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An Overview of Different Types of Real Estate Appraisals: An Interview with Ronald Baum of Baum & Associates

By Ronald Baum, MAI

Tell us about your company and its foundation.

Since moving to the Bay Area in 1987, my practice focus has been on dispute related matters such as property tax disputes, lease renewal and rent reset arbitration, estate and gift giving documentation. The property types have run the gamut from the Ferry Building and the San Francisco Center, to single family home sites in Marin County. I've been a real estate appraiser since 1973. I started my career with the Brooklyn Savings in Brooklyn, New York. I was employed in New York from 1973 through 1987 by two savings banks and two major brokerage firms. During that time, I appraised property in 22 states, primarily for mortgage purposes, but also for estate value documentation and other dispute related matters. Property types ranged from the late Gloria Swanson's Fifth Avenue cooperative apartment to what was at the time A.T. & T's world headquarters' on Madison Avenue.

What different types of appraisals exist?

Real Estate Appraisals are completed for a variety of reasons (i.e. mortgage, estate tax, condemnation) and can be presented in a number of different formats and sub-formats. The world of real estate appraisal is admittedly arcane to most people. However, it is important to understand several basic things regarding the content and performance of real estate appraisals that are used for mortgage lending purposes:

  • Any appraisal report submitted to a lender is perceived as being part of a "Federally Related Transaction". This means that the appraisal report must conform to the Uniform Standards of Professional Appraisal Practice, aka "USPAP"
  • The appraiser must be licensed in the state in which the property is located or cosign the appraisal report with an individual who is licensed. In some instances, particularly for those employed by or engaged by institutional lenders to appraise investment grade property such as hi-rise office buildings, a temporary license can be granted for a certain amount of time.
  • The appraiser needs to be competent pertaining to the property type and location of the property being appraised. If either is unfamiliar to the appraiser, then he or she needs to joint venture the assignment with someone who is.

What is the basic appraisal process?

The appraisal process entails basic steps such as identification of the problem, such as the type of value (i.e. market value, user value, investment value among others), the purpose and dates of the appraisal, intended user and the intended use of the appraisal.

The scope of work (necessary tasks to complete an appraisal) are outlined, data collection tasks are stated, use of relevant valuation approaches leading to reconciliation and final value conclusion are completed.

How does an appraisal influence a mortgage?

Depending on the property type, physical condition of the asset and other issues, an appraisal can and often does have an impact on the decision making process involving loans. The most common impact is that many loans, particularly those for single family homes and/or condominiums are based on a loan to value ratio. If a lender typically funds on a ratio of 80% loan to value and the appraised market value is below that of the acquisition cost, the loan amount that the borrower is applying for will less than 80% of the acquisition cost, thereby requiring additional equity on the part of the buyer/borrower. In some cases, typically with investment property, a debt coverage ratio is also an underwriting criteria supported by an appraisal. For example if an income property produces annual net operating of $125,000 and the annual mortgage payment is $100,000, the debt coverage ratio is 1.25 ($125,000/$100,000 = 1.25) If the lender requires a debt coverage ratio of 1.25 or higher, but the estimated net operating income in an appraisal is less than estimated by the buyer or the bank's loan officer, (in this case assume $115,000) the debt coverage ratio falls below the required target and jeopardizes the lender's ability or desire to lend on the property.

How is a mortgage appraisal different from an appraisal to documenting charitable donations?

Appraisals that are completed for mortgage purposes are typically prepared for conventional lenders. The appraisal reports are often prepared on forms that meet the approval of Fannie Mae, Freddie Mac as well as other institutional lenders. The definition of Market Value used in appraisal reports prepared for lenders are specific to the lending community. An appraisal prepared to document the amount of a gift, donation or inheritance opines to Fair Market Value as per the internal revenue code. An appraiser who prepares an appraisal for any of these purposes or any other issue that involves a federal tax dispute needs to view that appraisal report as a potential exhibit in Federal Tax Court. There are specific reporting requirements, which if not adhered to could get an appraisal disqualified as an exhibit in court. If that happens the financial consequences to the taxpayer could be substantial.

Does the process differ any?

From a client's perspective, the major difference between an appraisal report prepared for federal income tax purposes and a mortgage, other than cost, is that the appraisal report prepared for a lender is completed on a form and one which is completed for tax purposes is in a narrative format. The IRS requires that appraisal reports are "qualified appraisals" prepared by "qualified appraisers." IRS has specific guidelines for these terms which can be found in Treasury Regulation 1.170A-13(c). From the appraiser's perspective all data for appraisals submitted to IRS needs documentable verification, complete explanations why certain valuation techniques were included and others omitted. Whereas any appraiser who takes pride in their profession will include as much detail as the assignment warrants, since there is no direct examination in tax court, the appraisal report serves as the appraiser's direct examination. It is quite possible that a taxpayer will be required to appear in federal tax court for non-real estate related issues, with real estate having a secondary role in the dispute. A well prepared appraisal report will add credibility to a client's tax issues.

Is there any other information on this subject you would like to provide?

The value of a property has no correlation to the cost of an appraisal. There have been recent court cases where individuals who have donated or inherited property have not complied with IRS requirements regarding the qualifications of an appraiser and/or the content of an appraisal report which was used to document the fair market value of inherited property or gifted property. This resulted in denial of the deduction plus additional penalties.

With regard to mortgage lending, many lenders treat appraisals like commodities rather than as a professional service. Appraisals for lenders are often coordinated by appraisal management companies who by and large are not involved in the borrower's transaction and are not employees of the lender. Their ability to properly review and coordinate appraisals has been questioned by the brokerage and appraisal community. Borrowers are entitled to a copy of the appraisal prepared for a lender on their loan. If a borrower feels that there is an error in the report that has a material impact on their loan, question it.

What is the best way to contact you and your business?

Ronald Baum, MAI, can be reached at 415-389-6261, rbaum@baumandassociates.com, or visit my website: baumandassociates.com

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