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Dec 1, 2011

Appraisals play a critical role in the commercial real estate community. Investors, lenders and special servicers alike look to appraisals for guidance, but how reliable are they in today’s rocky market?

Brian Olasov, managing director in the Atlanta and Washington, D.C. offices of law firm McKenna Long & Aldridge LLP, doesn’t mince words. “My research has indicated that they are not reliable at all.”

Widely recognized as an expert on commercial mortgage-backed securities (CMBS), troubled mortgages and banking challenges, Olasov believes greater scrutiny of the appraisal process is needed.

“When you start talking about global solutions, I think that we need to take a look at the role appraisals are playing in slowing down the real estate recovery,” he says.

The provocative comments from Olasov came during a retail panel discussion at the ICSC 2011 Southeast Conference in Atlanta on Tuesday afternoon. The opening day of the two-day conference at Cobb Galleria attracted several hundred industry professionals, including retailers, developers, brokers, lenders and an assortment of exhibitors.

Appearing on the panel with Olasov were John Long, senior vice president with the OREO (Other Real Estate Owned) Group for commercial real estate at Atlanta-based SunTrust Banks, and Michael McGregor, vice president of Bethesda, Md.-based CWCapital Asset Management. Long and McGregor shared their strategies for dealing with troubled loans.

Olasov believes that appraisals tend to be overly optimistic in a down cycle, as is the case today. “Appraisals are typically backward looking, which makes sense if you can substitute good business judgment for that appraised value you know is off base. Unfortunately, a lot of times the appraisals become the beginning and ending point for discussions on price. In that respect, I think it’s very counterproductive,” emphasizes Olasov.

In loan workout situations, McKenna Long & Aldridge will routinely obtain appraisals on financially troubled properties, which enables the law firm to spot trends. In many cases, the appraised values bear almost no resemblance to the liquidation proceeds achieved at the end of the loan resolution period, says Olasov.

McGregor of CWCapital, the second largest special servicer in the country, says that there is no consistency across the board when it comes to appraisals. “Brokers’ opinions of value give us a better pulse of the marketplace,” he says.

CWCapital currently oversees a special servicing portfolio of $22.6 billion in delinquent CMBS loans, including more than $5 billion in retail loans.

Distress Strategies

As a special servicer, CWCapital has a two-pronged strategy. For properties with a loan balance of $10 million and under, the special servicer will either sell the note or foreclose on the property and sell it “as is”. Ultimately, the state in which the property is located plays a factor. For example, the foreclosure process takes 135 days to complete in Florida versus only 37 in Georgia. Thus, in the case of Florida, a note sale is a more expeditious way to proceed.

Of the 5,200 loans liquidated by CMBS special servicers since 2007, 1,300 loans were backed by retail properties, according to Olasov. Simply stated, the retail real estate sector has accounted for one in four loan liquidations during that time.

For properties with a loan balance $10 million and above, CWCapital is more inclined to hold the asset for as long as three to four years, if necessary, during which time it can lease up the empty space and stabilize the property in preparation for a sale.

When a loan defaults and goes into special servicing, the borrower needs to be willing to inject capital into the deal, emphasizes McGregor. “The first question we ask if you are the owner of the property is what can you do for us? Otherwise, we’re just going to take your property.”

Long of SunTrust, who oversees a $400 million portfolio of OREO properties encompassing about 1,000 assets, describes the bank as a highly motivated seller. The average length of time an asset remains in the OREO portfolio is approximately six months. “I can count on two hands the number of assets that we held for any period of time to try and reposition them,” says Long.

In addition to commissioning an appraisal on a distressed property targeted for sale, Long’s group will turn to brokers to obtain their opinions of value.

“So long as we’re in that strike range, we’re selling it,” says Long. “We spend a lot of time forecasting what we’re gong to lose on dispositions and making sure the reserves plus the proceeds get us something close to what the bank is carrying the asset at” on its books.

The best advice for opportunistic buyers or borrowers trying to cut a deal with special servicers or banks is to understand their motivations, says Olasov. For example, CMBS special servicers can’t deviate from the pooling and servicing agreement, he points out, otherwise they will run afoul of their contractual obligations.

“Understanding what they can and can’t do is really, really important.”

— Matt Valley



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