Commercial Real Estate Appraisal Thresholds: Guardrails or Handcuffs?
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:
- Raised the appraisal threshold level at or below which appraisals are not required for CRE transactions from $250,000 to $500,000.
- Required the use of state-certified appraisers for CRE transactions above $500,000.
- 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.
- 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.