Risk…tell me about it.
Should commercial appraisals emphasize a particular client’s risk perspective? For financial institutions, chief appraisers are concerned about collateral risk. Its impact on the quality of loan origination. For buyers, addressing potential investor red flags for proper due diligence is paramount. A property-specific risk analysis would add an additional desirable dimension to appraisals.
The commercial appraisal narrative with its market value opinion goal has largely remained unchanged since President Franklin D. Roosevelt. There’ve been tweaks along the way, though primarily regulatory (responding to bad events). USPAP came on the scene when Seinfeld, big hair and Madonna were popular in the late 1980s. Its goal was to promote a high level of public trust by establishing requirements. However, risk related to the value opinion hasn’t been a focal point of the current narrative.
Commercial properties are expensive, often complex, so appraisers should utilize their vast knowledge to educate their clients. One simple tool for starters would be SWOT analysis, qualitative insights on the market position of the subject relative to its competitive set. SWOT provides additional context for the selection of comparables and adjustments.
Let’s say the valuation assignment is a stabilized 75,000 square foot neighborhood shopping center. The reader may benefit from a SWOT risk discussion.
Strengths: Stabilized occupancy. Appropriate and supportive surrounding demographics for the subject. Currently demand outpaces supply for comparable retail product in the subject market area.
Weaknesses: Parking ratio low for center’s high percentage of restaurant tenants.
Opportunities: Leases are triple net terms, but ownership isn’t enforcing CAM collection.
Threats: Looming significant capital expenditures in the next five years, recommend Property Condition Assessment (PCA) report by qualified engineering firm.
I think the bottom line is for appraisers to view the subject property as if it was their money at risk. I’m not suggesting being overly conservative, but rather “talk to the reader” about risk issues that came to mind. Sanitizing appraisals via omissions without mentioning observed risks (albeit sometimes subjective) is a disservice to clients.
Scope of work is just that, expectations spelled out. We’re starting to see chief appraisers asking their fee panel, “Discuss the market position of the subject.” This helps identify risk factors that may impact collateral. Addressing the impact of risk and its probability of it actually happening is a great framework as a value-add for commercial appraisers. If I was helping a friend buy this shopping center, I definitely wouldn’t limit my discussion to just market value. I would help them see the potential risk and upside. I would tell them about it.