With all of the new regulations and changes in FDIC policy following the banking crash, one of the areas that has been effected significantly is commercial loan appraisals. The changes in how Banks must now handle commercial appraisals are having a resounding effect on the industry and commercial loan borrowers.
In the old days a borrower would get an approval for a commercial loan and after approval their lender would contact several appraisal manager and collect bids for the work and try to place the work with the most qualified appraiser at the best price with the quickest turnaround. Now, based on new regulations, the FDIC wants commercial lenders to have as little to do with commercial appraisers as possible. In fact, they would prefer the two did not talk at all. All FDIC insured institutions must now have a third party within the Bank order the appraisals; someone separate and apart from the commercial lender. In fact the commercial lender is supposed to have no control or influence over the person ordering the appraisal, meaning often times the individual or group (for larger banks) assigned to manage the appraisal process is not even involved in the loan process. This has led many Bank’s to utilize an out-sourced appraisal management services to manage the process for them.
Although on the surface this process appears to make sense as it prevents collusion between lenders and appraisers, when examined more closely this process clearly creates many problems and is hurting the quality of the work getting done while increasing the cost and time involved, which the following examples will clearly demonstrate.
1) Unlike residential home appraisals, which are very standard, commercial appraisals can vary quite significantly depending on the property type. Often times the individual or group ordering an appraisal does not know if the specific appraisers bidding a job have experience in the industry or have done significant work with a specific property type. This can lead to appraisers with less experience completing appraisals inaccurately that they never should have been given the opportunity to work on in the first place. Commercial lenders used to verify that the appraisers doing the required work understood the property type, and often times those lenders knew which appraisers to use with certain property types because they knew which appraisers had experience in those industries based on past work.
2) Many commercial properties are quite unique and often times there are details or items that need to be addressed by the appraiser as part of the appraisal process. Sometimes the type of appraisal or type of conclusion needs to be adjusted based on the property type or some factor affecting a property. It is hard for commercial lenders to communicate those items to a third party individual or group who is actually ordering the appraisal and be sure that information gets communicated through accurately to the individual appraisers. Most of the individuals now managing the appraisal process do not understand commercial lending and what is needed. This often times leads to miscommunication that can greatly increase the time involved and the accuracy of the final reports produced by appraisers.
3) In the past commercial lenders would work hard to keep appraisal bid prices in check, and would often times work appraisal pricing down for their clients to keep the loan affordable and their commercial loan borrower happy. A third party individual or group has no incentive to keep prices in check. Plus, once an appraiser is on a bank-approved checklist, it is usually guaranteed to get the chance to bid a certain amount of work. Because of this there is no longer an incentive for an appraisal company to lower its bids to attract more business from an individual bank or lender. Appraisers know that pricing control is now gone from the lenders, and across the board the cost for commercial loan appraisals is up at least 50% and in some cases with certain property types it is up as much as 100%. Commercial loan borrowers are forced to bear the burden of this increased cost.
4) When commercial lenders were involved in the process, they could push commercial appraisers to complete appraisals quicker and could hold appraisers to deadlines because appraisers knew if they missed deadlines they would not get additional work from that lender. Now because of the involvement of an additional level of bureaucracy either from a third party within a bank or an out-sourced service, additional time is added to the process. Furthermore, these groups and individuals rarely hold appraisers to a timeline and often accept bids based on the best price and not necessarily the time it will take to get the appraisal done. Once again because appraisers know they are going to see the same amount of opportunities, they are less incentivized to work quickly on particular appraisals. Also, the lenders used to be able to work with the appraisers and get them information in advance and help coordinate cooperation from the borrower, greatly speeding up the process. But since the lender can no longer speak with the appraiser, they can no longer provide this assistance and the appraiser must get all of the paperwork from the borrower directly. In general, the turn-around time for commercial appraisals as gone from two to three weeks to a minimum of three weeks and often times four weeks or more.
5) In most cases commercial lenders are no longer able to talk with the commercial appraiser. Sometimes appraisal reports come back incorrect. The square footage may be wrong, lease information is missing, or in some cases the appraiser has just clearly missed the boat and the value is way off from where it should be. Commercial lenders can no longer work with appraisers to get reports corrected. Often times third party individuals or out-sourced groups are not good at relaying the problems and do not put pressure on appraisers to correct bad reports, and again because the quantity of work is guaranteed, appraisers do not have an incentive to correct bad work. This often leads to deals getting blown up because the lender can no longer get them done due to a bad appraisal.
6) The FDIC is requiring all appraisals to be reviewed by a third party for accuracy. Many banks have internal staff dedicated to reviewing commercial appraisals. In some cases Banks utilize out-sourced appraisal companies to provide the review. The review must be completed prior to loan closing, and in many cases adds several days to a week to the appraisal process. In addition, out-sourced reviews are not cheap, and the customer ends up paying for that review fee.
7) The FDIC is now requiring most Banks to get updated appraisals with each renewal; and for problem loans are sometimes requiring updated appraisals annually. The days are gone of a customer getting a long-term renewal on a commercial real estate loan without an updated appraisal. This is adding additional cost to borrowers on each renewal, even in cases where properties are at low loan to values and there really is no need for an updated appraisal because the loan is performing and is just being renewed and not modified or increased.
8) The use of out-sourced appraisal companies not only typically increases the time involved in the appraisal process, but also the cost. These companies typically work in one of two fashions. Third party appraisal companies either charge a flat fee for appraisal ordering and review (if they do the review work), or they mark-up the bids from the appraisers and earn a spread over what the appraiser is charging (sometimes it is a straight percentage). Of course the Bank does not pickup this expense and this cost gets passed through to the borrower as an additional appraisal expense.
9) There was a time when banks would accept commercial appraisals prepared for other banks or lenders so long as those appraisals were not too old. Unfortunately today that has pretty much gone by the wayside, and in many cases an appraisal ordered from one bank just a month or two before will not be accepted by the next bank that looks at the transaction. This is because of a combination of factors including additional pressure from the FDIC for banks to order their own reports and the lack of bank confidence in other lenders ordering process. Banks want to verify directly that there has been no collusion between previous lenders and appraisers, and many feel the only way to do that is to order a new appraisal through their own process.
Just to be clear, we are not advocating anything that would resemble collusion on the part of commercial lenders and appraisers. We identify that during the heat of the lending boom collusion certainly existed; but we firmly believe that was not the norm but the exception. Most commercial lenders are out to get an accurate valuation not only so they can make new loans but so that they are comfortable and confident the loan decisions they have made are good ones and were made with the best and most accurate information. There is nothing more infuriating for a commercial lender than getting forced to accept a bad appraisal and not being able to do anything about it. Appraisers are only human, and they miss things or make mistakes just like anyone else. But the way the system is currently setup, many appraisers are able to act like gods when it comes to their reports, able to write and say whatever they want with no real recourse for the lender or the borrower. And that is not fair to the lender and especially the borrower, who is ultimately paying for that appraisal and deserves the highest quality of work and should have the right to discuss the conclusion with the appraiser they just paid for the work.
There are certainly still many good appraisal companies out there and many good out-sourced appraisal management companies that are not taking advantage of customers, but still overall the system has changed for the negative and the impact has been felt by commercial loan borrowers across the board. Many commercial loans that should be getting done are not either because an appraisal cannot get done in a timely manner or cannot get done correctly, and at this point there is little recourse to a system that is flawed in many ways. Although it is unlikely the system will ever revert back to a point where commercial lenders fully control the appraisal ordering process again, nor should it; the system does need to change back to the point where commercial lenders can have input and be part of the decision making process. That is the only way to be sure the right appraisals get ordered from qualified appraisers for a specific property type, and to keep costs in check and be sure quality work gets done. Unless some changes are made, commercial loan borrowers will continue to be negatively impacted by the time, cost, and poor quality of the commercial loan appraisals getting done in this market. This will lead to lost deals, time, and money, and is not helping commercial loan borrowers in the current economy recover any faster.