an inside look at the challenges facing lenders and appraisers today

Presented by:

Bill Garber, Director of Government and External Relations, Appraisal Institute

Brian Ginter, Director-Executive Staff, Diversif ied Real Estate Consulting Network

An Inside Look at the Challenges Facing Lenders and Appraisers Today

Smart Data. Smarter Workflow.

An Inside Look at the Challenges Facing Lenders and Appraisers Today

Bill GarberDirector of Government and

External Relations

About the Appraisal Institute

• Global professional society of real estate valuation experts

• 23,000+ members worldwide• MAI, SRA, AI-GRS, AI-RRS Designations• Largest appraisal education provider and

publisher in the world• About 8 percent of members work in an

institutional capacity 3

Top Level Issues

• In December, 2013, AI conducted a survey of appraisers and users of appraisal services

• Some results follow

4

CRE Appraiser Concerns

– Fee pressure & expanding scope of work – Lack of market data including comparables– Over regulation of appraisal profession– Formulary approach (forms, checklists, ratios,

indices) gaining more prominence– Greater liability– Increasing barriers to direct communication with

lenders resulting in appraisal report acceptance and/or perceived report quality issues

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Concerns of Appraiser Clients

– Long turnaround times– Cost of appraisals– Misunderstandings concerning the scope of work in

engagement letters– Compliance with standards/regulation – Sufficiently supported value conclusions– Quality work product – Shortage of qualified appraisers – Concise valuations (do not want lengthy reports)

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Concerns of Staff Appraisers Themselves

– Appraiser competency– Work product quality and consistency– Thoroughness of analysis/lack of analysis – Lack of local market knowledge – Work product inconsistent with engagement

letter/scope of work – Use of appropriate methodology– Timely delivery of appraisals & customer service– Delegation of appraisal assignment to lesser-qualified

appraisers 7

Hottest Topics for Staff Appraisers

– Inadequate market analyses – Appraisal compliance with bank regulations – Not recognizing or appreciating clients’ needs– Insufficient details on market conditions and trends

affecting real property – Going concern valuations (different methodologies

causing confusion) – Reluctance to interact with client out of fear of

violating appraiser/client “firewall”

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Take Aways

– Communication Breakdowns– Tough and uncertain regulatory environment– Unsatisfied clients and frustrated service

providers

– Clear need (and opportunity) to bridge the gap

9

1010

• Office of the Comptroller of the Currency• Commercial Real Estate Lending Handbook,

August 20, 2013• Third Party Relationships Guidance,

October 30 2013• Federal Reserve

• Managing Outsourcing Risks, December 5, 2013

New Policies

1111

• SEC Risk Retention• Appraisal • Environmental

Proposals

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• Interagency Appraisal and Evaluation Guidelines– As-is market value

• Prospective market value “as complete”

– Environmental contamination• Must update appraisal/evaluation if environmental

contamination is found

– “Threatened” Collateral • “…physical aspects of the property that threatens the adequacy

of the institution’s real estate collateral protection”

– Impairment– REO

Ongoing Issues

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• Hypothetical Conditions & Extraordinary Assumptions– FIRREA requires a market value “as is”. When an appraisal is

premised upon a hypothetical condition, the value is “as if” the condition were true, not “as is.”

– An appraisal report for FRT purposes could include a value premised on a hypothetical condition as long as the appraisal report also includes a market value “as is”.

Ongoing Issues

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• Hypothetical Conditions & Extraordinary Assumptions– If information is being withheld from the appraiser so that the

appraiser is not certain whether or not there is an environmental problem that impacts the value, the appraiser could only complete an appraisal premised on an extraordinary assumption about the missing information – e.g., assume that the property is not contaminated.

– When an appraisal is premised on an extraordinary assumption like this, it is not clear whether the value is an “as is” value. It might be, but it might not be.

– An appraisal premised on such uncertainty would not be acceptable for most lending purposes either.

Ongoing Issues

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• Underwriting vs. Appraisal– There is a tendency to place the burden of some underwriting

problems on the backs of appraisers– This includes environmental information and due diligence– Goal of the bank should be to make informed decisions, “eyes

wide open”

Ongoing Issues

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• Suggested Best Practice– Commission appraisal and environmental

together – Appraisal prepared for as-is market value– Environmental assessment returned to

bank and information provided to appraiser to determine value as-impaired

– “As is impaired” may not = “as-is clean”– Cost to cure because of potential

market resistance

Appraisal-Environmental Integration

• Challenges– Pressure on bank appraisal/environmental departments– Cost to cure calculations– Not all appraisers are competent to assess

environmental impacts (might have to call one in)– Bidding process – appraisers would need to know this

upfront because the as-is impaired is a different kind of assignment

– Potential project delay/cost increase17

Appraisal-Environmental Integration

Environmental Resources

• Relevant Textbooks– The Appraisal of Real Estate– Real Estate Damages, Applied Economics

and Detrimental Conditions– Valuing Contaminated Properties: An

Appraisal Institute Anthology– Appraising Industrial Properties

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• Appraisal of Real Estate, 14th Edition• Enhanced sections on environment• Chapter 12, Land and Site Description

• Guidance on hypothetical conditions and extraordinary assumptions

• Discussion of specialized methodologies

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• Education– Analyzing the Effects of Environmental Contamination

on Real Property • Available to banks or local organizations and being converted into

online seminar

– Appraising Distressed Commercial Real Estate – Condemnation Appraising– REO Appraisal – Valuation of Sustainable Buildings

• Four course professional development program

– Environmental Best Practices and Trends for Lenders


• Other activities– Guide Notes

• Updated Guide Note 6 - Consideration of Hazardous Substances in the Appraisal Process

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Bill GarberDirector of Government and External RelationsAppraisal Institute122 C Street, NW, Suite 360Washington, DC [email protected]

New Regulatory Landscape and the Challenges

Facing Lenders and Appraisers

June 18th, 2014

With regulatory scrutiny on the Enterprise Risk Management policies of lending institutions, the

linkage between valuation and environmental due diligence platforms is more critical than ever.

Brian A. Ginter, CCIMDirector - Executive Staff

DRCN, LLCDiversified Real Estate Consulting Network

Set The Stage

Bank regulators are emphasizing that environmental and valuation risk management programs work in concert – Non-Silo Operations.

While this sounds simple, it is not without challenges…

TODAY’S OVERVIEW:

• Added detail on the environmental side• Methodology for how banks can link environmental and valuation risk

management. • Guidance for specific audience segments

The Environmental Side –Environmental Risk Management

• Regulatory Environment/Dodd Frank - financial institutions are being forced to develop more “robust” environmental risk management capabilities.

• THE KEY COMPONENT – Policy, Procedure, Implementation (don’t ignore)… • Policy – How & What you’re going to do… to KNOW• Procedure – How & What you’re going to do… after you KNOW• Implementation – Prove You Did It. Document what you did with what

you KNOW.

Environmental PP&I often lacks the same level of development as Appraisal PP&I.

A good start is: * OCC Revised Guidance (18-pt. checklist) on Environmental Risk Management (Pg. 69 to 71). http://www.occ.gov/publications/publications-by-type/comptrollers-handbook/cre.pdf (Placed at the end of this presentation)

The Environmental Side –Environmental Risk Management – Some Points and Challenges

Where to Start

Non-Silo Operation of departments

is critical

Regulatory Paralysis

Always come back to Value vs Risk

An undefined and moving target – don’t let it overwhelm


Major Challenge – Limited Staff

Environmental issues

All reports must be reviewed

May originate or extend beyond the immediate site

The in-house reviewer (if even present) is typically overwhelmed and/or does not have the required minimum experience or training

The “two hat” concept. How often is one

individual responsible for everything?

How often is that person the Sr. underwriter,

compliance officer or even the CCO? Ever hear

“oh by the way you’re responsible for the

environmental dept. “


Environmental Operations – A Few More…

• Risk Matrix Program - Must be developed with increasing levels of due diligence. Institutional Risk Tolerance Levels…

• Qualify and/or quantify (differentiate) between environmental risk and cleanup risk.

• Staffing & Systems - A reluctance to hire qualified permanent staff or invest in proper systems and platform.

• Vendor Management - The Bank is ultimately responsible for any out sourced service or third party vendor.

Linkage:

Timing Coordination

Appraisers - Environmental Competency

Development and Implementation of policy & procedure

(valuation & environmental)

Overall Goal: Linkage and non-silo development.THE Challenges: Credit Risk Management in overall applications and the linkage between the valuation and environmental components

Timing on appraisal and environmental

engagement

Bank should provide transaction/risk

screens minimally. Full Environmental Reports if available

Remember Residential Property

Properly developed Policy & Procedure

Service Providers –Appraisers/Environmental Engineers/Data Vendors

Appraisal Institute, National Association of Realtors,

CCIM, other organizations

EBA, MBA and other National & Regional Banking

Organizations

Comptroller’s Handbook –Commercial Real Estate

Lending (8/2013)*

What approaches and tools are available to improve integration?

* OCC Revised Guidance (18-pt. checklist) on Environmental Risk Management (Pg. 69 & 70). http://www.occ.gov/publications/publications-by-type/comptrollers-handbook/cre.pdf

The Audience:

Linkage - The Service Providers

Appraisers Environmental PEs Data Providers

These are the easy ones.

The need for accountable, competent, services is greater than ever.

• Understand it’s all about Knowing – Your Job is to provide complete, accurate, information so your client is able to make an informed decision.

• Everyone is being held accountable.• Never Stop Asking Questions and Learning.

• Work Together… appraisers and environmental professionals need to gain a greater understanding of each others fields.

• Appraisers need to understand what environmental issues mean and how to determine the effect on the real estate.

• Environmental Professionals need to provide greater clarity on what is the real risk associated with their observations… (example)

The Audience:Linkage - The Bankers

Where to Start… It’s About –

Enterprise Risk Management

In addition to the environmental risk management points above…

I like thinking of an inverted pyramid - Start with the overall challenge (macro):• Keep asking questions until you know every possible point• Develop policy, procedure, and implementation systems that address every possible

point• Know you will never have everything covered. So anything developed must be

nimble and adaptable to the ever changing environment – external & internal.

A FEW POINTS: • Policy / Procedures / Implementation: Document / Document / Document -

Historically all that was needed was to show you had it… That is absolutely NO longer an option. Not only are the written policy and procedures required, the regulators will question, demand, how they are applied and implemented.

The Audience:Linkage - The Bankers

• Education and Training at every level! Understanding the basic concepts of the appraisal and environmental processes need to be part of any enterprise risk management program. Know…

• Who To Ask• What To Ask• Where To Go – To Ask

I never understood the pushback… Get the proper information/data at the beginning of the process. Knowing/Knowledge is the key to no surprises. Why wait to the last minute to discover/resolve a problem? If the challenge is within your bank’s risk tolerance then identify & deal… if not then you saved time, money, and credibility for you and your customer.

• Vendor Management – A real regulatory hot button. The Challenge: Development of approved services providers that are competent under today increased regulatory scrutiny. This can be done without sacrificing long established relationships. This should also include firms that provided data and support systems.

Bio / Contact Information:

I have been involved in the real estate industry for 30+ years, four of which (2009 – 2013) as Managing VP and developer of a combined appraisal and environmental departments for a major community bank. I currently maintain General Appraisal Certifications in multiple jurisdictions, have achieved the prestigious CCIM Designation, sit on the Board of the Washington, DC Chapter of the Appraisal Institute, and am completing the requirements for the MAI Designation.

Unlike typical appraisers or bankers my skill development came from being a Realtor, investor, developer, commercial loan officer/transactional lender, real estate underwriter, and a general real estate consultant; providing a unique understanding of valuation influences and the ability to work independently in any environment or market on typical and complex (fractured) real estate transactions and projects.

If you have any questions or comments do not hesitate to communicate.

Brian A. Ginter, CCIMDirector - Executive Staff

DRCN, LLCDiversified Real Estate Consulting NetworkE-Mail: [email protected] 703-969-6997

Comptroller’s Handbook – Commercial Real Estate Lending (8/2013)

Comptroller’s Handbook – Commercial Real Estate Lending