The appraisal, read like a lender.

The short answer

Lenders review a commercial appraisal by testing the assumptions behind the value: the comparables and their adjustments, the capitalization rate, the income and expense inputs, the highest and best use conclusion and any extraordinary assumptions. The review confirms the report meets appraisal standards and supports the lending decision.

Bank lenders also follow federal rules. Appraisals must conform to USPAP, commercial transactions above $500,000 need a state certified appraiser, and reviewers must be independent of loan production.

What is a commercial appraisal?

A commercial appraisal is a written opinion of market value, prepared by a licensed or certified appraiser. It arrives as a precise number inside a long report, and the precision invites more trust than an opinion earns. The number is the output of a chain of assumptions.

The appraisal drives the loan amount through loan-to-value, so a value built on a soft assumption produces a loan built on the same assumption. A lender's review reads for the places the value could be wrong.

What rules govern appraisals for bank loans?

The OCC's appraisal rules in 12 CFR Part 34 require appraisals for federally related transactions to conform to the Uniform Standards of Professional Appraisal Practice, be written with enough information and analysis to support the decision, be reviewed for USPAP compliance, and be performed by state licensed or certified appraisers.

Commercial real estate transactions above $500,000 require a state certified appraiser. At $500,000 or less, the rules allow an evaluation in place of an appraisal. Interagency guidelines issued in 2010 describe supervisory expectations for appraisal and evaluation programs, including appraiser selection and independence.

What is an evaluation, and when can a lender use one?

An evaluation is a valuation that falls short of a full appraisal. Federal rules allow one for commercial real estate transactions of $500,000 or less, and require that it be an appropriate evaluation consistent with safe and sound banking practices.

An evaluation still needs support. Lenders set policies for who performs evaluations, what data they rely on and how they are reviewed, and examiners test those policies the same way they test appraisal programs.

What are as-is, as-complete and as-stabilized values?

What deductions should the appraisal analyze?

Federal minimum standards require appraisals to analyze and report appropriate deductions and discounts for proposed construction or renovation, partially leased buildings, non-market lease terms and tract developments with unsold units.

Read those deductions closely on any property that is not stabilized. Lease-up costs, free rent, tenant improvements and leasing commissions all reduce value between today and stabilization, and an appraisal that skips them overstates what the lender can recover.

Which inputs move the value most?

• Comparable sales and rents

  How similar, how recent and how heavily adjusted. Large adjustments to distant or dated comparables deserve questions.
• Capitalization rate

  Small changes move value substantially. Ask what market evidence supports the selected rate.
• Income

  Market rent compared with in-place rent, and whether the gap is realistic to close.
• Vacancy and credit loss

  Whether the allowance reflects the property and market.
• Expenses

  Whether the expense load matches actual history and similar properties, including management and reserves.
• Highest and best use

  Whether the value depends on a use that zoning or current tenancy may not support.

Why read the assumptions section first?

Appraisals disclose extraordinary assumptions and hypothetical conditions: things the appraiser assumed to be true, such as completion of repairs, approval of a zoning change or a lease signed on stated terms. Each one is a condition the value depends on.

Turn each assumption into a question for underwriting. If the value assumes a lease will be signed, the loan needs either the signed lease or a structure that protects the lender until it is.

How should the appraisal be checked against the rest of the file?

Compare the appraisal to the lender's own evidence. Rents should match the verified rent roll and leases. Expenses should resemble the operating statements. Deferred maintenance should line up with the property condition assessment. Site facts should match the survey and zoning report.

Differences deserve an explanation in the review. An appraiser using market rents above in-place rents may be right about the market and still wrong about how quickly this property gets there.

Why does appraisal independence matter?

A well-reasoned appraisal from a compromised process loses its value as evidence. The OCC's Commercial Real Estate Lending handbook describes reviewers who should be independent of the transaction, have no direct or indirect interest in the property or transaction, and be insulated from any influence by loan production staff.

The handbook also asks for a risk-based approach to review depth, with reviewers whose education, expertise and competence match the complexity of the transaction, property type and market. Small institutions that cannot achieve absolute separation should put prudent safeguards in place.

How does the file prove the appraisal process was sound?

With names and dates. The OCC handbook expects the loan file to include the appraisal or evaluation, the bank's review, the engagement letter and the appraiser's qualifications.

The dates show sequence: engagement by someone outside production, delivery of the report, completion of the review, then credit approval. A review dated after approval tells an examiner the value did no work in the decision.

What changes for hotels and special-purpose properties?

Operating properties mix real estate with business value. The OCC handbook notes that hotel appraisals often include separate values for personal and intangible property, which creates issues when calculating loan-to-value on the real estate.

Special-purpose properties such as healthcare facilities and religious buildings can lean heavily on cost and market approaches, and their values depend on continued operation. Reviewers should understand what the lender could recover if the operating business stopped.

When should a lender update a collateral value?

Values age. The 2010 interagency guidelines make institutions responsible for monitoring and periodically updating collateral valuations for existing real estate loans and for transactions such as modifications and workouts.

Common triggers include a loan modification or extension, a significant drop in the property's income, a deteriorating market and a risk rating downgrade. Set those triggers in policy, so updates happen before a problem loan reaches a workout.

What happens when the appraisal comes in low?

The loan amount usually falls to fit the leverage limit, or the borrower adds equity to keep the terms. Lenders sometimes add structure instead, such as an earnout that releases proceeds when the property hits stated performance levels.

Challenge a low value only with evidence: comparables the appraiser missed or factual errors in the report. Pressure without evidence undermines the independence the file has to prove.

How does Prodeal support appraisal review?

Prodeal keeps the engagement letter, the report, the review and the approval on the deal record with an activity log, so the file shows who engaged the appraiser, when the review was completed and when credit approved the loan.