Sunday, December 28, 2014

Those “National Appraisal Firms”

Santiago Cuautlalpan, Mexico: a $10 million hillside?

Three years ago I pitched my valuation services to Citibank’s Latin American Region Appraisal Manager and was told “We’re sorry. We only use national firms.” I had never heard a condition like that before. I started my career 30 years ago at an international firm, Jones Lang Wootton, now known as JLL (Jones Lang LaSalle). Was I more qualified to appraise then than I am now? My observation of national firms is that the most knowledgeable and experienced appraisers sit behind desks and junior appraisers do the field work without adequate supervision. It’s a bait-and-switch system.

Three months prior to my meeting with Citibank, I had appraised (for a different lender) a potential subdivision north of Mexico City, outside the Distrito Federal and inside the Estado de Mexico. It was a piece of steep hillside land zoned for 100 homes. A neighboring subdivision had already failed, with only 18 homes being built. The immediate neighborhood lacked through streets to Federal Highway 57D, a few miles east, which is the main highway leading south into Mexico City. Many of the streets were unpaved and used mainly by stray dogs.

Several months later, my lender client contacted me to inform me that Cushman and Wakefield had since appraised the Mexican land for more than 17 times the value I had estimated. In reading their report it became obvious that the young appraiser had assumed that the property would be rezoned to 15 times its current permitted density, despite instructions from the lender to appraise “as is”. When asked why she made such an extraordinary assumption, the appraiser said that the loan broker told her to, despite no documented evidence of a zoning change in progress. Her report was co-signed by two appraisers with signatures accompanied by designations, but neither went to see the property.

Three years later, Citibank’s venture into subdivision lending in Mexico has been a loss-spewing disaster. I wonder if Cushman and Wakefield was who they hired. I don’t wonder, though, why C and W is facing more than $10 billion in appraisal malpractice lawsuits at the moment.

Meanwhile, a private lender client started telling me in the last year that they could not use me on particular appraisal assignments because the loan applicant had insisted on use of a “national firm”.

I had lunch with a Wells Fargo appraisal executive last summer and asked him if there was some type of “national firms only” trend going on, and he said that the requests only came from loan applicants, who understand that most of the national firms (and international firms) are brokerages and brokerages tend to appraise high, which pleases all their customers. Low values are bad for the brokerage business, and there are other conflicts of interest to consider, too.

The brokerages maintain that a Chinese wall separates their appraisers from undue influence from the sales and leasing side and that there is no bias. Some even claim to be separate companies. At Jones Lang Wootton we appraisers were generally left alone to reach our own value conclusions, but unexpectedly low appraisals sometimes had to be finessed or negotiated, such as in situations where someone’s foolishness had to be covered up (“But we told them to buy that building!”). Conflicts of interest arose because we were a full-service brokerage, and appraisal revenues are less than real estate sales, leasing and management revenues. For that reason, appraiser independence is always at risk of being compromised at brokerage firms.

I see the same forces at work with other international brokerages with valuation subsidiaries.

For instance, I have a client that finances discounted loan payoffs who sent me to research a situation in Baltimore in which they would finance a discounted loan payoff on a defaulted construction loan (from Citibank) for a 4.8 million square foot mixed use center on a waterfront brownfield next to the city’s impoverished and dangerous Westport neighborhood. There had been a lack of pre-leasing and pre-sales and the property was going into foreclosure.

They hired CBRE to appraise it “as is”, and the appraiser was initially skeptical about the prospects for the project, predicting a value in the low seven figures. My client was surprised to receive an appraisal for $23,300,000 instead. When asked by my client about the sudden change of heart, the appraiser made the remark that he believed that the developer “could pull it off”, an odd thing for an appraiser to say considering that “market value” is based on what the property would sell for and not who owns it, even if the owner is supposedly a genius in foreclosure.

Most of the comparable sales were over 4 years old and two were from Philadelphia and Yonkers, New York. I researched local sales and found recent waterfront or waterview land sales in the neighborhood, surely something he could have found in CBRE’s “unrivaled database”. When I asked him why he excluded those sales, though, he said that they were irrelevant because they were “distress sales”, as if the subject property was not in distress.

Suspecting bias, I uncovered a conflict of interest: CBRE had recently received the exclusive leasing contract for the high-rise office building approved for this site. This leasing contract had the potential to dwarf the amount of the appraisal fee.

This waterfront site has been in bankruptcy and was scheduled to be auctioned earlier this year, which was postponed until the bankruptcy was discharged, which happened last month.

When the national firm has already been working for the other side

Sometimes the conflict of interest is because the national firm had already been hired by the loan applicant or broker. My number one client is a wholesale lender, and many loan applications are accompanied by unsolicited appraisals from national firms. I end up having to reject such appraisals for reasons such as:

1. “Extraordinary assumptions”, such as rezoning.
2. Out-of-area comparable sales, always a surprise when coming from national firms that brag about their local databases.
3. Gamed discounted cash flow models which never have increasing expense ratios or assume that declining markets turn around in a V-shaped recovery.
4. Failure to deduct for deferred maintenance or site problems.

One example was in the Dominican Republic, where an unimproved, 59-acre waterfront land parcel in an overbuilt condo market was appraised by CBRE for $25,625,000, or about $100 per square meter, at  a time when comparable properties were listed for sale for as low as $12 per square meter.  The report did not disclose possible mangroves on the waterfront, which foul beaches (see photo) and cannot legally be removed, and also used 3-year- old comparable sales.  The report also disclosed a pre-existing business relationship with the developer.

Other national firms

Colliers and HVS also bear mentioning because of their heavy use by developers and brokers.
Colliers International has been rapidly expanding their appraisal business to catch up with CBRE and C&W, but this means not properly vetting new appraisers.  The property in the Dominican Republic was also appraised by Colliers, who sent an appraiser to fly over the property in a helicopter but photographed and appraised the wrong property. I was also recently sent to Texas to visit a failed subdivision appraised for $6 million by Colliers although the discounted loan payoff had steadily been reduced from $2.7 million to $2.3 million over the past year.  Never in the 186-page report did the Colliers appraiser mention that the subdivision was situated alongside an active railway.

HVS is a different type of company, as it is not a brokerage but mainly an appraisal company (Hospitality Valuation Services) founded by Steve Rushmore, the author of the textbook most commonly used for hotel valuation. They tend to hire fresh graduates from the hotel schools at Cornell and Lausanne but fail to train them in due diligence (such as verification of owner-supplied information). HVS also now licenses its name to too many other firms internationally and fails to vet these firms. The boilerplate in the HVS reports looks the same everywhere but sometimes bears little relation to the appraiser-written narrative.  One egregious report I discussed last year was a proposed 5-star marina hotel on a lochside brownfield in Scotland done for a con man who falsely claimed to own the site. HVS did not check title nor did they check to find out that the site had no marina permit.  Ironically, Colliers International appraised this property (as complete) for 113 million pounds sterling.

So when I hear that a borrower insists on a “national firm only”, what I think they really mean is “we can’t take a risk getting an honest appraisal”.

Tuesday, December 23, 2014

Another appraisal in Puntarenas, Costa Rica

The subject property was unimproved, mountainous, ocean view land of about 160 acres, located on the Nicoya Peninsula. It has no utilities, paved road access or development entitlements.

A decade ago, ocean view land parcels were trading at much higher prices because of their value to real estate developers, as each had dreams of building luxury vacation or retirement communities for wealthy foreigners. This same situation prevailed throughout Mexico and the Caribbean, too.

The only problem with this vision is that Costa Rica, owing to its topography and coastlines, has tens of thousands of square miles of land with ocean views, and there aren’t enough homebuyers to take up all the possible lots, particularly when having to compete with many other tropical paradise nations. Partially completed subdivisions ended up competing with other partially completed subdivisions when the market went into decline in 2007, and other projects never moved forward due to the difficulty in receiving all the necessary permits.

The land development approval process can take years in Costa Rica, much like in California, and typically entails:

1. Approval by the “municipality” (similar to a U.S. county),
2. Approval by the national environmental agency, SETENA (Secretaria Tecnica Nacional Ambiental),
3. Approval of all architectural and engineering design by the Department of Professional Responsibility of the CFIA (Colegio Federado de Ingenieros y de Arquitectos) [Translated: the Federal College of Engineers and Architects], and
4. Approval from the Ministry of Health

Last time I was in Puntarenas, in 2012, it seemed that every ocean view parcel of land was for sale and nothing was selling. Little has changed since then, except that asking prices are slightly lower now. Many landowners can’t reduce their prices any more and pay back the debt they’ve taken on. A broker was able to supply one closed sale occurring at a price at only one third of the asking prices of nearby parcels, but no large development parcels have been acquired since 2007.

There are enough land parcels with development entitlements or paved road access or utilities that unimproved land like the subject has little chance in competing for buyers, except at highly discounted prices.

Saturday, December 20, 2014

Latest appraisal in Bakken

This  appraisal assignment was of a proposed 35-acre business park in the Bakken area in North Dakota in one of the most active counties for drilling. The owner planned to build a hotel on this site, but wished to sell off 25 acres to other users. Having a hotel on site would be a good draw for a restaurant, for instance, or perhaps offices serving as regional headquarters for an oil or oil service company.

The city with jurisdiction over this site had granted a permit to build a 2-story hotel with 290,000 square feet of floor area with the belief that it would be a 110-room family-oriented hotel. The developer plans to build a 3-story, 400-room hotel. Like many community governments in the Bakken area, the city was rather unsophisticated, not realizing that 290,000 square feet could fit many more than 110 hotel rooms. Nevertheless, the city expressed a desire for a hotel that catered to families whereas the owner/developer is known as a developer of “man camps” – lodging for single oil workers – with small rooms appropriate for single occupants, not families.

Example of hotel operated as man camp by Target Logistics in Stanley, ND

The city’s prejudice against “man camps” and oil worker lodging is becoming common among community governments in the Bakken area. Williams County, generally considered as the locus of the North Dakota shale oil boom, with Williston as its county seat, has issued a moratorium on new man camps and RV parks, as has McKenzie County, with Watford City as its county seat. There is a shared perception that man camps demand extra law enforcement resources, as so many single, bored, lonely, uneducated men in their 20s and 30s increase the local crime rate in such categories as public drunkenness, disorderly conduct, assault and sexual assault. They are paid well, though, averaging about $32 per hour, with many taking advantage of double shifts and earning 6 figures, so theft and robbery is less of a problem.

Temporary worker housing that is needed but unwanted by many local governments

The Bakken area is known for shortages of real estate in certain categories, particularly housing and lodging, but one property type in abundance is raw land. Early successes with Bakken-area business parks have led to a proliferation of “me-too” business parks, often having not yet procured the permits or water necessary for development, listed for sale at inflated prices. The subject property seemed to be in this category. 

Another complicating factor is the recent drop in the price of oil, which closed at $57 per barrel on December 19th. It is estimated that 60% of Bakken’s shale oil wells are unprofitable at below $60 per barrel because of the expense of fracking technology. The cost to develop a new well, furthermore, is estimated to be as high as $85 per barrel. The number of drilling rigs in North Dakota is now 181, 16% below the peak of the shale oil boom.

The few commercial land sales which could be found were of single-user sites of half an acre or less, whereas there is a proliferation of large business parks with unsold lots. In this instance, I had to create a discounted cash flow model with an extended absorption period.