Transcript Valuation of Multifamily Properties: Perspectives from the End User Techniques, Procedures, and Guidance Presentation to the Appraisal Institute Indianapolis, Indiana July 2013 Martin A.

Valuation of Multifamily Properties:
Perspectives from the End User
Techniques, Procedures, and Guidance
Presentation to the Appraisal Institute
Indianapolis, Indiana
July 2013
Martin A. Skolnik, MAI (Marty)
Director, Multifamily Appraisals
Freddie Mac
Richard Meyer (Rich)
Director, Real Estate Services/Physical Risk
Freddie Mac
Introduction
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Speakers
Martin A. Skolnik, MAI (Marty)
Director, Multifamily Appraisals
[email protected]
Richard Meyer (Rich)
Director, Real Estate Services/Physical Risk
[email protected]
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Perspectives for this morning…..
"In a conversation, keep in mind that you are more interested
in what you have to say than anyone else is."
- Andy Rooney
“In a conversation, the other person is spending most of their
time thinking about what they are going to say next, rather
than listening to what you are saying now…”
- Anonymous
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Multifamily Real Estate Market in General,
and Freddie Mac in Particular
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Freddie Mac Corporate Overview
 Freddie Mac is a government-sponsored enterprise (GSE),
and we are now in conservatorship as managed by the
Federal Housing Finance Administration (FHFA) since
September 2008
 Our public mission is to provide liquidity, stability and
affordability to the housing market
 We operate in the secondary mortgage market, buying
loans through a network of seller/servicers noted on
FreddieMac.com
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Multifamily Overview
 Our Seller/Servicer network delivers conventional loans to
our four regional offices in McLean (Virginia), New York,
Chicago and Los Angeles
 Our Multifamily Seller/Servicer Guide (Guide), published
on AllRegs, outlines our lending parameters and
conditions of purchase;
» All third party report requirements are contained in the
Guide
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Multifamily Overview
 We are a prior approval lender and fully underwrite each
loan prior to purchase
 We began shifting in 2009 from a “buy and hold” to a “buy
and sell” model and are currently securitizing more than
90% of the loans we purchase
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Importance of Third Party Reporting
Core business principal: Transparent,
supportable assessment of risk to
promote sustainable lending platform
Need for HighQuality Third
Party Reports
Mission objective: Promote a safe
living environment through the
financing of multifamily properties
that represent high standards for the
applicable property class and market
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Market Metrics
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Background Information: Multifamily Real Estate Market
Apartment prices have increased by 12.5% over the last 12 months,
driving the 6.2% year-over-year gain in the national all-property index.
Source: Moody’s Investor Service
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How life imitates art…
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Background Information: Multifamily Real Estate Market
Multifamily Vacancy Rates and Effective Rents
1Q11 - 1Q13
Economic Indicators
1Q11 - 1Q13
9.4
4.5
8%
$1,070
2.5
8.2
2.0
7.8
1.5
$1,030
6%
$1,010
$990
5%
1.0
$970
7.4
0.5
7.0
4%
$950
-
Vacancy Rates
Real GDP Growth
Effective Rent
Unemployment Rate
Delinquency Rates
1Q11 - 1Q13
1,400
1,200
Basis Points
1,000
800
600
400
200
0
1Q11
2Q11
3Q11
4Q11
1Q12
2Q12
3Q12
4Q12
ACLI (60+ Day)
2
7
6
13
19
11
2
6
1
Freddie Mac (60+ Day)
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31
33
22
23
27
27
19
16
Fannie Mae (60+ Day)
MF CMBS Market (60+ Day, excl REO)
FDIC Insured Institutions (90+ Day)
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1Q13
64
46
57
59
37
29
28
24
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1,080
1,224
1,210
1,082
1,055
1057
965
994
854
367
334
290
253
236
204
185
155
135
Effective Rent ($)
3.0
7%
Vacancy Rate (%)
3.5
8.6
$1,050
Real GDP Growth %
Unemployment Rate %
4.0
9.0
Background Information: Multifamily Real Estate Market
Source: REIS
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Background Information: Multifamily Real Estate Market
Freddie Mac Multifamily Loan Volume
# of Loans
2005
$10,970,000,000
984
2006
$12,750,000,000
1,048
2007
$21,970,000,000
1,861
2008
$24,270,000,000
1,823
2009
$16,610,000,000
1,038
2010
$14,820,000,000
1,015
2011
$20,090,000,000
1,322
2012
$28,790,000,000
1,677
Freddie Mac Multifamily Loan Volume
2005 through 2012
$40,000,000,000
2000
Total Loan Amount
Total Loan Amount
$30,000,000,000
1500
$20,000,000,000
1000
$10,000,000,000
500
$0
0
2005
2006
2007
2008
2009
Year
Total Loan Amount
# of Loans
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2010
2011
2012
Number of Loans
Purchased
Fund Year
Pre-Discussion Warm-up
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How many appraisers are needed to change a light bulb?
» Answer: Three
One to research it, one to inspect it, and one to call
the client to ask exactly what number wattage they
want the appraiser to use.
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How many appraisers are needed to change a light bulb?
» Answer: One
If, in the appraiser’s opinion, the original light bulb
should be changed, the appraiser must identify and
set forth any data considered and relied upon, and
the reasoning and basis for installing a new light
bulb.
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How many appraisers are needed to change a light bulb?
» Answer: Appraisers do not change light bulbs.
Instead, they make an assumption that the light bulb
needs to be changed, then they do a Discounted
Cash Flow to estimate the use of the light over the
next ten years, even if the new bulb won’t last for
ten years.
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How many appraisers are needed to change a light bulb?
» Answer: Appraisers do not change light bulbs.
They make assumptions about why other people
change light bulbs, and then write a report about
other people’s light bulb purchases.
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How many appraisers are needed to change a light bulb?
Answer: Twelve …
•
•
•
•
•
•
•
•
•
•
•
One to take the light bulb order from the client;
One to sign the engagement letter with the client about how quickly the light
bulb is going to be changed and to specify the fee to change the light bulb
(including a penalty if the light bulb is changed late);
One to research how much light bulbs cost in a minimum of three separate
stores including, hopefully, the store across the street from the subject;
One to verify the comparable sales price data;
One to write about the history of light bulbs, how many light bulbs come into
the local port, and how many passenger miles the local airport handles;
One to re-read USPAP for regulations about light bulbs;
One to figure out why the Cost Approach can’t be used in changing the bulb;
Two to write the report (a senior appraiser and a trainee);
One to review the report;
One to deliver the report; and
One to tell the client why the appraiser won’t change the light bulb analysis
after report delivery, even though they got the wattage wrong in the report.
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How many appraisers are needed to change a light bulb?
Answer: It depends.
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Issues in Multifamily Appraisals
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Introduction
The underlying exercise of a Freddie Mac review of a third-party
real estate appraisal review is to determine if the appraiser has
adequately supported his/her opinion of market value.
So, the point of this presentation is to:
a) Talk about the risk factors that would indicate that an
appraiser has or has not adequately supported his/her
opinion of market value, and
b) Discuss suggested solutions to the issues we most
commonly find in appraisal reports
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Introduction (continued)
Appraisers are generally good at extracting data from the market
and analyzing that data in each of the three approaches to
value.
But, many appraisal reports we see lack a narrative thread that
relates how the appraiser’s observations and findings impact
the value of the subject property.
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Introduction (continued)
 A well-written appraisal anticipates and addresses a reviewer’s
questions in advance.
 We have found that the difference between a reasonably wellwritten appraisal and a below average appraisal is usually the
addition of a short/concise summary at the conclusion of each
section.
 Typically, the addition of this verbiage can dramatically improve
the efficiency of our review process by reducing the need for
“go-backs” to clarify the appraiser’s narrative.
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Introduction (continued)
Quick refreshers and “ground rules”:
» Appraisals on multifamily properties come to Freddie Mac
from two directions:
– Purchases of loans
 The appraiser is the vendor of the Seller (a/k/a lender), not
of Freddie Mac, but Freddie Mac is an intended user
 FM’s underwriters are the primary reviewer
– Asset Management issues
 Freddie Mac is the client
 FM’s Real Estate Valuaton unit is the primary reviewer
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Introduction (continued)
 Quick refreshers and “ground rules” (cont):
» The appraisal report should contain sufficient analyses,
discussion, data, and conclusions by the appraiser for the
reviewer to render an opinion as to the adequacy of the
value
» Freddie Mac’s underwriters use the appraisal conclusions,
discussions, and data to assist them in their derivation of an
underwritten value
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General Appraisal Issues
To be acceptable to support the Freddie Mac underwriting or asset
management processes, the appraisal report’s content,
discussion, analyses, and data:
– Must support the appraiser’s estimate of value
– Should comply with Chapter 12 of the Seller/Servicer
Guide
– Should comply with Freddie Mac’s appraisal Best
Practices
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Introduction (continued)

Definition of Market Value
The most probable price which a property should bring in a competitive and
open market under all conditions requisite to a fair sale, the buyer and
seller each acting prudently and knowledgeably, and assuming the
price is not affected by undue stimulus. Implicit in this definition is the
consummation of a sale as of a specified date and the passing of the
title from seller to buyer under conditions whereby:
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–
Buyer and seller are typically motivated.
–
Both parties are well informed or well advised, and acting in what they
consider their best interests.
–
Reasonable time is allowed for exposure in the open market.
–
Payment is made in terms of cash in U.S. dollars or in terms of financial
arrangements comparable thereto.
–
The price represents the normal consideration for the property sold
unaffected by special or creative financing or sales concessions granted by
anyone associated with the sale.
General Appraisal Issues
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Introduction (continued)
A fundamental problem in multifamily appraisals:
Property Interest Being Appraised is Wrong
Many times, an appraiser will state that the appraisal is the
valuation is of the “fee simple” interest.
» The Appraisal of Real Estate (13th edition, page 114) states
that leased fee ownership is the ownership interest held by
the lessor regardless of the duration of the lease or of the
specified rent.
» Specifically, “a leased property, even one with rent that is
consistent with market rent, is appraised as a leased fee
interest, not as a fee simple interest.”
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Introduction (continued)
Property Interest Being Appraised is Wrong (cont.)
» The sales in the Sales Comparison Approach are all leased
fee transactions. That is, the sales price is based on the
income at each property.
» Additionally, the capitalization rates derived from these sales
are also leased fee capitalization rates
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Introduction (continued)
Property Interest Being Appraised is Wrong (cont.)
» Real life example:
A property with short-term leases at market rent levels is
required to be appraised as a leased fee property.
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General Appraisal Issues
History of the Subject Property

Previous history of a sale of the subject property
»
If there is a recent purchase of the subject property, is the price similar to
the value?
–
If not, why not?
True to life example:
The listing price for the Subject property is approximately $13,600,000.
As a result of our analysis contained in this appraisal report, we have
concluded to an “as is” value of approximately $21,700,000 for the
Subject property, which is above the current listing price. The
discrepancy between our concluded value and the listing price is partly
attributed to the fact the Subject is currently being marketed as a part of
a portfolio of assets, which may not reflect the true value of each
individual asset. More importantly, we believe the property could be
operated at a lower expense level relative to the historical data.
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General Appraisal Issues (continued)
Property Inspections:
»
Which units did you inspect?
»
What was their condition, configuration, and utility?
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General Appraisal Issues (continued)
Focus your inspection on particular issues:
»
Down units
»
Vacant units
»
A sample of each unit type
»
Top floors and bottom floors
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General Appraisal Issues (continued)
Speaking of Property Inspections…
This is my favorite description of on-site conditions, taken from the
appraisal of a 50%-occupied seniors housing property:
“In addition to significant turnover in the senior management team, we
observed during our inspection that the Director of Marketing kept
confusing assisted living with independent living and was not sure what
the asking rates were or how the additional fees for care were assessed
or charged. There were no brochures or any kind of promotional
materials available for any prospective residents or family members. The
Assisted Living Manager was too busy texting to look up or introduce
herself while we stood in her office. The Executive Director had been
there only a few days and represents at least the third ED in as many
years. In fact, the only person who seemed to have a handle on the
subject and its operations was the Maintenance Director."
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General Appraisal Issues (continued)

Everyone who signs the appraisal must have inspected the
property

Everyone who signs the appraisal must be
licensed/certified in the state in which the property is
located!
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General Appraisal Issues (continued)

Photos
»
Current?
»
Internet photos??

Maps

Market Area Discussion
»
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What are the drivers of multifamily occupancy and rents?
General Appraisal Issues (continued)
Required Regulatory Language (in Section 12.12 of the Seller/Servicer Guide):
The Seller/Servicer must direct the appraiser to include the following language in the letter of transmittal
above the appraiser’s signature and/or on the appraiser’s Certification page above the appraiser's
signature:
“This report is for the use and benefit of, and may be relied upon by,
a) The Seller/Servicer, Freddie Mac and any successors and assigns (“Lender”);
b) Independent auditors, accountants, attorneys and other professionals acting on behalf of Lender;
c) Governmental agencies having regulatory authority over Lender;
d) Designated persons pursuant to an order or legal process of any court or governmental agency;
e) Prospective purchasers of the Mortgage; and
f) With respect to any debt (or portion thereof) and/or securities secured, directly or indirectly, by the Property
which is the subject of this report, the following parties and their respective successors and assigns:
 Any placement agent or broker/dealer and any of their respective affiliates, agents and advisors;
 Any initial purchaser or subsequent holder of such debt and/or securities;
 Any Servicer or other agent acting on behalf of the holders of such debt and/or securities;
 Any indenture trustee;
 Any rating agency; and
 Any institutional provider from time to time of any liquidity facility or credit support for such financings
In addition, this report, or a reference to this report, may be included or quoted in any offering circular, information
circular, offering memorandum, registration statement, private placement memorandum, prospectus or sales brochure
(in either electronic or hard copy format) in connection with a securitization or transaction involving such debt (or
portion thereof) and/or securities.”
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General Appraisal Issues (continued)

Third-party reports are typically available from the Lender
– Environmental
– Engineering / Property Condition Assessment
– Zoning
– Flood Hazard
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General Appraisal Issues (continued)
 The appraiser needs to reference any material issues raised by
the third-party consultant and state their impact on value.
 For properties in where the third-party consultant has identified
issues, it is not sufficient for the appraiser to just state that there
is “no impact on value” without sufficient support for this
conclusion
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General Appraisal Issues (continued)

If there are issues on the property that might impact value but
for which the appraiser says that there is no value impact (i.e.,
location within a flood zone, hazardous material remediation),
the appraiser should discuss the reasoning for its non-impact
and provide market support for his/her rationale.
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General Appraisal Issues (continued)
The appraiser’s zoning discussion should address:
– Is the subject’s use a legal use? If not, why?
– Are there an adequate number of parking spaces for its
occupancy? (This could be based on zoning and/or based
on market expectations & comparables)
– Does the developed density comply with current zoning
requirements?
– Does the subject comply with the current floor-area-ratio
(FAR) requirements?
– Can the property be rebuilt to its current inventory of units if
there is a casualty loss?
– What is the impact on value?
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General Appraisal Issues (continued)
Parking -- Real life example #1:
The appraiser states, “We requested, but were not provided
an exact number of parking spaces.”
Solution: Count them…!
» Walk the site, or
» Plat or survey, or
» Aerial photograph (Google or Bing)
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General Appraisal Issues (continued)
Parking -- Real life zoning example #2:
The appraiser says that parking is “assumed adequate.”

There was no discussion of:
• the actual number of spaces at the property,
• the ratio of spaces per unit, and/or
• the local zoning requirement

Questions that the appraiser must answer in the appraisal:
• Is the parking ratio in compliance with local zoning regulations?
• Is the parking ratio/number of spaces adequate in this market?
If the answer to either or both questions is “no”,
then what is the impact on value?
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General Appraisal Issues (continued)

Property taxes
» Does the appraisal have current, correct tax assessment
and property taxes?
» Is the tax assessment value similar to the appraiser’s value
estimate?

If not, why not?

California issues
» Tax comparables
» Risk of reassessment at the appraiser’s value

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It is not appropriate to estimate the risk of reassessment by
merely applying an unsupported bump to the capitalization rate
General Appraisal Issues (continued)
Suggested methodologies for incorporating risk of reassessment:
1. Select several multifamily sales within the same or similar
taxing jurisdiction that have been reassessed after the sale

A comparability chart can be constructed to compare each sales
price with the new tax assessment

So, if other comparable/similar properties were reassessed at an
average of, say, 75% of the sales price, then it would be
reasonable to assume that the subject would be also be
reassessed at that amount
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General Appraisal Issues (continued)
Suggested methodologies for incorporating risk of reassessment
(continued):
2. If the appraiser’s sales comparables were mostly chosen from
the same or a similar taxing jurisdiction, then the market’s
measurement of the uncertainty of reassessment could already
be built into the capitalization rate

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There would be no need for an adjustment to the appraiser’s
capitalization rate.
General Appraisal Issues (continued)
Other Issues: Real life example
“We were not given a title report to review. We do not
know of any easements, encroachments…”
The appraiser does not state whether they asked for a title
report nor did they discuss their efforts to obtain a copy of the
recorded plat from the courthouse or to request a survey from
the property owner or from the lender.
USPAP Standards Rule 1-2 (e)(iv) “Identify … any known
easements,
restrictions,
encumbrances,
leases,
reservations, covenants, contracts, blarh blarh blarh…”
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General Appraisal Issues (continued)
Building Description – Real life example:
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General Appraisal Issues (continued)
What’s wrong with this statement?
The Comment to USPAP Standards Rule 1-2(e)(v) (which
Advisory Opinion 17 expounds upon) states:
“When appraising proposed improvements, an appraiser must
examine and have available for future examination plans,
specifications or other documents sufficient to identify the
character of proposed improvements.”
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Income Approach
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Income Approach

Do the recent rents from the rent roll support the appraiser’s
opinion(s) of market rents for each unit type?
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
If not, what is the differential?

Is this a material difference in value?

The Freddie Mac test of reasonableness
Income Approach (continued)

Does the appraiser reasonably support the estimate of:
– Vacancy?
– Concessions?
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Income Approach (continued)
Operating Expenses

We typically review the totality of the operating expenses, not
necessarily each line-item

We benchmark the appraiser’s operating expenses against the
comparables provided

»
Subtracting real property tax
»
Subtracting reserves for replacements
Is the appraiser’s estimate of operating expenses supported by
the expense comparables:
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
On a per-unit basis?

On a percentage of effective gross rent?
Operating Expenses (continued)
 We do a correlation between the historical expenses the
appraiser included in the Addenda to the chart of historical
expenses presented in the body of the report.
» Many times, there are inconsistencies that affect value
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Income Approach (continued)
 Is the appraiser’s replacement reserve supported by the
property condition report?
 Is the management fee reasonable for this property type?
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Income Approach (continued)
Capitalization rate

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The appraiser must discuss and relate the selected
capitalization rate to the subject property’s particular
characteristics such as market and regional issues, physical
condition, economics (e.g., vacancies and operational
issues), and legal constraints (e.g., zoning and ownership
structure)
Income Approach (continued)
Capitalization rate (continued)

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The selected final overall capitalization rate should be
representative of the range of the results from these
methodologies and not show a bias to either the low or high
side of the range
Income Approach (continued)

Capitalization rate (5 ways to estimate the rate):
1. Sales
2. Band of Investment model
3. Debt Coverage Ratio (DCR) model
4. Published sources
5. Interviews
Correlate the results of these five methods into a single
capitalization rate conclusion
(and discuss ‘why’)
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Income Approach (continued)
1. Sales
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•
Financial data of the comparable sales should be
verified and the source of the data should be disclosed
in the appraisal
•
Generally, the preferred type of data is either current to
the date of value or forward looking
•
An “Appraiser’s Estimate” of financial terms, conditions,
and operating parameters is not appropriate
Income Approach (continued)
»
Sales (Example):
The date of value was September 1, 2009….
What is the appraiser’s concluded capitalization rate?
7.0%
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Income Approach (continued)
2. Band of Investment
Band of Investment model
Loan %
x Mortgage Constant
= Loan contribution
Equity %
x Equity Dividend Rate
= Equity contribution
= Capitalization Rate
– Tell us the source(s) of your financial data!
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Income Approach (continued)
2. Band of Investment (continued)
Equity Dividend Rate

Meaning of the rate relationship

Sources
»
RealtyRates.com
»
American Council of Life Insurers
»
Sales
Band of Investment model
Loan %
x Mortgage Constant
= Loan contribution
Equity %
x Equity Dividend Rate
= Equity contribution
= Capitalization Rate
I.
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Income Approach (continued)
2. Band of Investment (continued)
The appraiser should refrain from using the Ellwood
mortgage-equity calculation.
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
It is not supported in The Appraisal of Real Estate
textbook (13th edition).

Typically, the appraiser’s assumptions and
components of his Ellwood calculations (property
appreciation and equity build-up) are usually not
supported or discussed, just presented as fact
Income Approach (continued)
3. Debt Coverage Ratio (DCR) model:
Mortgage Constant
x Loan Percentage
x Debt Coverage Ratio
= Capitalization Rate
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Income Approach (continued)
4. Published Sources: PwC survey (free version from App. Institute)
Ranges so large you can pick any number you want
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Income Approach (continued)
PwC survey (continued)
Respondents for the National Apartment Market Survey:
 Insurance company
 Pension fund advisor
 Domestic pension fund
 Institutional investor
 Private investment firm
 Pension fund advisor
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Income Approach (continued)
CBRE publishes a semi-annual capitalization rate survey for
approximately 40+ metropolitan areas and by property class
http://www.cbre.us/services/capitalmarkets/multihousing/Pages/knowledge-center.aspx
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Income Approach (continued)
5. Interviews with local market participants
»
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The date of the interviews and the names of the interviewees
would be helpful
Income Approach (continued)

Other Considerations
»
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Temporary market conditions, such as unusual vacancy or
concessions, should not be capitalized in perpetuity but
should typically be considered as a present value deduction
from the valuation, either from each approach to value them
separately or from the overall value conclusion after
reconciling the three approaches
Income Approach (continued)

Other Considerations (continued)
»
A discounted cash flow analysis may be required for a
property that is experiencing unstabilized operations
»
If a DCF analysis is included in the appraisal, the appraiser
should discuss and provide adequate support for the
model’s inputs
»
Generally, extending the analytical period to only the first
full year following stabilized operations will produce the
most accurate value
– That is, 10-year cash flows for a multifamily property
that is anticipated to be stabilized in 18 months is
probably not appropriate
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Sales Comparison Approach
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Sales Comparison Approach
» The phenomenon of "economies of scale" is typically a byproduct of normal price negotiation and is a relatively minor
feature of the value of a property
» We have seen adjustments of 10%, 15%, and 20% for
“economies of scale”, and this is just wrong.
– Is “economies of scale” more important than, say, location or
physical condition?
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Sales Comparison Approach
» Sometimes an appraiser will inappropriately use very small
percentage adjustments in the Sales Comparison
Approach, such as 2%, 3%, 7%, etc.
» These indicate a level of precision that probably does not
exist in the market
» There are times, though, that the appraiser can provide
adequate support for this type of precision from the local
market
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Sales Comparison Approach (continued)
» The sales comparables need to be verified with a source
familiar with the transaction and the primary data source for
the financial indicators must be provided.
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Sales Comparison Approach (continued)
» Sometimes appraisers try to force a sale to be “comparable”
to the subject by using unusually large individual line-item
adjustments or if the cumulative number of adjustments to
that sale is large.
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Sales Comparison Approach (continued)
» Appraisers should provide an adequate description of the
factors that differentiate the comparable from the subject
» Statements such as, “the comparable was adjusted upward
for inferior condition” are not sufficient
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Sales Comparison Approach
Net Income Adjustments or Multipliers
» Applying a blanket adjustment for income characteristics
(sometimes referred to as an NOI adjustment or net income
adjustment) is not a reasonable valuation technique
» As stated in The Appraisal of Real Estate (13th edition), a
net income multiplier analysis is simply the reciprocal of the
capitalization of net income from the income approach and
is not an appropriate analytical tool for the sales comparison
approach
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Sales Comparison Approach
Net Income Adjustments or Multipliers (continued)
» Typically, adjustment should reflect specific characteristics
that affects a property’s income such as level of operating
expenses, quality of management, tenant mix, rent
concessions, lease terms, and the like, not just that the
resulting NOI is greater or lesser than the subject.
» That is, in the Sales Comparison Approach typically an
appraiser should discuss the causes of the differences in
NOI, not just that a difference exists.
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Sales Comparison Approach (continued)

Things we look at in particular in the Sales Comparison
Approach:
» Are the sales in reasonably close proximity to the subject
and are they reasonably recent?
» Are the sales of a similar market appeal and investment
class as the subject property?
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Sales Comparison Approach (continued)

Things we look at in particular (continued):
» Are any of the individual adjustments in the sales grid
unusually large?
» Is the totality of the adjustments unusually large?
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Sales Comparison Approach (continued)

Things we look at in particular (continued):
» Do any one or two sales stand out?
» Does the financial information make sense?
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Sales Comparison Approach (continued)
Question: “Can appraisers use listings or sales in escrow in the
Sales Comparison Approach?
Answer: Of course, with an explanation
The Seller/Servicer Guide states (Section 12.14(b) that the appraiser
must use at least three recently sold comparable properties. However,
it does not say that listings or contracts cannot be used.
“A listing is just a listing. A sale isn't a sale until it sells" should
be in the back of the appraiser's mind as he/she analyzes the local
market.
Although it can be done, we would be wary of an appraisal where the
conclusion to the Sales Comparison Approach is based mostly on
listings or contracts
–
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It would take a significant amount of data, local interviews, and
wordsmithing to be convincing, though.
Sales Comparison Approach (continued)
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Sales Comparison Approach (continued)
Student Housing Example
The subject is a 27-story former office
building located at the southwest corner
of Van Buren Street and Wabash Street.
The subject was originally developed in
1927/1929 and has been vacant the last
few years.
The property operated from inception until
2002 as a commercial office building,
housing such tenants as Mobil Oil.
In 1999 The Buckingham was listed on
the National Register of Historic Places,
and in 2002, the city of Chicago
designated the building as part of the
Historic Michigan Boulevard District, a
Chicago Landmark District.
The building was vacant for the three
years preceding 2007.
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Sales Comparison Approach (continued)
Subject Property
Sale #1 (The best sale?)
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Sales Comparison Approach (continued)
The project amenities include a 1,500 square foot fitness,
rooftop club room, internet café, study rooms, practice
rooms 9 (musicians), meeting rooms, bicycle storage,
residency life center with advisors and a state-of-the-art
security card reader system. The entire building contains
high speed telecommunications including WIFI “ready” in
all units and common meeting rooms.
The interior of the units contain 9.5 foot ceilings,
washer/hook-ups, walk-in closets and track lighting.
All units with the exception of the studios are corner units
featuring views of the Lake Michigan, Grant
Park
90and Millennium Park.
© Freddie Mac
This property, one-block from USC, has resort-style amenities,
such as a swimming pool and two spas, a large indoor/outdoor
fitness center (including treadmills and ellipticals with individual
plasma TVs), a health spa that includes 2 steam rooms, 2 saunas,
several showers, a massage therapy room and a rooftop sundeck
with views from the Coliseum to the downtown skyline. All
residential floors include group study rooms, study lounges with
individual work spaces, and laundry facilities with smart card
technology. Each apartment has high speed internet, Dish
Network TV service (HDTV-ready), and one gated, reserved
subterranean parking space per bedroom, with additional parking
available at $150 per space.
Cost Approach
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Cost Approach

If the appraiser did not develop the Cost Approach, there must
be a reasonable rationale for its exclusion

Throw-away statements are not acceptable or appropriate:
» “The Cost Approach has not been developed due to
difficulty estimating depreciation due to current market
conditions”
» “Buyers do not use the Cost Approach in their analysis of
properties”
» “I did not feel like it”
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Cost Approach

Is the subject property’s construction recent enough that the
Cost Approach could tell the reader something about external
obsolescence or current market conditions?
» External obsolescence:
– Correlation of actual construction costs with value
– Correlation of replacement costs with feasible rents
» Functional obsolescence:
– Comparison of actual construction costs with replacement cost
(i.e., Marshall Valuation estimates) could indicate
overimprovement
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Cost Approach
Real life appraisal report example for a property built between 2002 and
2006 in a major metropolitan area:

“In deriving a cost figure for the subject, Marshall Valuation Service
(MVS) was used. Data pertaining to the subject’s original construction
costs were not made available to the appraiser. The Insurable Value
Base Building Cost figure derived from MVS of $182,700,000
(rounded) is above the market value derived by the Income and Sales
Comparison Approaches. As this figure does not include indirect costs
or land value, there is obviously some form of obsolescence occurring,
most likely external obsolescence as there is no evidence that the
property suffers from functional obsolescence. There are already new
projects under construction in the immediate area, and it is the
appraiser’s belief that the inclusion of the Cost Approach would not
help to define any significant market occurrence or trend at this point
in time. As a result, the addition of the Cost Approach is not seen as a
reliable valuation method for the subject property and has not been
included.”
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Cost Approach

Are the land sales reasonably recent and have a similar Highest
and Best Use as the subject?
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Cost Approach

Is the estimate of depreciation reasonable and adequately
discussed?
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Cost Approach (continued)
 The construction cost classification from Marshall Valuation
Service (in the Cost Approach and in the Insurable Value
sections) must match the description of the subject’s
construction in the Description of Improvements section of the
report.
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Cost Approach (continued)
Example of construction description error
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Structural
System:
Brick bearing walls
and wood joists
Exterior
Walls:
Brick façade
Reconciliation of the three approaches to value
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Reconciliation

Reconciliation of the three approaches to value
» Any adjustments made by the appraiser for loss-to-lease,
property condition, income lost due to absorption of vacant
space, unusual obsolescence or deprecation, and the like,
should be reflected in all three approaches to value
(Income, Sales, and Cost).
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Reconciliation

Relative weight of the Approaches
» If you say, “Each approach is valid and yields a reasonable
estimate of the subject’s market value”, then you cannot put
all or most of your weight on the Income Approach
» If you say, “All my weight is placed on the Income Approach
because that is how investors buy properties such as the
subject” then, in the Sales Comparison Approach, you
cannot say that “these sales are a good representation of
the market value of the subject”
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Other Valuation Issues
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Other Valuation Issues
» Contributory value of tax credits
– Did the appraiser include the value of low-income
housing tax credits as part of the real estate value, or
are the LIHTCs valued separately? (Hint: They should
not be included in the real estate value.)
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Other Valuation Issues (continued)
» Contributory value of bond financing
– Does the technique used by the appraiser to value the
contribution of bond financing make sense?
– Are the appraiser’s market-rate financing assumptions
logical and supported by sources other than the
Seller/Servicer?
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Other Valuation Issues (continued)
» Property tax abatements
The preferred Freddie Mac methodology is:
 First, full stabilized real estate taxes are used to
calculate the NOI that is used to determine the
property value with full taxes.
 Next, the present value of the tax savings over the
term of the tax abatement is determined using a
discount rate supported fully by the Appraiser.
 The present value of the tax savings is then added to
the Property value with full taxes to determine the
value of the property with the tax abatement.
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Wrap Up
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The following are common signs of above average report:
 Complete and germane data
 Consistent and easy to follow format
 Appropriate choice, placement, quantity, and quality of
exhibits
 Accurate math calculations
 No catchall disclaimers such as, “The appraiser did not
observe any easements during the inspection” or “A legal
description (or plat, survey, and/or construction drawings)
was not provided to the appraiser.”
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Favorite phrases:
 “The sales indicate that, in general, investors are willing to
pay more for properties with greater income potential.”
 “Economics are the primary factors driving the sales prices
of seniors housing properties, not physical differences.”
 “Based on my years of experience and knowledge of the
area, I conclude that….”
 “But if I make that change to the rents, I’ll have to report a
lower value.”
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 Freddie Mac Multifamily Appraisal discussion group on
LinkedIn
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I.
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Speakers
Martin A. Skolnik, MAI (Marty)
Director, Multifamily Appraisals
[email protected]
Richard Meyer (Rich)
Director, Real Estate Services/Physical Risk
[email protected]
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Questions?
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Notes:
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