The Freddie Mac Optigo SBL Appraisal Process
The appraisal is perhaps the most important third-party report required during the Freddie Mac SBL application process. Freddie Mac Multifamily has a specific series of guidelines for property appraisals, and, while most of these concern the appraiser, rather than the borrower, they are still important to understand. A faulty or incomplete appraisal can significantly slow down the loan approval process, and could even result in a borrower being denied funding.
Therefore, not only is it important to hire a highly qualified appraiser, it’s also essential for a borrower to prepare correctly for the appraisal itself. In most cases, the appraisal will be the last (or one of the last) third-party reports ordered, as the appraiser will generally need to utilize information gleaned from the Phase I Environmental Assessment and Engineering Report in order to properly estimate the value the property.
The below information is taken directly from Chapter 12 of the Freddie Mac Multifamily Revised Seller/Servicer Guide:
Overall Appraisal Recommendations
Appraisals must not simply state the estimated value of a property; they need to engage in an in-depth explanation of the apparier’s knowledge, the reasoning for that knowledge, and how that knowledge was applied to the property valuation process. In addition, each appraiser needs to be a certified general appraiser in the state where the property is located. Appraisal trainees may contribute to an appraisal, but only under certain conditions, detailed in the next section of this guide.
Appraisal trainees are allowed to be involved in the Freddie Mac Multifamily appraisal process, but specific guidelines must be followed. Like appraisers, appraisal trainees need to be currently registered as appraisal trainees in the state where the subject property is located. However, an appraisal trainee is permitted to co-sign an appraisal if:
- The trainee’s trainee ID/licenses number is clearly identified
- The Letter of Transmittal definitely states the trainee’s involvement in the project– what exactly they contributed to the appraisal
- The trainee signs the appraisal, taking full responsibility for its content and conclusions
- The trainee states if they have personally inspected the property
In general, the lender must give the appraiser the property condition assessment (PCA), as well as the Phase I Environmental Assessment before they complete their appraisal. These reports should be provided as soon as possible, as their contents may influence the appraiser’s valuation of the property. Draft reports can be used in order to speed up the process, but if the drafts are significantly different than the final reports, the appraiser will need to make changes based on this new information.
Appraiser Inspection Guidelines
Appraisers are required to inspect a property thoroughly. This includes an inspection of:
- One type of each unit (to analyze marketability)
- Vacant units, to see if they are ready for new tenants
- Down units, to see what types of repairs they may require
- At least 5 units, and at most 25 units (if required units exceed 25, an appraiser can round down)
- The appraiser must note each unit that is inspected
Deferred Maintenance and Property Repairs
Analyzing deferred maintenance and property repairs is also an essential part of the property appraisal process. Property appraisers need to:
- Review a property for required repairs
- Estimate repair completion costs and completion dates
- Determine whether repairs will temporarily increase vacancy rates/reduce occupancy rates, and, if so, by how much
- Estimate the impact that any repairs will have on the value of a property
- Utilize the PCA and Environmental Assessment in order to further the quality of their report
Property Tax Assessments
A property tax reassessment can significantly increase a property’s annual tax liability, increasing expenses (and risks) from the standpoint of both borrowers and lenders. Appraisers must incorporate their estimation of the risk of a reassessment into their appraisal. This part of their report should be well-reasoned and highly specific. Factors that should be addressed include:
- The chance that the property will be reassessed in the next few years
- If the property is reassessed, how large will the tax difference be
- How this will impact that overall value of the property
In addition, appraisers will ideally look at other properties that have been sold in the area to determine whether they faced tax assessments, and, if so, by how much. Special attention should be paid to the relationship between property sale prices and reassessments.
Sales Comparison Valuation Method
The sales comparison approach is one of the most common commercial property valuation methods and involves comparing the subject property to a similar property in a nearby location. Appraisers should be careful to include why the net operating income (NOI) is different, and should compare the two properties based on factors including location, occupancy rate, unit size, property condition, amenities, and other relevant factors.
Income Approach Valuation Method
The income approach is another popular valuation method for commercial properties, and involves looking at a property’s rental income as the major measure of the value of the property itself.
A property valuation using the income approach must first look at any differences between the market rents for the building and the actual rents being charged to tenants. If there are major differences, they should be accounted for. In this case, appraisers should determine why rents aren’t yet at market levels, the time that it will take for the property to achieve market rents, and how current rental prices affect the value of the property.
In the past, Freddie Mac required appraisers to include at least 5% vacancy when calculating a property’s NOI for valuation purposes. However, as of 2014, this rule has been eliminated, permitting appraisers to use whatever amount is accurate for the market in which the property is located. In general, properties should be at least 90% occupied.
Capitalization Rate (Cap Rate)
As part of the income approach to valuation, appraisers will also need to calculate the estimated capitalization rate or (cap rate) for the property. Estimations of cap rates can be determined from published sources, including surveys, and models including the debt coverage ratio model and the band of investment model (though these must be backed with sources).
Photographs of the subject property must also generally be included in a property appraisal. Photos, however, must be clearly dated, with an identified source and date for each individual photo. Common sources include marketing materials, websites, and photos taken by the appraiser themselves. However, if photos are not taken by the appraiser, they need to accurately reflect the property at the time of valuation.
Insurable Value of Property
All Freddie Mac Multifamily appraisals must provide the insurable value of the property. This is generally based upon a property’s replacement cost, which is defined as the cost to replace the property– i.e. to rebuild a property with the same amount of units that would be a reasonable replacement for both an average tenant and investor. This does not include any site improvements, such as landscaping or driveways, the cost of the land itself, foundation reconstruction costs, goodwill, or other intangible costs.