martin a. skolnik, mai (marty) director, multifamily appraisals freddie mac richard meyer (rich)

Valuation of Multifamily Properties: Perspectives from the End User

Techniques, Procedures, and Guidance

Presentation to the Appraisal InstituteIndianapolis, IndianaJuly 2013

Martin A. Skolnik, MAI (Marty)Director, Multifamily AppraisalsFreddie Mac

Richard Meyer (Rich)Director, Real Estate Services/Physical RiskFreddie Mac

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Introduction

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Speakers

Martin A. Skolnik, MAI (Marty)

Director, Multifamily Appraisals

[email protected]

Richard Meyer (Rich)

Director, Real Estate Services/Physical Risk

[email protected]

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Perspectives for this morning…..

"In a conversation, keep in mind that you are more interested in what you have to say than anyone else is."

- Andy Rooney

“In a conversation, the other person is spending most of their time thinking about what they are going to say next, rather

than listening to what you are saying now…”

- Anonymous

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Multifamily Real Estate Market in General,and Freddie Mac in Particular

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Freddie Mac Corporate Overview

Freddie Mac is a government-sponsored enterprise (GSE), and we are now in conservatorship as managed by the Federal Housing Finance Administration (FHFA) since September 2008

Our public mission is to provide liquidity, stability and affordability to the housing market

We operate in the secondary mortgage market, buying loans through a network of seller/servicers noted on FreddieMac.com

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Multifamily Overview

Our Seller/Servicer network delivers conventional loans to our four regional offices in McLean (Virginia), New York, Chicago and Los Angeles

Our Multifamily Seller/Servicer Guide (Guide), published on AllRegs, outlines our lending parameters and conditions of purchase;

» All third party report requirements are contained in the Guide

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Multifamily Overview

We are a prior approval lender and fully underwrite each loan prior to purchase

We began shifting in 2009 from a “buy and hold” to a “buy and sell” model and are currently securitizing more than 90% of the loans we purchase

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Importance of Third Party Reporting

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Market Metrics

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Background Information: Multifamily Real Estate Market

Apartment prices have increased by 12.5% over the last 12 months, driving the 6.2% year-over-year gain in the national all-property index.

Source: Moody’s Investor Service

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How life imitates art…

1212

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0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

7.0

7.4

7.8

8.2

8.6

9.0

9.4

Re

al G

DP

Gro

wth

%

Un

em

plo

yme

nt

Ra

te %

Economic Indicators1Q11 - 1Q13

Real GDP Growth Unemployment Rate

$950

$970

$990

$1,010

$1,030

$1,050

$1,070

4%

5%

6%

7%

8%

Eff

ec

tive

Re

nt

($)

Vac

ancy

Rat

e (%

)

Multifamily Vacancy Rates and Effective Rents1Q11 - 1Q13

Vacancy Rates Effective Rent

1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13

ACLI (60+ Day) 2 7 6 13 19 11 2 6 1

Freddie Mac (60+ Day) 36 31 33 22 23 27 27 19 16

Fannie Mae (60+ Day) 64 46 57 59 37 29 28 24 39

MF CMBS Market (60+ Day, excl REO) 1,080 1,224 1,210 1,082 1,055 1057 965 994 854

FDIC Insured Institutions (90+ Day) 367 334 290 253 236 204 185 155 135

0

200

400

600

800

1,000

1,200

1,400

Ba

sis

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ints

Delinquency Rates1Q11 - 1Q13


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Source: REIS

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Freddie Mac Multifamily Loan Volume

Fund Year Total Loan Amount # of Loans

2005 $10,970,000,000 984

2006 $12,750,000,000 1,048

2007 $21,970,000,000 1,861

2008 $24,270,000,000 1,823

2009 $16,610,000,000 1,038

2010 $14,820,000,000 1,015

2011 $20,090,000,000 1,322

2012 $28,790,000,000 1,677

Freddie Mac Multifamily Loan Volume 2005 through 2012

$0

$10,000,000,000

$20,000,000,000

$30,000,000,000

$40,000,000,000

2005 2006 2007 2008 2009 2010 2011 2012

Year

To

tal L

oan

Am

ou

nt

0

500

1000

1500

2000

Nu

mb

er of L

oan

s P

urch

ased

Total Loan Amount

# of Loans

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Pre-Discussion Warm-up

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How many appraisers are needed to change a light bulb?

» Answer: Three

One to research it, one to inspect it, and one to call

the client to ask exactly what number wattage they

want the appraiser to use.

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» Answer: One

If, in the appraiser’s opinion, the original light bulb

should be changed, the appraiser must identify and

set forth any data considered and relied upon, and

the reasoning and basis for installing a new light

bulb.

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» Answer: Appraisers do not change light bulbs.

Instead, they make an assumption that the light bulb

needs to be changed, then they do a Discounted

Cash Flow to estimate the use of the light over the

next ten years, even if the new bulb won’t last for

ten years.

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» Answer: Appraisers do not change light bulbs.

They make assumptions about why other people

change light bulbs, and then write a report about

other people’s light bulb purchases.

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Answer: Twelve … • One to take the light bulb order from the client;• One to sign the engagement letter with the client about how quickly the light

bulb is going to be changed and to specify the fee to change the light bulb (including a penalty if the light bulb is changed late);

• One to research how much light bulbs cost in a minimum of three separate stores including, hopefully, the store across the street from the subject;

• One to verify the comparable sales price data; • One to write about the history of light bulbs, how many light bulbs come into

the local port, and how many passenger miles the local airport handles;• One to re-read USPAP for regulations about light bulbs; • One to figure out why the Cost Approach can’t be used in changing the bulb;• Two to write the report (a senior appraiser and a trainee);• One to review the report;• One to deliver the report; and • One to tell the client why the appraiser won’t change the light bulb analysis

after report delivery, even though they got the wattage wrong in the report.

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Answer: It depends.

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Issues in Multifamily Appraisals

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Introduction

The underlying exercise of a Freddie Mac review of a third-party real estate appraisal review is to determine if the appraiser has adequately supported his/her opinion of market value.

So, the point of this presentation is to:

a) Talk about the risk factors that would indicate that an appraiser has or has not adequately supported his/her opinion of market value, and

b) Discuss suggested solutions to the issues we most commonly find in appraisal reports

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Introduction (continued)

Appraisers are generally good at extracting data from the market and analyzing that data in each of the three approaches to value.

But, many appraisal reports we see lack a narrative thread that relates how the appraiser’s observations and findings impact the value of the subject property.

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A well-written appraisal anticipates and addresses a reviewer’s questions in advance.

We have found that the difference between a reasonably well-written appraisal and a below average appraisal is usually the addition of a short/concise summary at the conclusion of each section.

Typically, the addition of this verbiage can dramatically improve the efficiency of our review process by reducing the need for “go-backs” to clarify the appraiser’s narrative.

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Quick refreshers and “ground rules”:

» Appraisals on multifamily properties come to Freddie Mac from two directions:

– Purchases of loans

The appraiser is the vendor of the Seller (a/k/a lender), not of Freddie Mac, but Freddie Mac is an intended user

FM’s underwriters are the primary reviewer

– Asset Management issues

Freddie Mac is the client

FM’s Real Estate Valuaton unit is the primary reviewer

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Quick refreshers and “ground rules” (cont):

» The appraisal report should contain sufficient analyses, discussion, data, and conclusions by the appraiser for the reviewer to render an opinion as to the adequacy of the value

» Freddie Mac’s underwriters use the appraisal conclusions, discussions, and data to assist them in their derivation of an underwritten value

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General Appraisal Issues

To be acceptable to support the Freddie Mac underwriting or asset management processes, the appraisal report’s content, discussion, analyses, and data:

– Must support the appraiser’s estimate of value

– Should comply with Chapter 12 of the Seller/Servicer Guide

– Should comply with Freddie Mac’s appraisal Best Practices

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Definition of Market Value

The most probable price which a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently and knowledgeably, and assuming the price is not affected by undue stimulus. Implicit in this definition is the consummation of a sale as of a specified date and the passing of the title from seller to buyer under conditions whereby:

– Buyer and seller are typically motivated.

– Both parties are well informed or well advised, and acting in what they consider their best interests.

– Reasonable time is allowed for exposure in the open market.

– Payment is made in terms of cash in U.S. dollars or in terms of financial arrangements comparable thereto.

– The price represents the normal consideration for the property sold unaffected by special or creative financing or sales concessions granted by anyone associated with the sale.

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A fundamental problem in multifamily appraisals:

Property Interest Being Appraised is Wrong

Many times, an appraiser will state that the appraisal is the valuation is of the “fee simple” interest.

» The Appraisal of Real Estate (13th edition, page 114) states that leased fee ownership is the ownership interest held by the lessor regardless of the duration of the lease or of the specified rent.

» Specifically, “a leased property, even one with rent that is consistent with market rent, is appraised as a leased fee interest, not as a fee simple interest.”

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Property Interest Being Appraised is Wrong (cont.)

» The sales in the Sales Comparison Approach are all leased fee transactions. That is, the sales price is based on the income at each property.

» Additionally, the capitalization rates derived from these sales are also leased fee capitalization rates

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Property Interest Being Appraised is Wrong (cont.)

» Real life example:

A property with short-term leases at market rent levels is required to be appraised as a leased fee property.

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History of the Subject Property Previous history of a sale of the subject property

» If there is a recent purchase of the subject property, is the price similar to the value?

– If not, why not?

True to life example:

The listing price for the Subject property is approximately $13,600,000. As a result of our analysis contained in this appraisal report, we have concluded to an “as is” value of approximately $21,700,000 for the Subject property, which is above the current listing price. The discrepancy between our concluded value and the listing price is partly attributed to the fact the Subject is currently being marketed as a part of a portfolio of assets, which may not reflect the true value of each individual asset. More importantly, we believe the property could be operated at a lower expense level relative to the historical data.

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General Appraisal Issues (continued)

Property Inspections:

» Which units did you inspect?

» What was their condition, configuration, and utility?

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Focus your inspection on particular issues:

» Down units

» Vacant units

» A sample of each unit type

» Top floors and bottom floors

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Speaking of Property Inspections…

This is my favorite description of on-site conditions, taken from the appraisal of a 50%-occupied seniors housing property:

“In addition to significant turnover in the senior management team, we observed during our inspection that the Director of Marketing kept confusing assisted living with independent living and was not sure what the asking rates were or how the additional fees for care were assessed or charged. There were no brochures or any kind of promotional materials available for any prospective residents or family members. The Assisted Living Manager was too busy texting to look up or introduce herself while we stood in her office. The Executive Director had been there only a few days and represents at least the third ED in as many years. In fact, the only person who seemed to have a handle on the subject and its operations was the Maintenance Director."

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Everyone who signs the appraisal must have inspected the property

Everyone who signs the appraisal must be licensed/certified in the state in which the property is located!

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Photos

» Current?

» Internet photos??

Maps

Market Area Discussion

» What are the drivers of multifamily occupancy and rents?

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The Seller/Servicer must direct the appraiser to include the following language in the letter of transmittal above the appraiser’s signature and/or on the appraiser’s Certification page above the appraiser's signature:

“This report is for the use and benefit of, and may be relied upon by,

a) The Seller/Servicer, Freddie Mac and any successors and assigns (“Lender”);

b) Independent auditors, accountants, attorneys and other professionals acting on behalf of Lender;

c) Governmental agencies having regulatory authority over Lender;

d) Designated persons pursuant to an order or legal process of any court or governmental agency;

e) Prospective purchasers of the Mortgage; and

f) With respect to any debt (or portion thereof) and/or securities secured, directly or indirectly, by the Property which is the subject of this report, the following parties and their respective successors and assigns:

Any placement agent or broker/dealer and any of their respective affiliates, agents and advisors;

Any initial purchaser or subsequent holder of such debt and/or securities;

Any Servicer or other agent acting on behalf of the holders of such debt and/or securities;

Any indenture trustee;

Any rating agency; and

Any institutional provider from time to time of any liquidity facility or credit support for such financings

In addition, this report, or a reference to this report, may be included or quoted in any offering circular, information circular, offering memorandum, registration statement, private placement memorandum, prospectus or sales brochure (in either electronic or hard copy format) in connection with a securitization or transaction involving such debt (or portion thereof) and/or securities.”

Required Regulatory Language (in Section 12.12 of the Seller/Servicer Guide):

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Third-party reports are typically available from the Lender

– Environmental

– Engineering / Property Condition Assessment

– Zoning

– Flood Hazard

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The appraiser needs to reference any material issues raised by

the third-party consultant and state their impact on value.

For properties in where the third-party consultant has identified

issues, it is not sufficient for the appraiser to just state that there

is “no impact on value” without sufficient support for this

conclusion

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If there are issues on the property that might impact value but for which the appraiser says that there is no value impact (i.e., location within a flood zone, hazardous material remediation), the appraiser should discuss the reasoning for its non-impact and provide market support for his/her rationale.

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The appraiser’s zoning discussion should address:

– Is the subject’s use a legal use? If not, why?

– Are there an adequate number of parking spaces for its occupancy? (This could be based on zoning and/or based on market expectations & comparables)

– Does the developed density comply with current zoning requirements?

– Does the subject comply with the current floor-area-ratio (FAR) requirements?

– Can the property be rebuilt to its current inventory of units if there is a casualty loss?

– What is the impact on value?

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Parking -- Real life example #1:

The appraiser states, “We requested, but were not provided an exact number of parking spaces.”

Solution: Count them…!

» Walk the site, or

» Plat or survey, or

» Aerial photograph (Google or Bing)

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Parking -- Real life zoning example #2:

The appraiser says that parking is “assumed adequate.”

There was no discussion of:

• the actual number of spaces at the property,

• the ratio of spaces per unit, and/or

• the local zoning requirement

Questions that the appraiser must answer in the appraisal:

• Is the parking ratio in compliance with local zoning regulations?

• Is the parking ratio/number of spaces adequate in this market?

If the answer to either or both questions is “no”, then what is the impact on value?

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Property taxes

» Does the appraisal have current, correct tax assessment and property taxes?

» Is the tax assessment value similar to the appraiser’s value estimate?

If not, why not?

California issues

» Tax comparables

» Risk of reassessment at the appraiser’s value

It is not appropriate to estimate the risk of reassessment by merely applying an unsupported bump to the capitalization rate

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Suggested methodologies for incorporating risk of reassessment:

1. Select several multifamily sales within the same or similar taxing jurisdiction that have been reassessed after the sale

A comparability chart can be constructed to compare each sales price with the new tax assessment

So, if other comparable/similar properties were reassessed at an average of, say, 75% of the sales price, then it would be reasonable to assume that the subject would be also be reassessed at that amount

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Suggested methodologies for incorporating risk of reassessment (continued):

2. If the appraiser’s sales comparables were mostly chosen from the same or a similar taxing jurisdiction, then the market’s measurement of the uncertainty of reassessment could already be built into the capitalization rate

There would be no need for an adjustment to the appraiser’s capitalization rate.

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Other Issues: Real life example

“We were not given a title report to review. We do not know of any easements, encroachments…”

The appraiser does not state whether they asked for a title report nor did they discuss their efforts to obtain a copy of the recorded plat from the courthouse or to request a survey from the property owner or from the lender.

USPAP Standards Rule 1-2 (e)(iv) “Identify … any known easements, restrictions, encumbrances, leases, reservations, covenants, contracts, blarh blarh blarh…”

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Building Description – Real life example:

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What’s wrong with this statement?

The Comment to USPAP Standards Rule 1-2(e)(v) (which Advisory Opinion 17 expounds upon) states:

“When appraising proposed improvements, an appraiser must examine and have available for future examination plans, specifications or other documents sufficient to identify the character of proposed improvements.”

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Income Approach

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Income Approach

Do the recent rents from the rent roll support the appraiser’s opinion(s) of market rents for each unit type?

If not, what is the differential?

Is this a material difference in value?

The Freddie Mac test of reasonableness

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Income Approach (continued)

Does the appraiser reasonably support the estimate of:

– Vacancy?

– Concessions?

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Operating Expenses

We typically review the totality of the operating expenses, not necessarily each line-item

We benchmark the appraiser’s operating expenses against the comparables provided

» Subtracting real property tax

» Subtracting reserves for replacements

Is the appraiser’s estimate of operating expenses supported by the expense comparables:

On a per-unit basis?

On a percentage of effective gross rent?

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Operating Expenses (continued)

We do a correlation between the historical expenses the appraiser included in the Addenda to the chart of historical expenses presented in the body of the report.

» Many times, there are inconsistencies that affect value

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Is the appraiser’s replacement reserve supported by the property condition report?

Is the management fee reasonable for this property type?

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Capitalization rate

The appraiser must discuss and relate the selected capitalization rate to the subject property’s particular characteristics such as market and regional issues, physical condition, economics (e.g., vacancies and operational issues), and legal constraints (e.g., zoning and ownership structure)

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Capitalization rate (continued)

The selected final overall capitalization rate should be representative of the range of the results from these methodologies and not show a bias to either the low or high side of the range

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Capitalization rate (5 ways to estimate the rate):

1. Sales

2. Band of Investment model

3. Debt Coverage Ratio (DCR) model

4. Published sources

5. Interviews

Correlate the results of these five methods into a single capitalization rate conclusion

(and discuss ‘why’)

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1. Sales

• Financial data of the comparable sales should be verified and the source of the data should be disclosed in the appraisal

• Generally, the preferred type of data is either current to the date of value or forward looking

• An “Appraiser’s Estimate” of financial terms, conditions, and operating parameters is not appropriate

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» Sales (Example):

The date of value was September 1, 2009….

What is the appraiser’s concluded capitalization rate?

7.0%

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2. Band of Investment

– Tell us the source(s) of your financial data!

Band of Investment model

Loan % x Mortgage Constant = Loan contribution

Equity % x Equity Dividend Rate = Equity contribution

= Capitalization Rate I.

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2. Band of Investment (continued)

Equity Dividend Rate

Meaning of the rate relationship

Sources

» RealtyRates.com

» American Council of Life Insurers

» Sales

Band of Investment model

Loan % x Mortgage Constant = Loan contribution

Equity % x Equity Dividend Rate = Equity contribution

= Capitalization Rate I.

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2. Band of Investment (continued)

The appraiser should refrain from using the Ellwood mortgage-equity calculation.

It is not supported in The Appraisal of Real Estate textbook (13th edition).

Typically, the appraiser’s assumptions and components of his Ellwood calculations (property appreciation and equity build-up) are usually not supported or discussed, just presented as fact

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3. Debt Coverage Ratio (DCR) model:

Mortgage Constant

x Loan Percentage

x Debt Coverage Ratio

= Capitalization Rate

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4. Published Sources: PwC survey (free version from App. Institute)

Ranges so large you can pick any number you want

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PwC survey (continued)

Respondents for the National Apartment Market Survey:

Insurance company

Pension fund advisor

Domestic pension fund

Institutional investor

Private investment firm

Pension fund advisor

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CBRE publishes a semi-annual capitalization rate survey for approximately 40+ metropolitan areas and by property class

http://www.cbre.us/services/capitalmarkets/multihousing/Pages/knowledge-center.aspx

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5. Interviews with local market participants

» The date of the interviews and the names of the interviewees would be helpful

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Other Considerations

» Temporary market conditions, such as unusual vacancy or concessions, should not be capitalized in perpetuity but should typically be considered as a present value deduction from the valuation, either from each approach to value them separately or from the overall value conclusion after reconciling the three approaches

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Other Considerations (continued)

» A discounted cash flow analysis may be required for a property that is experiencing unstabilized operations

» If a DCF analysis is included in the appraisal, the appraiser should discuss and provide adequate support for the model’s inputs

» Generally, extending the analytical period to only the first full year following stabilized operations will produce the most accurate value

– That is, 10-year cash flows for a multifamily property that is anticipated to be stabilized in 18 months is probably not appropriate

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Sales Comparison Approach

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» The phenomenon of "economies of scale" is typically a by-product of normal price negotiation and is a relatively minor feature of the value of a property

» We have seen adjustments of 10%, 15%, and 20% for “economies of scale”, and this is just wrong.

– Is “economies of scale” more important than, say, location or physical condition?

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» Sometimes an appraiser will inappropriately use very small percentage adjustments in the Sales Comparison Approach, such as 2%, 3%, 7%, etc.

» These indicate a level of precision that probably does not exist in the market

» There are times, though, that the appraiser can provide adequate support for this type of precision from the local market

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Sales Comparison Approach (continued)

» The sales comparables need to be verified with a source familiar with the transaction and the primary data source for the financial indicators must be provided.

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» Sometimes appraisers try to force a sale to be “comparable” to the subject by using unusually large individual line-item adjustments or if the cumulative number of adjustments to that sale is large.

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» Appraisers should provide an adequate description of the factors that differentiate the comparable from the subject

» Statements such as, “the comparable was adjusted upward for inferior condition” are not sufficient

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Net Income Adjustments or Multipliers

» Applying a blanket adjustment for income characteristics (sometimes referred to as an NOI adjustment or net income adjustment) is not a reasonable valuation technique

» As stated in The Appraisal of Real Estate (13th edition), a net income multiplier analysis is simply the reciprocal of the capitalization of net income from the income approach and is not an appropriate analytical tool for the sales comparison approach

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Net Income Adjustments or Multipliers (continued)

» Typically, adjustment should reflect specific characteristics that affects a property’s income such as level of operating expenses, quality of management, tenant mix, rent concessions, lease terms, and the like, not just that the resulting NOI is greater or lesser than the subject.

» That is, in the Sales Comparison Approach typically an appraiser should discuss the causes of the differences in NOI, not just that a difference exists.

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Things we look at in particular in the Sales Comparison Approach:

» Are the sales in reasonably close proximity to the subject and are they reasonably recent?

» Are the sales of a similar market appeal and investment class as the subject property?

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Things we look at in particular (continued):

» Are any of the individual adjustments in the sales grid unusually large?

» Is the totality of the adjustments unusually large?

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Things we look at in particular (continued):

» Do any one or two sales stand out?

» Does the financial information make sense?

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Question: “Can appraisers use listings or sales in escrow in the Sales Comparison Approach?

Answer: Of course, with an explanation

The Seller/Servicer Guide states (Section 12.14(b) that the appraiser must use at least three recently sold comparable properties. However, it does not say that listings or contracts cannot be used.

“A listing is just a listing. A sale isn't a sale until it sells" should be in the back of the appraiser's mind as he/she analyzes the local market.

Although it can be done, we would be wary of an appraisal where the conclusion to the Sales Comparison Approach is based mostly on listings or contracts

– It would take a significant amount of data, local interviews, and wordsmithing to be convincing, though.

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The subject is a 27-story former office building located at the southwest corner of Van Buren Street and Wabash Street. The subject was originally developed in 1927/1929 and has been vacant the last few years.

The property operated from inception until 2002 as a commercial office building, housing such tenants as Mobil Oil.

In 1999 The Buckingham was listed on the National Register of Historic Places, and in 2002, the city of Chicago designated the building as part of the Historic Michigan Boulevard District, a Chicago Landmark District.

The building was vacant for the three years preceding 2007.

Student Housing Example

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This property, one-block from USC, has resort-style amenities, such as a swimming pool and two spas, a large indoor/outdoor fitness center (including treadmills and ellipticals with individual plasma TVs), a health spa that includes 2 steam rooms, 2 saunas, several showers, a massage therapy room and a rooftop sundeck with views from the Coliseum to the downtown skyline. All residential floors include group study rooms, study lounges with individual work spaces, and laundry facilities with smart card technology. Each apartment has high speed internet, Dish Network TV service (HDTV-ready), and one gated, reserved subterranean parking space per bedroom, with additional parking available at $150 per space.

The project amenities include a 1,500 square foot fitness, rooftop club room, internet café, study rooms, practice rooms 9 (musicians), meeting rooms, bicycle storage, residency life center with advisors and a state-of-the-art security card reader system. The entire building contains high speed telecommunications including WIFI “ready” in all units and common meeting rooms. The interior of the units contain 9.5 foot ceilings, washer/hook-ups, walk-in closets and track lighting.All units with the exception of the studios are corner units featuring views of the Lake Michigan, GrantPark and Millennium Park.

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Cost Approach

If the appraiser did not develop the Cost Approach, there must be a reasonable rationale for its exclusion

Throw-away statements are not acceptable or appropriate:

» “The Cost Approach has not been developed due to difficulty estimating depreciation due to current market conditions”

» “Buyers do not use the Cost Approach in their analysis of properties”

» “I did not feel like it”

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Cost Approach

Is the subject property’s construction recent enough that the Cost Approach could tell the reader something about external obsolescence or current market conditions?

» External obsolescence:

– Correlation of actual construction costs with value

– Correlation of replacement costs with feasible rents

» Functional obsolescence:

– Comparison of actual construction costs with replacement cost (i.e., Marshall Valuation estimates) could indicate overimprovement

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Cost Approach

Real life appraisal report example for a property built between 2002 and 2006 in a major metropolitan area:

“In deriving a cost figure for the subject, Marshall Valuation Service (MVS) was used. Data pertaining to the subject’s original construction costs were not made available to the appraiser. The Insurable Value Base Building Cost figure derived from MVS of $182,700,000 (rounded) is above the market value derived by the Income and Sales Comparison Approaches. As this figure does not include indirect costs or land value, there is obviously some form of obsolescence occurring, most likely external obsolescence as there is no evidence that the property suffers from functional obsolescence. There are already new projects under construction in the immediate area, and it is the appraiser’s belief that the inclusion of the Cost Approach would not help to define any significant market occurrence or trend at this point in time. As a result, the addition of the Cost Approach is not seen as a reliable valuation method for the subject property and has not been included.”

© Freddie Mac

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Cost Approach

Are the land sales reasonably recent and have a similar Highest and Best Use as the subject?

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Cost Approach (continued)

The construction cost classification from Marshall Valuation Service (in the Cost Approach and in the Insurable Value sections) must match the description of the subject’s construction in the Description of Improvements section of the report.

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Cost Approach (continued)

Structural System:

Brick bearing walls and wood joists

Exterior Walls:

Brick façade

Example of construction description error

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Reconciliation

Reconciliation of the three approaches to value

» Any adjustments made by the appraiser for loss-to-lease, property condition, income lost due to absorption of vacant space, unusual obsolescence or deprecation, and the like, should be reflected in all three approaches to value (Income, Sales, and Cost).

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Reconciliation

Relative weight of the Approaches

» If you say, “Each approach is valid and yields a reasonable estimate of the subject’s market value”, then you cannot put all or most of your weight on the Income Approach

» If you say, “All my weight is placed on the Income Approach because that is how investors buy properties such as the subject” then, in the Sales Comparison Approach, you cannot say that “these sales are a good representation of the market value of the subject”

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Other Valuation Issues

» Contributory value of tax credits

– Did the appraiser include the value of low-income housing tax credits as part of the real estate value, or are the LIHTCs valued separately? (Hint: They should not be included in the real estate value.)

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Other Valuation Issues (continued)

» Contributory value of bond financing

– Does the technique used by the appraiser to value the contribution of bond financing make sense?

– Are the appraiser’s market-rate financing assumptions logical and supported by sources other than the Seller/Servicer?

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Other Valuation Issues (continued)

» Property tax abatements

The preferred Freddie Mac methodology is:

First, full stabilized real estate taxes are used to calculate the NOI that is used to determine the property value with full taxes.

Next, the present value of the tax savings over the term of the tax abatement is determined using a discount rate supported fully by the Appraiser.

The present value of the tax savings is then added to the Property value with full taxes to determine the value of the property with the tax abatement.

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The following are common signs of above average report:

Complete and germane data

Consistent and easy to follow format

Appropriate choice, placement, quantity, and quality of exhibits

Accurate math calculations

No catchall disclaimers such as, “The appraiser did not observe any easements during the inspection” or “A legal description (or plat, survey, and/or construction drawings) was not provided to the appraiser.”

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Favorite phrases:

“The sales indicate that, in general, investors are willing to pay more for properties with greater income potential.”

“Economics are the primary factors driving the sales prices of seniors housing properties, not physical differences.”

“Based on my years of experience and knowledge of the area, I conclude that….”

“But if I make that change to the rents, I’ll have to report a lower value.”

© Freddie Mac

Speakers

Martin A. Skolnik, MAI (Marty)

Director, Multifamily Appraisals

[email protected]

Richard Meyer (Rich)

Director, Real Estate Services/Physical Risk

[email protected]

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martin a. skolnik, mai (marty) director, multifamily appraisals freddie mac richard meyer (rich)

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