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Appraisals Assist in Underwriting Loans to Minimize Risks

Posted On November 10, 2016

Lenders use many services, including appraisals, to assist in underwriting loans,  and the integration of these services to obtain data is a main component toward real estate due diligence. BBG, a national valuation and assessment company, brings to light specific services including appraisals, surveys, title reports, environmental site assessments (ESAs), property condition assessments (PCAs) and zoning reports. The effort has increased to integrate information obtained from these services, while lenders gain a better understanding of a property and how it will perform.

“When evaluating risks, lenders look at multiple aspects of a property such as value, cash flow, physical condition and potential environmental liabilities,” BBG Assessment President Richard Dagnall says. “You don’t want to do a leveraged loan and then find out a year later that $1 million has to be put into a new roof. Non-recourse lenders often require PCAs, which determine immediate needs in terms of deferred maintenance repairs and how much capital will be put into the property each year over the term of the loan to keep it functioning.”

Similarly, according to Dagnall, an appraisal is more useful when it can take into consideration the actual level of deferred maintenance at a property, as determined by a PCA, or the presence of an environmental impairment at a property, as determined by an ESA. It’s usually the lender’s responsibility to integrate all of the reports while underwriting the loan with each service provider potentially having differences in different property size, building size, date of construction and other salient property information.

Regulators understand  the importance of how all of these services interact with one another, as seen through the Office of the Comptroller of the Currency (OCC) providing examples to appraisers on requirements for disclosing and taking into consideration the environmental risk factors. The Appraisal Institute (AI) has also released similar guidance to appraisers pertaining to their role in considering what constitutes an environmental hazard.

“The ESA reports, which almost all lenders require, identifies potential liabilities that could undermine the loan,” Dagnall said. “For example, a neighboring property such as a gas station or an onsite dry cleaner could have a release creating a potential liability. You are looking at any environmental risk that could impact the loan. With some environmental laws, the liability to the property owner can be more than the value of the property,”

Dagnall added. “When we do an ESA, we look at the historical usage uses of the property, the current operations and at available environmental records of properties with known or suspected environmental issues.”

“We used to have about 3 to 4 weeks to accomplish due diligence. Now, it’s down to about 2 weeks,” Dagnall noted. “Regulators are looking how much corporate commercial real estate the banks have on their books. Lenders need to make sure they are truly evaluating the potential risks on each deal. More oversight is present making certain due diligence is in place.”

Dagnall points out that there are multiple ways of addressing environmental issues, and the purpose of the environmental report is to allow for business decisions. A property may be impacted by a neighboring property so lenders can enroll in an Innocent Owner Operator program that provides liability protection.  Some lenders may prefer to get a lender’s insurance policy that will cover them for the lesser of the cleanup cost of the outstanding amount of the loan.

Dagnall said the expectations on lenders continue to increase. This creates more pressure for service providers to meet those expectations which prompts service providers to offer multiple services. It is common practice for lenders to order ESAs and PCAs together from one provider. “Now we are starting to see national firms offering appraisals, ESAs and PCAs,” according to Dagnall. “Everybody working together can ensure more consistent reports and the best possible results as far as underwriting loans.”

“When lenders feel as though they are working with a team with their service providers, the better the results,” Dagnall said. “The lender knows what the borrower’s plans are and what the intent of the loan is.  Is the borrower getting the loan to buy the property, pull cash out of a property they already own or to reinvest in the property to repositions it? All are acceptable reasons, but the more understanding of the deal everyone has, the better things will be overall.

“Technology is another integral service in this process,” Dagnall said. “We always look at ways to efficiently write reports and at the same time, take the data we collect or generate and include it our appraisals, PCAs and ESAs.”

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