Incorporating a Discussion of Risk in Appraisals: A New Direction for the Appraisal Industry.

Author:Skolnik, Martin A.


Risk is an ongoing discussion in the mortgage lending industry, both across property types and geography, and on a property-specific basis. During an appraisal engagement, appraisers collect and discuss many risk factors that might tangentially describe the risk to the mortgage lender, but the appraiser's analysis of risk is embedded into the report's narrative and not a distinct discussion. This article outlines a framework for a potential expansion of the appraiser's scope of work (and new business opportunities) to evaluate and discuss risks, which might affect how lenders analyze the subject property, and also result in a more uniform consideration of mortgage risk. This framework would also provide a new value-added opportunity between lenders and appraisers beyond what is typically part of appraisal reports.


Traditionally, commercial appraisers have been engaged by lenders to provide a written credible opinion of market value for an income-producing property that is used as part of the loan package as support for a lending decision. In a customary 100- to 150-page narrative appraisal report, the focus of the lender-client primarily has been on the appraiser's estimate of market value, which is used in conjunction with loan-to-value criteria and information from the income approach to help inform the lender of the property's debt coverage capabilities. Appraisals for income-producing properties are typically used by lenders to identify the value portion in the loan-to-value analysis, and the net operating income in the debt coverage ratio analysis.

Since the Great Recession of 2008, however, there has been considerably more focus in the commercial lending industry on factors beyond a property's market value and its net operating income. The industry is placing considerable emphasis on identifying risks associated with the loan, with the borrower, and with the property. It is here that there is a disconnect between the needs of lender-clients and appraisers' traditional appraisal report writing and analytical focus.

Descriptive versus Analytical Appraisal Reports

A commercial mortgage lender typically reviews an appraiser's report and extracts the estimate of value and the net operating income as part of its underwriting analyses. However, the data and analyses within the report could be useful to the lender for much more than just those numbers, and the appraiser could he a more significant contributor to the lender's underwriting process.

A flaw in contemporary appraisal reports is that there are pages and pages of description (i.e., description of the subject's regional market and local market, its site and improvement characteristics, zoning, and property taxes), but there is little discussion of how this material has been used by the appraiser and very little about its applicability to the valuation of the subject property. Even though many appraisers title these sections as "analytical" (i.e., market analysis, site analysis, zoning analysis), these sections are descriptive, not analytical.

Examples of where analytic information could enhance descriptive information and help the lender-client assess risk include the following:

* Flood zone--The appraiser might describe a property as being in a 100-year floodplain and also analyze or discuss its impact on market value.

* Zoning--An appraiser might describe a property as being legally nonconforming and also analyze or discuss the valuation implication or investment risk of such a classification.

* Market/Geographic--An appraiser might describe the subject property's metropolitan area in detail and also analyze the subject property's location within or outside a redevelopment zone.

* Data--The appraiser might describe capitalization rate data taken from a published survey and also analyze or discuss the risk that the survey is weak for the subject property's use, type, or location.

* Comparable sales--The appraiser might describe the comparable sales' characteristics and also analyze or discuss the risk implications if the most recent comparable sales transferred significantly before the date of value.

The list of examples could be extensive. The point is, the contemporary appraisal report is becoming increasingly a descriptive document, not an analytical document structured to assist the lender-client with its decision making. As data continues to become inexpensive and widely available, this trend toward descriptive reports will continue, to the detriment of the appraisal industry and to its lender-clients who would benefit from analytical assistance in identifying risk in their lending activities.

One Size Does not Fit All

Appraisal reports from commercial appraisal firms are fairly uniform in their composition regardless of the firm or the client's intended use. For example, the format of an appraisal report for lending purposes looks, feels, and reads very similar to an appraisal report developed for condemnation purposes, for a property tax assessment appeal, or for bankruptcy or foreclosure. This inhibits the appraisal report's practical usefulness to the lending industry. If all reports are formatted the same, with most data from the same providers (making the data ubiquitous), and the analytics within the report indistinguishable between firms, then it is clear why a lender might view only a few numbers in a report as being germane to its underwriting efforts. The analytical and evaluation needs of a lender-client are different from those of a tax appeal client, so why are the underlying data, discussion, analyses, and reporting formats similar?

Identification of Risk

In 1996, Eric T. Reenstierna observed that an appraiser traditionally is asked what a property is worth, but the appraiser should analyze more than just the property's value. Reenstierna states:

The simplicity of the question masks larger issues. Value is complex. To discuss value for buyers, sellers, and lenders properly requires that appraisers not only provide a one-number answer but address value in its complexity. To the extent that appraisers can address not only the simple question but also the need for risk assessment that gives rise to it, they can provide their clients with more comprehensive services that are better suited to those clients' needs. (1) What if an appraisal for lending purposes focused on analysis...

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