The elusive art of commercial appraisals
After underwriting dozens myself and reviewing hundreds of apartment building loans, I have been wanting to buy one of my own for quite some time. I thought that the opportunity had finally presented itself when I found a property that met all of my requirements.
- Good condition with no significant amount of deferred maintenance.
- A relatively nice location.
- Enough potential to make a nice return.
Because I live in a large metropolitan area, good apartment building opportunities have a lot of interested parties when they go on the market. This is the reason why I decided to go to a smaller city about two hundred miles from home to look at some apartment buildings.
Before the trip, I did a lot of due diligence on the listings. I got CoStar comparables, reviewed any court documents, past deeds, demographics, and recent multifamily sales in this city. I concluded that there were some serious issues in the area. Not only has unemployment stayed high, but vacancies are around 30% due to excess supply in the form of “for sale” product that is now being rented. To make it more difficult for multifamily landlords, single family houses are being sold at a bargain, which makes potential renters into homeowners. The situation was discouraging, but there is opportunity everywhere, and I was hoping to have found it here.
The problem came down when it was time to negotiate with the lender that owns the apartment building. They want at least 30% more than my offer. To support their case, they provided a couple of appraisals done by the same appraiser for the last two years. I had a couple of problems with the appraiser’s methodology.
1) He stated in both appraisals the one from last year and the one from a couple of months ago that the vacancy on the rent comparables was running about 28%. Something that my own research had confirmed. The subject property has a 65% vacancy rate. Nevertheless, the appraiser decided to use a 14% vacancy for its stabilized calculations. The appraiser did mention that there was a subset of comparables within the data that was more similar to the subject, but he then went to say that this subset showed an 18% vacancy. I am still trying to get my head around how he got to such a low percentage of vacancy.
2) He could not find any comparables in the area, and ended up using comparables in other cities up to 60 miles away. While it is true that there have not been any sales in the last year, I found some sales that closed about 16 months ago for similar apartment buildings that went for $20,000 a unit instead of the $40,000 a unit that occurred 6 months ago but are 30 miles away in a completely different city.
After going trough this experience, I have become much more empathetic to those looking for financing or looking to buy a commercial property. I am pretty sure that the MAI that wrote the appraisal did not do anything wrong according to USPAP, but I am still shaking my head about the whole process.
The bank turned down my offer. They did not have any other choice with a third-party appraiser showing them that the property was worth 50% more than my offer, they were willing to give a 20% break on the price but no more. I suspect that this asset might languish on their OREO books for a while, maybe there will be another chance for me in a few months.