Feature
by Jay M. Harper
The definition of a real-estate appraisal is simple: an impartial estimate of your property's value. But the actual appraisal process can be tougher to navigate with the twists and turns of myriad types of appraisals, reports and, of course, appraisers themselves. In San Francisco the matter gets even murkier, considering the city's unique markets, zoning and ever-changing Rent Ordinance.
Appraisals can be divided into two groups: those that involve bank financing and those that do not. Congress requires an appraisal of the real-property collateral pledged as security for any loan made with bank deposits guaranteed by the government's insurance plan (FDIC). Bank appraisals are completed as part of the process of acquisition, refinancing and construction lending. Essentially, the appraisal mandate is an insurance policy for the lender and, ultimately, the taxpayer. The cost of an appraisal fee is at least partly offset by the lower interest rate available because the collateral is more secure. If you disagree with this, look at the rate-spread between a bank loan and a private loan.
Nonfederal appraisals include those prepared for partnerships, estates, trusts, divorce, insurance coverage and claims, litigation, investment analysis, condemnation and eminent domain, and nonbank financing. These can be more contentious than typical appraisals, often due to disagreements over the property value. Approximately 25% of my assignments fit into this category. The experience and market knowledge I have developed in performing ordinary, financing appraisals is vital to addressing these more complex jobs.
A complete appraisal considers three approaches to value—cost, sales comparison and income. However, if any particular approach goes unused in appraising one type of property, it may be omitted. For instance, the cost approach, broadly described as Land + Construction Cost + Profit = Value, is typically not employed when appraising older apartment buildings.
Most apartment appraisals are an estimate of the property's leased-fee estate, where ownership is limited by the rights of tenants. By restricting rent increases, San Francisco's Rent Ordinance creates leasehold values, wherein each tenant has a leasehold equal to the difference between the actual contract rent and market rent. An apartment appraisal should include an estimate of that difference; gross-income multipliers are strongly influenced by a property's rental upside to market.
All appraisals must include an estimate of as-is value, which means what is the real estate worth in its current condition, with the existing tenants? With proper documentation, the appraisal may also include value estimates based on assumptions or hypothetical conditions. Most lenders will make a loan based on the current as-is value and may later increase the loan if those conditions are met and/or assumptions found to be true.
An extraordinary assumption is one that may be true or false, but if found false could alter the appraiser's opinions or conclusions. For example, the owner might comment, "I don't know if that basement apartment is permitted or not, but if it is, its value increases by X dollars." A hypothetical condition is an appraisal based on a "what if?" The most common hypothetical question an owner might raise is, "What would this property be worth if I completed those renovations?"
Once an appraisal is complete, the documentation and presentation process begins. Most lenders and attorneys want a self-contained appraisal report. Once known as a full-narrative report, but now commonly called “the phone book,” the report must contain a detailed description of the subject property and market data as well as an explanation of the reasoning used to arrive at the value conclusion. Such a report also serves to ensure that the appraiser did a thorough job; since the entire process must be explained in writing, the appraiser cannot skip a step or two and jump straight to the value conclusion.
A summary appraisal report is a short version of the data and analysis used in making the value conclusion. It must be detailed enough to make sense to the user. My largest client accepts the four-page Federal National Mortgage Association apartment form appraisal for loans under $750,000. That threshold doesn't go very far these days in San Francisco, so most of my jobs are summary narrative appraisals that are about 30 to 50 pages, including exhibits.
Would you buy a building without going inside? To an appraiser, a client's request for a drive-by appraisal is an open invitation to a liability claim. Technically, I can appraise a property without looking inside, but there better be a very good reason, such as an uncooperative tenant or because a fire has already burned it to the ground. Trying to save money or time is not a good reason. This type of appraisal will be plastered with a disclaimer that states: “The appraisal is based on an assumption that the subject building's interior was in good condition, and if it later turns out to have been in poor condition, this appraisal is void.” The report will contain a hypothetical property description and the basis for that description, such as plans, tax records or an interview with the owner.
Appraisers were once allowed to recertify, or "recert", that the property value today is no lower than when it was appraised in the past. Under current rules, however, the appraiser is only allowed to recertify that renovations planned as of the appraisal date have actually been completed.
An updated appraisal is a cost-saving report format permitting reuse of the subject property description and market data. Appraisal rules allow an update only if the property and market conditions have not changed since the original appraisal was performed. Some lenders will allow an update if the original appraisal was completed less than three to six months ago.
Any appraiser you hire should be well-versed in all these things, knowledgeable in construction, construction materials and the like and, of course, fully aware of San Francisco's particulars. Federal law mandates appraisers be licensed by the State of California's Office of Real Estate Appraisers (OREA). Residential Appraisers and Certified Residential Appraisers may appraise one- to four-unit buildings. Certified General Appraisers may appraise all types of real estate. When looking for an appraiser, I recommend you also watch for The Appraisal Institute's MAI (Member Appraisal Institute) and SRPA (Senior Real Property Appraiser) designations, which carry more stringent educational and experience requirements than the State's certification process.
The opinions expressed in this article are those of the author and do not necessarily reflect the viewpoint of SFAA or the San Francisco Apartment Magazine. Jay M. Harper has 18 years' experience appraising commercial real estate in San Francisco. He holds the MAI designation from The Appraisal Institute and is licensed as a Certified General Appraiser by the State of California. Copyright © 2005 by the San Francisco Apartment Magazine. All rights reserved.