt appraisals, creating bottlenecks for their underwriting departments.

As supporters of the $500,000 threshold like to point out, lending volumes tend to increase and decrease faster than the supply of qualified appraisers. Consequently, boom cycles (such as the one currently prevailing) can exert extreme pressure on the appraisal industry. This scenario, in turn, can lead to a decline in quality control.

Thus — the argument goes — using more efficient, i.e., automated, evaluation methods on low-risk transactions can improve risk management overall by empowering lenders to dedicate their scarcest resources. i.e., human experts, to vetting riskier transactions. And there is much to be said for the wise allocation of such resources.

Is the New Appraisal Threshold An Overcorrection?

However, the most vocal opponents of the new rule are concerned that it could expose the CRE market to more risk. This is the position taken by the Appraisal Institute, whose President James L. Murrett has expressed the fear that one likely result of the rule change will be a return to the overly permissive, loan production-driven environment seen during the lead up to the financial crisis of 2008.

On the topic of competitive balance, meanwhile, some valuation experts argue that this rule revision may be unfair to licensed appraisers. From their point-of-view, the raising of the threshold favors the use of algorithms and automation tools over the knowledge and insights possessed by professionals with years of experience in determining fair market value (FMV).

Ultimately, raising or lowering the appraisal threshold does not change the fact that valuation reports written by actual human beings remain the “gold standard” in the CRE industry. Accuracy is one reason why. So is principled conduct. As many observers have noted, bias can infect even the most sophisticated machine learning procedures.

Well-written appraisal reports do more than check off boxes. And they are far from one-size-fits-all propositions. Each type of report contains unique business intelligence and has different applications. A truly actionable appraisal is as qualitative as it is quantitative. In its own way, it tells the story of the property’s past, present, and future, interpreting that narrative and making it relevant to the client’s interest in and plans for their investment.

In our experience, many — but not all — of our clients desire the level of protection a formal appraisal offers. That’s why, in addition to focusing on integrity, excellence, teamwork, and selfless service, we continuously innovate. Our compliance-based services and solutions are scalable, customizable, and nimble. Our CRE experts are skilled at producing a wider range of valuation services, which include both evaluations and restricted appraisal reports as well as traditional appraisal reports. Regardless of format, our experts also pride themselves on timely delivery, accuracy, and credible assignment results.

Markets fluctuate. But the conventional wisdom states that commercial real estate (CRE) almost always appreciates, provided you treat it like the investment it is. Key to achieving the highest rate of return on that investment is equipping yourself with the right data about your real property holdings, both those you own and those you’re considering acquiring.

But not all CRE valuations are created equal. Methodology matters, as does the integrity of the vendor providing this all-important service. In fact, and as widely reported, inflated valuations and appraisals were a significant contributor to the 2008 financial crisis.

Accurate valuations do more than provide the kind of actionable intelligence you need to make the right business decisions. They also protect you from liabilities and the sort of unpleasant surprises that can damage your company’s bottom line, future prospects, and reputation.

Read on to learn more about how businesses benefit from procuring accurate, principle-driven, unbiased commercial real estate valuations.

Selling

Imagine this scenario: all signs in your region point to a seller’s market in CRE. But how do you chart a course between the price you’d like to command, the amount of cash buyers are willing to spend, and what counts as fair market value?

You need numbers you can trust. Moreover, since the value of real property is realized over time, that means your situation is almost always fluid. Demand, utility, scarcity, and transferability can all be defined by volatility, even in a seller’s market. A truly accurate valuation will factor in these complexities when quantifying market value.

Underwriting

Valuations help underwriters assess and manage risk. They rely on these documents and expect them to be accurate, transparent, and free of potentially misleading information. In fact, the number one question underwriters need to answer is: “Does the actual value of the property justify the loan amount being requested by the borrower?”

Most underwriters will not approve a CRE mortgage unless they can establish a 60- to 80- percent loan-to-value ratio. An expertly prepared commercial real estate valuation report will provide the information the underwriter needs to feel confident in their calculations.

Planning Improvement

A valuation report can provide useful insights into how much you should spend on improving any given property. More importantly, it can also indicate whether or not you should develop the property at all. An accurate commercial real estate valuation will therefore take into consideration:

• The current value of the land itself.
• The costs (labor, materials, etc.) of replacing the property’s existing structures.
• Any accumulated depreciation. In weighing depreciation, the valuation should assume that buyers wouldn’t spend more for commercial property than they would for acquiring land and building from scratch. The cost of these improvements might not exceed potential depreciation and can make prospective buyers wary.

Finally, a high-quality valuation will determine your property’s highest and best use — that is, the most profitable use of the property. If the cost of proposed improvements exceeds the highest profitable use, you’ll want to adjust your budget accordingly.

Compliance and Due Diligence

When you’re looking to expand your portfolio, you want to minimize your exposure to buyer’s remorse. Doing so entails being as thorough as possible before making any purchasing decisions. You have to dig beneath the surface to reveal hidden risks, unforeseen (but inevitable) losses, and any shaky foundations, all of which can doom your investment.

A qualified, credentialed commercial real estate valuation expert can help you at every step of the buying process. They will inspect the fundamentals of the property, vet sellers, and survey your compliance obligations to mitigate financial uncertainties. They will also assist in assessing the condition of the property (the land as well as any existing structures) as well as any potential use issues that might require additional investment to balance the cost of acquisition.

The Rise of Automated Valuation Models (AVMs)

The rise of Automated Valuation Models, or AVMs, has exerted some downward pressure on traditional real property appraisals. While AVMs are readily available to lenders, consumers, and real estate agents (especially those concentrating on residential properties), most of these algorithms have a major blind spot — specifically, they fail to account for a property’s physical condition. That’s because AVMs determine value using market averages and public records, both of which are notoriously slow to update with the latest data about real CRE transactions.

Furthermore, by relying on online information — the quality and integrity of which can vary significantly — AVMs can be influenced by misinformation, generating inaccuracies that can tilt negotiations in favor of buyers hoping to score on lowball offers. An experienced valuation expert who is both on-site and capable of telling the story of a property’s actual status is therefore increasingly valuable in an industry in which technology is still not as sophisticated as some may believe.