82.1 F
San Fernando
Tuesday, Feb 7, 2023

Brokers, Lenders, Appraisers Spar Over Property Values

During a recent industrial real estate transaction in Van Nuys, the buyer and seller agreed to a sales price of $2.6 million. And the buyer was planning to obtain bank financing for the deal, according to George Stavaris of Grubb & Ellis, who represented the seller. Only problem: The initial appraisal came in at $1.5 million. The seller wasn’t willing to budge that much, so the buyer couldn’t afford the property. And Stavaris claimed the appraiser came up with the number by simply taking 50 percent off the building’s market high. “There was no rationale behind his appraisal,” said Stavaris, adding the 11,500 square foot space is located in a tight industrial market. Vacancy rates in Van Nuys are much lower than most markets nationally. So a second appraisal was ordered, and the deal eventually closed for $2.4 million. Stavaris and other local commercial real estate brokers said lenders and appraisers are missing the mark on property values in the Valley. Numbers are often based on broad brush strokes about the market, which is killing some transactions, stalling others and keeping prices down. But appraisers and lenders said there’s no conspiracy. It’s difficult to find solid sales comps these days, because there have not been many sales in the down economy. Uncertainty about where vacancy and rental rates are headed also factor heavily into appraisals and how much banks are willing to lend. “The truth is there’s been a tectonic shift in appraising, and these brokers are spoiled,” said Chuck Hershson, a hard money commercial real estate lender with Fidelity Mortgage Lenders in Santa Monica. “The sales comparison approach is all but gone in this market, and lenders are basing their valuations largely on the income approach,” he added. “Income is what pays all of the expenses of commercial real estate and shows yield for owners.” When commercial real estate was booming, brokers and property owners got used to capitalization rates (a percentage number applied to future income to determine current value ) around four and five percent, said Hershson. Cap rates are now in the 7.5 to 8.5 percent range, which decreases property values. When appraising the value of commercial real estate, you also have to take into account whether or not old leases are coming due. Because of today’s market conditions, property owners are likely going to have to decrease the rental rate and make other concessions when renewing the lease, said Hershson. “Our loan to value ratio is 40 to 45 percent,” he said, adding many bank’s loan-to-value ratio is 50-65 percent, if they’re lending at all. “And all of my appraisers use a 10 cap rate. As lenders, we’re the ones who ultimately have liability for loans. And in today’s market you have to be careful. ” Scott Romick of Lee & Associates, who specializes in office real estate, said one tenant and prospective owner/user recently agreed on a sales price with the property owner. But the appraisal came in 20 percent less than the agreed upon price. “The comps were not that good, because there wasn’t much to choose from,” said Romick, adding the lender also considered the transaction an investment deal because it wasn’t owner occupied yet. If the buyer were to occupy the building immediately, the appraisal itself would have likely been higher. Historically, owner-user sales command higher prices. Underwriting rules also prevent lenders from straying from the appraised value. “Once you have an appraisal it’s difficult to get another,” said Romick. Eventually the seller absorbed some of the difference and lowered the sales price. But Romick said low appraisals such as this, and lenders not straying from appraisals, have killed some deals altogether. It’s also leading to other deals dragging on. Tom Curtis, senior appraiser at Curtis-Rosenthal, Inc. in Los Angeles said appraisers better have a good reason for valuing properties lower than a mutually agreed upon sales price. But lack of comparable commercial real estate transactions is certainly making the appraisal process harder. “The comps are just not out there,” said Curtis. “But you have to find them further back in time or further out geographically. And what we have done here, to make sense of it all, is also interview local brokers, investors and others to find out what they think the property is worth. People in the trenches have a solid idea of what’s going on.” Loan-to-value ratios are a lot less than the past, he said. And if lenders make a loan amount that’s higher than the property is worth, they’re walking a tight rope. Many lenders are hesitant to fund the purchase of older buildings that might not last as long as the loan term. And some take an income approach to the property. “At the end of the day, appraisals are just opinions of value,” said Curtis, adding they’re a snapshot in time and bound to change. “Lenders have to make a business decision. And you can always hire another appraiser.” Todd Sherman, principal at First Pacific Financial – a commercial mortgage company, said very few lenders are doing commercial deals these days other than Small Business Administration backed loans. And borrowers need to be rock solid financially. “They need to be perfect borrowers,” said Sherman, who deals primarily in multi-family transactions. “Appraisals are down because cap rates are higher and rents are lower.” And nobody knows where the market is going, he added. Buyers also need to be prepared to put down 40 percent. Multi-family lending is a little better than other types of commercial real estate, he said. More people are renting because it’s tough to get residential loans, so values tend to be stronger. But they are still lower than past years because of high vacancy rates and landlords making concessions. Stavaris said some buyers no doubt benefit from low appraisals. But others are forced to pony up more cash, or walk away, if the seller is not willing to budge. In general, he argues that lenders should not base their numbers on what’s happening nationally, or even in other California markets, especially if a buyer and seller have agreed on a price. The Valley is its own micro climate, he said. “I think what banks, through direction to appraisers, have done is stymie the capitalistic market,” said Stavaris. “That’s a problem for the Valley.”

Featured Articles

Related Articles