Saturday, March 17, 2012

Some thoughts about "geographic competency" in international assignments

U.S. appraisers are largely governed by a document known as Uniform Standards of Professional Appraisal Practice. One key rule in USPAP is called the Competency Rule.

The Competency Rule requires that the appraiser determine his own competency prior to an appraisal assignment, and if he lacks certain competencies necessary to complete the assignment, he must disclose the lack of competency to the client and then take all the steps necessary to acquire the competency needed to complete the assignment correctly. This Rule also specifically states that “in an assignment where geographic competency is necessary, an appraiser who is not familiar with the relevant market characteristics must acquire an understanding necessary to produce credible assignment results for the specific property type and market involved.

Sometimes when I’m socializing with other appraisers and I mention my international work, I encounter an indignant residential appraiser who asks “What about the Competency Rule!?”

For instance, during a coffee break at an appraisal seminar, I told a Senior Residential Appraiser that I had just returned from appraising one square mile of beachfront land in Fiji. He sternly rebuked me with “What about the Competency Rule?”, as if an American appraiser cannot possibly conduct market research there without a subscription to the Fiji residential MLS (multiple listing service).

I can understand residential appraisers’ preoccupation with geographic competency when out-of-town appraisers invade their turf and don’t even know that the next block from the house being appraised is in a better or worse school district.

As for Fiji, my client already knew I had never been there, saying “We know, and we trust you to ask the right questions,” whereupon I made the efforts to learn the market for this entitled leasehold development land in Fiji. [I have been there three times since.] This included a visit to the relevant government office to discuss planning approvals and Fijian law relating to leasehold interests, and interviews with two appraisers with local knowledge, including the always-helpful Professor Matt Myers, MAI from the University of the South Pacific in Fiji. It also involved reading countless news articles and blogs about other large-scale, beach-oriented tourist developments and their progress.

A locally done appraisal had already been provided by the borrower. It used small lots as comps for this one-square-mile parcel and failed to disclose that one of the two ground leases was expiring in one year. How much value can be assigned to an expiring ground lease with no assurance of renewal? This Fijian property was later foreclosed on. The local appraiser has since lost his appraisal license.

Another time, I was sent to review an appraisal report in Canada. The question from the client was “Does this appraisal meet USPAP standards?” Discussing this on an on-line appraisers forum, one appraiser became indignant. “What about the Competency Rule?”

My response was that I saw myself as more of an authority on USPAP than Canadian appraisers, some who say they comply with USPAP, but really don’t. In this particular case, the Canadian appraiser violated USPAP by failing to properly disclose “extraordinary assumptions”. In this instance, his report assumed the land had been legally subdivided, but it hadn’t been.

Commercial appraisers don’t criticize me about the geographic scope of my work, probably because there is no guarantee that a local appraiser is competent in the property type being appraised. Most local commercial appraisers do not know how to appraise gas stations or golf courses or hospitals, for instance. Sometimes a specialist needs to be called in from out-of-town, particularly when the only comparable sales available are likely to be in other states, as for ski resorts, for instance.

But there are sometimes other reasons making it preferable to bring in an outside appraiser, such as:

1. Independence from local powerbrokers. I once appraised a proposed lakeside development in a relatively unpopulated county, and the developer, who insisted that his property was worth $5 million, also insisted that a local “MAI” (member of the Appraisal Institute) be used instead. I searched for my client and found only one MAI in the entire county. He told me that he had already been contacted by the developer and refused the assignment. He said that the property couldn’t possibly be worth $5 million and that if he gave his honest opinion, which would probably be around $1 million, he might not be able to get any more work in that county, a common problem for any appraiser in a small market, as was described by Appraisal Institute President Richard Powers at the Appraisal Foundation's Fraud Symposium in 2006. Once you've upset Boss Hogg (The Dukes of Hazzard), he’ll make sure you never appraise in Hazzard County again.

2. Objectivity. Some appraisers think as boosters for their local community, even saying with a straight face that the laws of economics (such as the law of supply and demand) do not apply to their own community. Some are also hamstrung by old data and don’t stay alert to recent new trends. I started my career in Texas in the mid-1980s and saw it then, and then encountered it again when I moved to California in the late 1980s. As vacancies escalated, some local appraisers refused to believe that commercial property values were decreasing. It had never happened before in their states.

3. Having a broader perspective. One of my specialties is super-regional malls, and I often have to gather data from several states. It brings a smile to my face when a local residential appraiser suggests that I can't appraise the local regional mall because I don't have access to the local MLS (listing service for residential properties.)

4. Level of training. There are many countries that do not set any minimum level of training or credentialing for persons advertising themselves as appraisers or valuers. And even if they did have proper training, there is often no local enforcement of ethics.

5. Lack of sanctions against dishonest appraisers.  Unfortunately, in most countries, an appraiser or valuer is no more than the paid advocate of the one who hired him.  I recently worked in a Caribbean nation, for instance, where the "most respected" local appraiser valued the subject property at more than twice the price the property had been listed for sale for the last 4 years. 

6. Lower level of due diligence.  My number one client does not allow me to delegate valuation work.  I'm allowed to hire a local appraiser to accompany or advise me, but this client expects more research than the typical valuer/appraiser is prepared to do, such as background checking, studying listings, and exhaustive verification of the property owner's representations.

Some larger properties may need a larger perspective, too.  Consultant Stephen Roulac, for instance, states:

The local expert may know the local scene, but may lack knowledge of how the local scene fits into the larger context...The local expert may have no real idea whether out-of-town capital would be interested or not interested in that market.  The local expert may be clueless as to whether people residing in other places would want to live in that market, locate a retail store in that market, or put an office in that market. Relying too heavily on the local expert may be a big mistake.”[1]

[1] Stephen Roulac, 255 Real Estate Investing Mistakes, Property Press: San Rafael, CA, 2004, p. 239.

The USPAP Competency Rule is actually a good rule. I do my best to comply with it, and I don’t see the Rule as automatically prohibiting me from getting on an airplane to go value a property, as long as I discuss the matter with my client beforehand, the client trusts me enough to continue with the assignment, and I perform the necessary inquiries and market research to become familiar with the distant market.
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Wednesday, February 15, 2012

The effect of mangroves on the valuation of tropical waterfront land

Mangrove-fouled beach near San Pedro de Macoris, Dominican Republic

Many of my appraisal assignments involve tropical waterfront land with plans for tourism-related development. One common impediment to the development of many of these land parcels has been the presence of “mangroves”, also known as "mangle" and "manglar" in Latin America.

Those readers who have driven from Miami to Key West in Florida will have driven past miles of mangroves along Highway 1. These are protected by law. I have also encountered such laws when appraising in Mexico, Costa Rica, Fiji, Brazil and the Dominican Republic.

The word “mangrove” has more than one connotation, however. There is a specific family of plants, Rhizophoraceae, known as mangroves, but many environmental laws apply more generally to coastal marine habitats in which Rhizophoraceae may be present.

Mangroves are legally protected not because they are endangered, but because they serve as important marine wildlife habitats. They are found in 118 countries, mostly between the latitudes of 25 degrees north and 25 degrees south, and are estimated to dominate 75% of the coastlines in the tropical latitudes, as is demonstrated in the Wikipedia map below:
Source: Wikipedia

Mangroves impair the value of beachfront parcels in two ways:

1. In most countries they are protected by law and cannot be removed.

2. Mangroves create dark, organic sediment that fouls beaches.

The issue of mangrove removal is also problematic. First of all, it is illegal in many countries, and can be easily caught by satellite photography. Secondly, mangrove sediments are known to concentrate toxic metals, and the disturbance of these sediments pollutes the surrounding environment.

The issue of mangroves has come up in an APR (American Property Research)appraisal assignment in the Dominican Republic. The top photo demonstrates what I saw. Most of the subject property’s waterfront is dominated by dense vegetation that grows straight up to the waterline. The beachfront in the foreground appears to be fouled by dark sediments typically released by mangroves. This is not the pretty beach scene that typically serves as the foreground of a Four Seasons Resort.

Some clients have a policy of hiring a “national firm” for their appraisals, most often the appraisal subsidiary of a global real estate brokerage, in order to lessen the amount of thought going into the appraiser selection process. There is often a division of labor and responsibility, with one appraiser inspecting the property and another writing the report, which only exacerbates miscommunication and abdication of personal responsibility. The least experienced appraiser often does the lion's share of the work. (I began my career as an appraiser in one such global firm, Jones Lang Wootton.)

In this particular case in the Dominican Republic, there were two other appraisals of the same property done by national firms.

In one appraisal report, all the photos were of the wrong property, and all were taken by air. The property was described as hilly and having utilities, unlike the property I visited. I surmise that the property developer rented a helicopter and took the appraiser to the wrong property on purpose.

The other appraisal report was originally done for the developer and disclosed a long established relationship with the developer, a possible conflict of interest with the lender who re-hired them as appraisers.

Neither report disclosed the presence of mangroves, which leaves me wondering if most appraisers, particularly American appraisers, even know to look for it or consider its significance in the valuation of waterfront land.
Mangrove-fouled beach in Fiji
Mangrove-fouled beach in Costa Rica
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Friday, February 10, 2012

Appraisal of Beach Land in Nayarit, Mexico

This appraisal assignment illustrates the problems in obtaining reliable Mexican market data.

The subject property is about 100 hectares of raw, beachfront land located on the Novillero Peninsula in the state of Nayarit, about a two-hour ride south from Mazatlan, Sinaloa on Mexico’s west coast. Playa Novillero has the distinction of being Mexico’s longest continuous beach, at 82 kilometers. The beach itself is not particularly impressive, consisting of dark colored sand and lacking distinctive physical features, but it does have coconut palms and is quite wide and flat.

Unlike the Mazatlan area to the north and the Nayarit Riviera to the south (close to Puerto Vallarta), the Novillero area is characterized by abandonment rather than development. I saw no new development, but plenty of abandoned beach homes. One problem is the lack of good road access to this area.
Abandoned Novillero beach homes

Prior to my arrival I was told that the owner had acquired the parcel in 1998, had received an offer of $7 million for the property and had a Mexican appraisal estimating value to be about $5.9 million.

When I obtained the escritura (deed), however, it indicated that the owner had purchased the property a year ago for only about $85,000.

Which number more accurately reflected market value? Most likely, none of these numbers, for the following reasons:

1. The only honest Mexican appraisal I’ve ever seen was one I ordered myself.

2. If I took “offers” seriously as indicators of market value, my lender clients would have ended up foreclosing on allegedly $50 million worth of scattered woodlands in rural Tennessee, an allegedly $100 million mountain in northern California, and an allegedly $100 million isolated Texas beach.

3. It is standard practice in Mexico to understate sales prices in deed transfers in order to minimize the 2% transfer tax required of the seller. It doesn’t matter that it is also illegal tax evasion witnessed and sanctioned by notaries public; the tax laws do not seem to be enforced.

I did ask the property owner to tell me whether the deed was correct, to which he indicated no, and then submitted documentation that he actually paid over $1 million, more than 12 times as much as was recorded, which seemed credible in light of much higher asking prices in the area.

Still, it bothered me that the Mexican appraisal valued the property at more than 5 times the price allegedly paid for it a year ago (and 68 times what was officially recorded as being paid), when this was the last sale in the area. How could he document an increase in value of that magnitude? When asked to show his comps, the Mexican appraiser presented listings only, no closed sales, with prices ranging from $10,000 to $30,000 per lineal meter of beach. The last closed sale I know of was at about $1500 per lineal meter, so why are asking prices so much higher than the last closed sales?

One factor influencing asking prices in southern Sinaloa, on the other side of the estuary from Novillero, was the announcement 3 years ago of a grand tourist development project sponsored by FONATUR, the Mexican government's tourist development agency. Southern Sinaloa state will be groomed to become "the next Cancun", although it lacks Cancun's white sand beaches.
The excitement has driven up beach land prices in southern Sinaloa to as high as $30,000 per lineal meter.

These high expectations have crossed the estuary which separates the states of Sinaloa and Nayarit, and asking prices on Novillero beach land are also in the range of $10,000 to $20,000 per lineal meter. Unfortunately, although Sinaloa and Novillero are just a few km apart as the crow flies, there is no bridge over the estuary and one has to drive miles inland to the highway to travel north and then travel miles back to the beaches of Sinaloa, which are much more accessible to tourists coming from Mazatlan, the general entry point for tourists in this region.

Inflated asking prices are not the same as closed sales as indicators of value, and the only closed sale I have was at about $1500 per lineal meter, far lower than current asking prices in the area. It also worries me that everything is for sale and nothing is selling.

Next stop: Bahia, Brazil
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Tuesday, January 31, 2012

When real estate scoundrels pretend to be saints

"As God is my witness, I can GET YOU FINANCED!"

Now that Andy Rooney has passed away, it’s my turn to talk about what annoys me most. In the commercial real estate industry, I am annoyed by real estate scumbags-turned-saints.

Now we all know that the real estate industry does not naturally attract saints. It may attract sincere people, but mostly people who just sincerely want to become rich.

Sometimes, when a convicted fraudster, perhaps a mortgage broker, is led from court in handcuffs, he or she may say, “But I was making the dream of homeownership a reality for underprivileged families!” in a tone of voice so sanctimonious as to make one wonder why Mother Theresa herself wasn’t a mortgage broker, too, until one considers that people with bad credit who lie about income and assets might not actually deserve homeownership.

Those people who must announce their integrity!

The louder he proclaimed his honor, the faster we counted the spoons”--Ralph Waldo Emerson

Two weeks ago I received a comment on my Costa Rican tree farm scams post which basically said that my comments did not apply to a company named Ethical Forestry, which owns teak farms in Costa Rica and uses telemarketers to lure UK citizens to invest in trees.

If the proof of integrity is in the name of the company, this gives me an idea to create The Ethical Bridge Company. The company’s purpose will be to ethically sell the Brooklyn Bridge, not like all those other Brooklyn Bridge salesmen who give bridgeselling a bad name. 10% of your purchase money will be used to buy wheelchairs for crippled orphans.

It may be no coincidence, too, that the only client who ever cheated me out of my fee proclaimed his Christianity in every conversation we had. Have a blessed day in Hell, Mr. Scott.

Those ethics awards!

A developer once deceived my bank into making a $30 million land speculation loan at a 5% interest rate and 97% loan-to-value ratio. The loan was allegedly for the purpose of constructing a surface parking lot supposedly worth $65 million, according to their appraiser (but had just been bought for $24,375,000). When I raised doubts about the developer’s intentions, the loan officers dismissed them, pointing out that the developer had just received an “ethics award” from a realtors’ organization. Ethics awards from realtors? What could be next -- a humanitarian award from Osama bin Laden?

In any event, the Chief Lending Officer who rigged this deal is now being sued for $300 million by the FDIC (Federal Deposit Insurance Corporation).

Those philanthropists!

Eighteenth century philosopher Samuel Johnson once said “Patriotism is the last refuge of a scoundrel.” Let me update Johnson by adding the word “philanthropy” to the list. Some of the best known “robber barons” of the 19th Century (and at least one from the 20th) became philanthropists. My alma mater, the University of Chicago, was founded by one such philanthropist, John D. Rockefeller. Bernard Madoff was also a known philanthropist.

Take Richard Simring, for instance, a co-conspirator to Ed Okun, who I mentioned in my international real estate syndication fraud post. Before confessing his guilt, he was also serving as the Chairman of the Board of the Voices for Children Foundation, a charity that raised money to advocate for abused or neglected children, in addition to serving the Lighthouse for the Blind and serving on the board of directors of Educate Tomorrow, a foundation making education attainable to children in the third world nations of Niger and Miami, Florida.

Young Irish real estate mogul Darragh MacAnthony dropped out of college to sell timeshares in Spain and ended up founding MRI International, which took funds from UK and Irish investors to buy overseas vacation homes and furnishings. The company was headquartered in Spain and went into liquidation in 2009, and hundreds, if not thousands, lost their cash deposits, for which MacAnthony faces Spanish litigation for “theft by swindle and misappropriation of funds”. He is also chairman of the Helping Hands Group, a charity that provides free transport, training and physical therapy to brain-injured or learning-disabled adults, and chairman of the Peterborough United Football Club. What a nice man. Meanwhile, an “MRI Victim Support Group” of more than 800 members has protested in front of the UK Prime Minister’s House (10 Downing Street).

The real estate industry often accommodates such paradoxes. When I was in banking I sometimes had to present the unpleasant news that we had been deceived by a borrower, only to hear an admonishment such as “How dare you question his integrity! Don’t you know he’s chairman of the Pathetic Crippled Children’s Foundation?” Charity and honesty are not necessarily synonymous, and I hypothesize that the biggest crooks often turn to charitable giving to assuage the guilt they feel in receiving ill-gotten gains. Everyone wants to feel good about himself.

“Martin, before you call this man a liar, you should know that he’s chairman of the Pathetic Crippled Children’s Foundation.”
Cartoon art was purchased from CartoonStock and captions changed.
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Monday, January 30, 2012

Appraisal in Perth, Australia

This is my third appraisal assignment in Perth. This assignment is similar to any appraisal of a Class C downtown office building in the U.S., only that Perth is experiencing classic “boomtown” economic conditions as a result of it being the corporate hub of the Western Australian mining industry. Chinese demand for Australian minerals has created a huge economic boom for this region, which had previously been languishing between the years of 1990 and 2005.

Price inflation in Perth has been so profound that a can of coke in a convenience store costs 2 Australians dollars (equivalent to $2.12 USD) and a McDonalds breakfast costs 3 times the price in Los Angeles. My host told me that his son is a truck driver earning $180,000 per year, and when I asked other Australians, they confirmed that it was an ordinary wage for Western Australian truck drivers. Some of my appraiser friends in LA would gladly cross the ocean for work paying like that.

The subject property is an older office building constructed in the 1960s and showing its wear. The owner has a plan to renovate the building into commercial condominiums (AKA “strata” in Australia and the UK) and a conditional commitment from an Australian bank once the renovation has been done. My client was to serve as a bridge lender in the mean time and was only interested in “as is” value, however.

The building is 92% occupied in a CBD office market with 96% occupancy, and is predominantly occupied by an English language school and a commercial fitness center.

An English language school is a good tenant to have in Perth, which is very much a city of immigrants. I did my own informal survey of the locals, asking “Are there too many immigrants in Perth?”, to which 28% responded “Yes”, 20% responded “No” and 52% responded “No speak English”. OK, I made this all up – just trying to keep you readers awake.

The main Perth office district, though, is located two blocks south of here on St. Georges Terrace and Adelaide Terrace (same street, two names), and includes high-rise office towers adorned with the names of major banks, whereas the subject is in a secondary, lower-density location of older buildings, some dating back to the 1920s, and can be characterized as a middle-income pedestrian retail environment. There are several nearby restaurants serving either Kebabs or Korean food, for instance.

As is sometimes the case in appraising properties slated for renovation, the owner wanted me to appraise the property as if renovated and subdivided into condos (or strata), whereas the lender was only interested in “as is” value, or what they could sell the property for tomorrow. Despite Perth’s booming economy, it is interesting to note that office buildings trade at capitalization rates in the 8 to 10% range, well above those of California, possibly indicating either that Australian real estate investors have less appetite for risk than U.S. investors or else that there is a feeling that the Western Australian gravy train might not last forever. The fortunes of this region are very tied to China, and if China sneezes, Perth could catch pneumonia.

PS: I've found another low-cost way to get to Australia from the U.S. (besides the unreliable Air Pacific) -- China Southern Airlines. The connecting point is Guangzhou. The Chinese air hostesses are eager to please, but haven't quite mastered conversational English. They serve meals in record time, but when they ask "May I take away your plate?" I found that my usual answer, "Not yet" sounds like "Yes" to their ears, as my unfinished meals got quickly and efficiently whisked away.

Upgraded to first class from Guangzhou to Perth, I was greeted by two airline representatives who were to promptly escort me through customs and security to the first class lounge. When I asked, "Is there food in the lounge," one representative replied, "I don't know about that." When I responded, "Could you let me stop at a restaurant first?" he then replied, "Oh, I thought you were asking if there were fools in our lounge." Rest assured, I am willing to share first class lounges with fools, as long as they are not children.

Be sure to watch the hilarious "in-flight exercise" videos, in which two robotic, unblinking air hostesses perform Tai Chi-inspired exercises while the narrator dispenses pearls of ancient Chinese medical wisdom for each exercise, such as "Subdue the liver, extinguish the wind." What wind would that be?

Next stop: Nayarit, Mexico.

Friday, December 30, 2011

Those “Guaranteed Income” Rental Home Investments

Rental condos in Kissimmee, Florida

A recent inquiry from a Canadian journalist has me revisiting this topic, as there is now a burgeoning industry of selling “rental home investments” to foreign investors, particularly the Canadians and the Chinese. For instance, some unsuccessful builders of failed subdivisions in places like Arizona and Nevada are advertising their unsold homes as “rental home investments” for which they or their agents promise to rent and manage for foreign investors. Their ads often tout “guaranteed ROI of xx%” or “guaranteed rental income for two years”. Are such investments a good deal?

“Guaranteed rental income for the first two years” is a seller promise that should be interpreted as a sign of weakness, not security, because a rental property in a stable market need not be sold with any such guarantees. What often happens, too, is that the property’s previous asking price has been inflated to more than cover the amount of these guaranteed rents.

Enforceability of guarantees

Guarantees are not quite guarantees if the builder or manager goes out of business, even if just to emerge again as another legal entity (for example, if the principals of Get Rich Quick LLC dissolved their LLC and reorganized as Get Rich Guaranteed LLC). If the guaranteed rents stop coming in, there is also the logistical problem of filing a lawsuit far away from home to collect what is due, and foreign investors are at a disadvantage in negotiating the complex U.S. justice system. Accept this common piece of advice from Craigslist:

Only a scammer will ‘guarantee’ your transaction.”

Recommended Due Diligence for U.S. rental homes

1. Try to get vacancy rate data for the community the home is in at the most granular level, whether it is the subdivision, the zip code, or the census tract. One helpful tool at the moment is the U.S. Census, which recently completed a decennial census with data as of April 1, 2010. The U.S. Census Bureau counted vacant housing units as of that date and will soon publish data down to the census tract level. For instance, realtors crow about Green Valley, Arizona, being the second fastest growing town in Arizona, itself one of the fastest growing states, all according to the U.S. Census, but may neglect to mention that in Green Valley, a suburb of Tucson, the Census counted 4581 vacant housing units out of a total of 17,322, equivalent to a vacancy rate of 26.5%. What will happen to a rental home there after the guaranteed rental income runs out after one or two years? Tucson isn’t much better, having a 15.9% rental vacancy rate.

2. Google the name of the seller and the management company and look for consumer and investor complaints. It helps to add the words “scam”, “fraud” or “complaint” to your search terms to get beyond the pretty web sites of the scammers. Try “MRI Overseas Property scam”, for instance. The really active fraudsters, though, will publish articles designed to show up in such search results, such as “Get Rich Quick LLC – No Scam!” or “Guaranteed Riches, LLC – No Complaints Here!”, and may even write their own highly favorable Wikipedia article, so keep on searching all the results. If the company is so new that nothing can be found in a background search, Google the name of the principal of the company, and that’s often where you will find a history of a swindler moving from state to state or even nation to nation to perpetrate scams.

After applying the aforementioned screening criteria, you should have a much smaller list of prospective investments.

Sunday, December 18, 2011

The Weakest Link in Appraisal/Valuation Reports is the Information Supplied by the Property Owner

Do not hire this kind of appraiser.

Some of my previous blog posts have touched upon this subject, whether it was the Jakko Poyry forest valuation report that SinoForest investors relied upon to their detriment (including John Paulson, who lost more than half a billion dollars), or the valuation report relying on false financial statements in the case of the Beijing Gateway Plaza fraud, or the Costa Rican appraisal report based on false representations of the property having full development entitlements.

The commonality in these instances was that an appraiser or valuer unwittingly relied upon false statements made by a property owner, resulting in a flawed valuation.

One thing missing from real estate appraisal and valuation textbooks is a statement of one fundamental human truth: People lie.

Because an appraisal or valuation report is often used to gain financing or to lessen taxes, appraisers should expect to be lied to. Most appraisers don’t seem to care about this, though, instead filling their reports with multiple disclaimers and limiting conditions. We are even taught that this is good appraising. In most English language valuation reports, for instance, one finds a standard exculpatory statement such as the following:

No responsibility is assumed for accuracy of information furnished by the property owner.”

This is the Achilles heel of the appraisal profession throughout the world –-acceptance of inaccurate information from biased parties without verification. Some appraisers in high places even contend that it is not an appraiser or valuer's responsibility to verify such information. "Who am I, the fact police?" asked one. Yes, you should be.

Last week I was appraising an isolated “cave lodge” in hillbilly country. A New York area hotel valuation firm came in before and appraised it for $5 million based on the owner’s representations of renting it out at nightly rates of $1000 to $1800 for more than 85% of the year, with annual revenues of $368,200. No efforts were made to verify these revenues despite their implausibility and lack of customary expense categories, such as Payroll expense.

I asked for tax returns, both Federal income tax and state sales tax returns, and got a runaround with plenty of excuses and contradictions. The owner finally admitted that he has paid no sales taxes on his lodging revenues, and the only Federal tax return produced indicated revenues of about $36,000, or about 10% of what was previously represented.

My favorite tall tale was when the owner told me that Cher had rented the place for a Halloween party last year. He should have picked a more mysterious celebrity, as Cher is a known concert performer, and it has been well established that she performed in Las Vegas (more than 1500 miles away) on Halloween night last year, and there are unauthorized YouTube videos to prove it.

A few weeks ago I was also asked to look at a vacant, 85-year-old multi-story warehouse. Two appraisers had relied on the owner’s representations and had made “extraordinary assumptions” that the elevators were operational (they were not) and relied on owner representations of “clear height” (the height to which goods can be stacked) and building area, apparently not measuring the building. Although the warehouse had been purchased for $430,000 in 2005, at the top of the market, and has remained vacant and unsold since then (having been listed for sale and lease in the mean time), both appraisers now estimated value to be about $2 million.


An appraisal or a valuation is only as good as the data and assumptions that it relies upon. Garbage in, garbage out. It is time for users of valuation services to ask questions about the reports they rely upon, questions such as “How did you verify this?”

Friday, December 2, 2011

Three Appraisals in Britain

London bed-and-breakfast inn

After Cozumel I flew to London, England, to appraise a portfolio of hospitality properties – a bed and breakfast inn and two restaurant/pub buildings in London, Windsor and Buckinghamshire.

My client, a private U.S. lender, had already received valuation reports prepared by British chartered surveyors which proved that the United States and the United Kingdom are two great nations separated by...a common language. Terms like “chartered surveyor”, “lettings”, “trading potential”, “realisable”, “consents” and “solicitors” are confusing to Americans in the context that they are presented in British reports. The reports reminded me of a classic “I Love Lucy” episode in which Lucy attempts to get walking directions in London. One reason I think that U.S. clients send me to appraise in so many British Commonwealth nations is that I write appraisal reports in American English and try to follow North American (US and Canadian) reporting standards.

I worked the first three years of my commercial appraisal career at a British company, Jones Lang Wootton. (JLW was eventually acquired by LaSalle Partners and the new entity was named Jones Lang LaSalle under different ownership and management.) Thus I have worked under both real estate valuation regimes and have some knowledge of British valuation methods and jargon.

The English properties

Restaurants and bed-and-breakfasts are not usually very profitable enterprises. While I don’t have current figures, a traditional rule-of-thumb has been that 80% of restaurants and bars do not last five years. Bed-and-breakfasts have had a similar failure rate, as they are often founded by amateurs.

As luck would have it, though, all 3 properties were owner-occupied and consisted of valuable real estate. The London metropolitan area, much like New York City, has a general shortage of available land for new construction, and a well-constructed building often has an intrinsic value independent of the relatively unprofitable businesses which may occupy it.

The London bed-and-breakfast, for instance, had previously been used only as a 12-bedroom residence. Similar residential sales in the area suggested a value of about one million pounds, a value not otherwise justified for a bed-and-breakfast business with a net income of less than 40,000 pounds per year.

The restaurant/pub building in Buckinghamshire had apartments on the second floor and was also situated on a block with one-million-pound residences, but the value had to be adjusted downward for the cost of conversion back to a residence. Pub sales in the area were at considerably lower prices in the range of 350,000 to 450,000 pounds, so my highest and best use analysis, considering the restaurant’s financial statements, established that the property was not being used in a manner which maximized value.

One nice thing about working in the UK is the availability of residential sales data. It is all contained in a national registry, unlike the United States. Similar to the U.S. is the prevalence of automated valuation technology, including free AVM technology, such as the Zoopla and Mouseprice web sites, which are similar to Zillow and Trulia in the U.S.

The restaurant in Windsor was more difficult to appraise, partly because it consisted of 3 adjacent buildings, one of which was owned only as leasehold. The leasehold building’s annual rent of 60,000 pounds per year (equivalent to $93,600 at today’s exchange rate), when compared to restaurant revenues, strongly suggested a negative leasehold value for these premises, which were not being fully utilized, and the leasehold building would therefore not be suitable for loan collateral. In addition, the entire restaurant property was not configured or located in a manner befitting a residential highest and best use.

Most of the restaurant operations seemed to be actually conducted in the freehold (fee simple owned) buildings, thus suggesting continued viability of a restaurant business if the lender had to foreclose on two of the three buildings.

In the end I relied most upon a gross rent multiplier method for the Windsor property, but estimating market rent as a function of the revenues earned by the restaurant operations. Finding comparable restaurant rentals is a difficult task, as restaurants are retail properties that can have significantly different rental values based on location and visibility. Very few leased restaurants, though, can afford rent beyond 8% of gross revenues, which limited affordable rent to about 61,000 pounds per year for this particular operation if it was a rental operation. While it could be argued that a more profitable restaurant operator could justify a higher rental rate, the occupying restaurateur was already a highly experienced restaurateur and celebrity caterer.

Differences between British and North American commercial appraisals

The British “valuer” is much more likely to have collegiate instruction in real estate and building subjects; North American (Canadian and American) appraisers typically receive their appraisal education from professional associations or trade schools after college. Present-day certification and designation requirements for U.S. commercial appraisers require them to hold baccalaureate degrees (unless “grandfathered in”), but the degree can be in any subject and often is. Americans do not typically train early in their lives to become appraisers; they accidentally become appraisers.

North American appraisal reports, on the other hand, are more complete and try to be prima facie cases in support of estimates of value. British reports are briefer, do not demonstrate the analytical process used, do not present a “highest and best use analysis” (as in “would this building achieve the highest value as a residence or as a bed-and-breakfast?”) and do not typically present photographs or maps of comparable sales and rentals. They cannot therefore be reviewed critically by a foreigner. In other words, there is no basis for the reader to judge the competence or honesty of the valuer.

Working alongside British valuers, though, I sensed that they perceived more honor for their profession than North Americans appraisers do. There seemed to be more emphasis on honesty in their work, although there were certain practices that Americans would label as unethical, such as charging a professional fee as a proportion of the appraised value, which presents a conflict of interest. That being said, I trust the honesty of British valuation reports more than North American reports when I do not specifically know the appraiser or valuer.

Still, the considerably lesser British valuation reporting standards can be a cover for sloppy work. The most egregious case I saw at Jones Lang Wootton was in the appraisal of a portfolio of over 200 surplus bank branches as a result of the merger between Wells Fargo and Crocker Banks in 1986. The Director of Valuation saved the premier property for himself to appraise, the Wells Fargo Tower in downtown Los Angeles. When he arrived at an internal company meeting to go over final values, it was clear that he had not done his homework. He said, “So what’s a downtown L.A. office building worth, any way? $200 per square foot?” The chartered surveyor from San Francisco yelled out, “No! $300 per square foot”. “Well, then $300 per square foot it is,” said the Director of Valuation and the supporting two-page report quickly got written.

It is hard to judge professional ethics enforcement in either country. The Appraisal Institute, the most highly regarded of the several U.S. appraisal associations, has an ethics enforcement staff of just one, and she has been in situations of siding with appraisers who have already been disciplined by state appraiser licensing agencies; it is rare for a member of the Appraisal Institute to be expelled for ethical violations. RICS, the governing body over British Commonwealth valuers and many other types of real estate professionals, is said to have an ethics enforcement staff of about 3 dozen persons, a considerably more impressive number.

Yet, a few years ago when I pointed out to RICS that their international president was a U.S. appraiser who had actually lost his appraisal certification due to disciplinary action, RICS investigated and informed me that he did nothing wrong and voluntarily surrendered his certification in order to obtain an appraisal certification in another state, an action not required in the U.S., as I have held as many as 5 concurrent and different state certifications at one time. The Appraisal Subcommittee web site ( publishes the names of all appraisers who are no longer licensed due to disciplinary action by a state agency, and his name is there, one of about 50 in his state.

Professional organizations cannot really be expected to police themselves well, though, due to professional friendships, potential "loss of face" and a prevailing sense of "There but for the grace of God go I," particularly when appraisers and valuers are constantly confronted with ethical challenges.

I am also skeptical of the massive RICS recruitment effort in the U.S., as RICS does not offer an educational program or testing here. A U.S. appraisal designation plus $500 per year gets one an MRICS designation, but what does that all really mean if RICS is not educating or testing here? It seems that their main goal is to collect $500 each from as many U.S. appraisers as possible without contributing to our profession here.

Some of my colleagues told me they pursued an MRICS or FRICS designation in order to solicit international work. As someone who worked at a British-owned international firm, however, I was never encouraged to pursue an RICS designation, but encouraged to pursue an MAI designation instead. Since then, I have worked many times in British Commonwealth nations
(Australia, Canada, Jamaica, Barbados, South Africa, Fiji, Singapore, Malaysia, Hong Kong and Great Britain) and not been asked if I have an RICS designation. Moreover, when I have called on RICS members in these countries, most have been cost estimators ("Quantity surveyors") rather than valuers.

Capturing the best of both systems

A British subject named John Lennon once wrote a memorable song called “Imagine” shortly before moving to the United States in 1971. Imagine if the English-speaking appraisers of the world could capture the best of both the British Commonwealth and North American systems, with British-style collegiate instruction and sense of professional honor coupled with the more descriptive and informative appraisal reporting standards found in the United States, while agreeing on a common professional vocabulary?

You may say that I'm a dreamer, but I'm not the only one.
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Monday, November 21, 2011

Condo project appraisal in Cozumel

I am currently revisiting a condo project in Cozumel, Mexico, that I appraised three years ago. Cozumel is an island off of Mexico's Yucatan peninsula, a land full of lush tropical jungles and Mayan pyramids.

This particular condo project had a successful, sold-out first phase, but by late 2008 it was apparent that many vacation condo projects all over the world were in trouble. Many condo projects that I was visiting had stopped making sales altogether.

This project in Cozumel was faring slightly better; its rate of sales was down only 50% due to one of Cozumel’s unique attractions– it is a mecca for scuba divers from all over North America. Condo buyers at this particular project were typically both doctors and scuba divers, and the recession had hit this population subgroup less severely. Still, the forecast of a prolonged absorption of the unsold units resulted in a decision to not fund the construction of another phase. It was hoped that another lender would step in, but as can be seen in the photo, construction has been halted since 2008.

General worldwide conditions for vacation condos

The last three years or more have been difficult for second-home markets all over the world, as I have witnessed in such far-ranging locales as Barbados, Fiji, the Dominican Republic, Costa Rica and Canada.

Many of the failed overseas second home projects were high end luxury projects focused on a growing number of “multi-millionaires” in the world. Each project tried to achieve a certain prestige by promising top shelf amenities vital to the ultimate success of such luxury projects.

Unfortunately, the market for vacation real estate is discretionary, and the purchase of vacation real estate has moved further down the priority scale for a large number of potential buyers. For instance, one of the main motivations for the purchase of vacation real estate has been the potential for financial return from the investment. While there were forces in place for price appreciation in advance of the recent financial crisis, buyers now recognize that the potential for appreciation of luxury second homes has significantly deteriorated. As for the ability subsidize ownership costs or earn a return on investment by renting out one’s property, a worldwide oversupply of vacation homes is driving down returns on investment.

Another concern from likely buyers relates to the continued financial viability of substantially unsold projects, and the risk of promised amenities not being built or else operating at a substantial deficit which would require increases in homeowners association dues. For instance, many golf course sales nowadays are to homeowners associations trying to rescue an affiliated golf course from bankruptcy. That often requires a substantial increase in POA dues.

In addition, the allure of owning a home in high-end vacation communities comes from the prestige of belonging to a successful community. The financial distress and litigation associated with an unsuccessful project may instead have the opposite impact. Being associated with a troubled project affects the psychology of potential luxury real estate buyers. Instead of looking savvy, a purchaser could now look naive. This makes the proposition for purchase due to a project’s prestige more difficult than before.

The valuation of a failed project is exceedingly difficult, as it typically takes several years to get such a project restarted if at all. Patient capital is required, and it is difficult to construct a discounted cash flow model that can correctly forecast the timing of the project’s turnaround.

Other Yucatecan ruins

The following photos are of ruins left behind in Cozumel by a post-Mayan race of people known as "speculative real estate developers".

Next stop: London
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Sunday, November 13, 2011

South African update: Will the ouster of Malema stop the decline in farm values?

In my last report on South Africa, I mentioned two possible factors in the price decline for South African game farms. One factor was the overall world surplus of vacation properties for the super-rich, and the second factor was political rhetoric calling for uncompensated government expropriation of white-owned land, rhetoric amplified by a rising star in South African politics, Julius Malema, the ANC’s Youth League President. Last Thursday, Malema was removed from his position and suspended from ANC for five years for bringing disrepute to the party, because of his divisive speeches within South Africa as well as his interference in the politics of neighboring countries. He has been constantly opposed by President Jacob Zuma.

The removal of Malema may help restore investor confidence, although the Johannesburg Stock Exchange All Shares Index was up by less than one percent after his sacking. The JSE AS index was hit hard earlier this week by a sovereign ratings downgrade from Moody’s.

Expropriation of white-owned properties

Confiscation of white-owned properties occurred during the 1990s in nearby Zimbabwe (formerly known as Rhodesia) and has resulted in a decline in agricultural productivity there and an overall implosion of the economy after a period of hyperinflation.

At end of the Apartheid Period of South Africa in the 1990s, 87% of commercial farmland was white-owned, and the new ANC-led government pledged a compensated program of land redistribution that would transfer 30% of white-owned land to blacks. Progress has been slow, and whites still own 84% of commercial farmland.

It is difficult to calculate the effect of the removal of Malema in restoring real estate market confidence. The ANC Youth League which he presided over still insists, after his ouster, on the nationalization of mines, a similar issue, and this matter is still being actively studied by the African National Congress despite the insistence of national leaders that it would never happen.

One problem also besetting the agricultural sector is the reportedly high murder rate of white farmers, most who are allegedly killed during ordinary robberies rather than politically motivated violence. More than 3000 farmers are alleged to have been murdered so far, a very alarming number, and Malema's removal will have little effect in stopping this trend.
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