Appraisal review tips for bankers: Tips 1 & 2

RMA Journal, The, July-August, 2005 by Frank DiLorenzo

This series is intended to help a bank's beginning to intermediate-level appraisal reviewer identify some of the more common issues.

Time Warp

It's not unusual for an appraisal to include a line adjustment in the sales comparison approach entitled "time adjustment." In those instances, the appraiser is making an adjustment in estimated market value from the date of the previous comparable sale to the present time. In doing so, the appraiser is indicating that the prices of the type of property being appraised have risen from the sales date of the comparable property to the date of the current appraisal.

Let's say you're reviewing an appraisal of some residential waterfront lots in an area that is already largely developed and only a few waterfront lots remain. In this case, the comparable sales of the lots used as comps in the appraisal are dated 2001, 2002, and 2003. The appraiser may reflect in the appraisal an upward "time adjustment" of 16% per year.

That adjustment may be justified by a variety of factors, including lack of available developed residential waterfront lots (an example of limited supply and strong demand resulting in an increase in price). What's important here is that the passage of time does not in and of itself necessarily result in higher real estate values.

Time adjustment is not really an adjustment based on the passage of time; rather, it is a function of the relationship between supply and demand that has changed over time. Time adjustments need to be explained, justified, and supported in a self-contained appraisal format. The greater the adjustment, the more important it is for the appraiser to address the reasoning behind it.

Perhaps the best illustration of the vagaries of time adjustment is an article on downtown Jacksonville office space that appeared in the Florida Times Union on February 12, 2004. The author said that a building now referred to as the SunTrust Bank Building in downtown Jacksonville was constructed in 1991 at a cost of $76 million. Let's assume that the market value of the building approximated or exceeded the cost of the building; otherwise, it would not have been built.

The author went on to say that the building was subsequently sold to Humana in 1998 at a sales price of $32 million. Then the building was sold in February 2004 to the current property owner for a sales price of $16 million: $60 million of value gone in just 13 years.

Let me repeat that: $60 million of value. Vanished. Obviously, in this case, the mere passage of time did not automatically warrant upward adjustments in real estate values.

Real estate is an asset. It is an investment. As such, it is subject to the economic laws of supply and demand, lf a piece of real estate is no longer economically viable because demand for that property has diminished, its value and marketability go down and there will not be any upward adjustment for "time." What the appraiser is saying when he or she includes an upward time adjustment is that economic factors have caused properties of that type to appreciate.

What about costs? What about an upward adjustment for time because the cost of construction materials has increased over the years? Let's refer back to the SunTrust Bank Building example. lf that building cost $76 million to build in 1991, you can rest assured that the cost to construct that building today would be much greater, yet the building's value (assuming the most recent purchase price approximated its value at that time) was only $16 million. Could cost increases over time enter into the reason for upward time adjustments in appraisals? Possibly, but only if the property itself is economically viable and in demand.

Long story short. Don't blindly accept upward time adjustments in appraisals. The reasons for those adjustments need to be clearly stated and justified by the appraiser in the appraisal. Upward time adjustments cannot simply be assumed.

Targeting Comps

Ideally, the sales comparison approach of an appraisal will show comparables that are somewhat uniformly disbursed geographically from the subject property. Unfortunately, that's not always possible. While there may be other comparable properties in the vicinity of the subject, the key word in this appraisal approach is sales.

Therefore, even if there are comparable properties within the vicinity of the subject property, if they haven't sold within the past five years, they cannot be used as comparables in the sales comparison approach. Unfortunately, if what has sold doesn't represent the best in comparable sales, the appraiser is sometimes forced to use those numbers anyway and then make the appropriate adjustments--including market, submarket, and geographic adjustments.

Along these same lines, take a look at the sales comparables in Figure 1, bearing in mind locational factors. The appraiser's access to market information is key. Some questions to keep in mind when considering locational differences between the subject and the comparables include the following: [degrees] Is traffic flow comparable?