Real Estate Appraisal Tips for Lending Success
Pittenger, William, The Journal of Lending & Credit Risk Management
On November 8, 1996, RMA hosted its second audioconference, Real Estate Appraisal Tips for Lending Success. From nearly 300 telephone locations in the U.S. and Canada, an estimated 2,500 to 3,000 lending professionals listened to James Zeiger, vice president of appraisal policy for Fleet Financial Group, and William Pittenger, chief appraiser for Barnett Banks Inc., offer appraisal tips ranging from appraisal regulation and policy to using appraisal services in real estate loan underwriting.
The Financial Institutions Reform Recovery and Enforcement Act of 1989 (FIRREA) was arguably the most sweeping piece of banking legislation enacted in the previous 50 years. Virtually all depository institutions, their regulators, and even their customers were affected in some way.
Title XI of FIRREA - the Appraisal Reform Amendments - had a profound effect on appraisers and financial institutions that use their services. Title XI required states to enact appraiser licensing and certification programs. It created an Appraisal Subcommittee of the Federal Financial Institutions Examination Council (FFIEC) and gave it broad oversight powers. It attempted to create uniformity in appraisal services provided to financial institutions and to restore independence to the appraisal process.
For some institutions, turmoil followed. Post-FIRREA conventional wisdom seemed to be, "If it looks like real estate - appraise it." Indeed, some institutions - often at regulatory insistence - blindly obtained appraisals without regard to the real source of repayment of the proposed credit. The obvious effect was dollars spent for appraisals that were sometimes unnecessary. The not-so-obvious effect was that some lenders, after receiving an appraisal, gained a false sense of security by believing the bank was adequately secured by real estate when, in fact, real estate had nothing to do with repayment of the credit.
James Zeiger: When Is an Appraisal Required?
The short answer is the expected source of loan repayment dictates the need for an appraisal. Specifically:
* If loan repayment depends on revenue generated by the real estate security property, either through its rental or sale, an appraisal by an appropriately state-certified or licensed appraiser is required. This applies to most real estate loans secured by income-producing properties, such as shopping centers, apartment projects, and office buildings. It also applies to properties intended for sale such as subdivisions or condominiums in which lots or units are sold over time.
* Conversely, if loan repayment does not depend on rental or sale of the real estate, an appraisal is not required. Indeed, the regulation describes nine types of transactions that fall into this category, including occasions when a lien is taken against real estate in an abundance of caution or a lien is taken for reasons other than the value of the real estate. Bankers should consult the regulation issued by their banks' primary regulators for a complete list of exemptions.(1)
The confusion lies between these two repayment sources. For example, if rental or sale of real estate is secondary or tertiary in terms of repayment or if the transaction is small ($250,000 or less), then some sort of analysis and valuation of the real estate and its competitive market is necessary, but the depth of analysis and the extent of the report may be less than if repayment was critically linked to the performance of the real estate. Moreover, the agencies do not require that this form of evaluation be prepared by a state-certified or licensed appraiser.(2)
Transactions that fall into this category include:
* The proposed loan amount is $250,000 or less.
* The transaction is a business loan of $1 million or less and does not depend on rental or sale of real estate for repayment.
* The transaction is a renewal of an existing credit.
Bankers that make real estate lending and credit decisions should have at least a working knowledge of three basic appraisal related documents: