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Commercial Real Estate
Mar 2, 2015

Why There’s A Gap Between Real Estate Market Values And Appraisals

Sponsored Content provided by W. Grayson Powell - Broker, Managing Partner, Coldwell Banker Commercial SunCoast

It’s no secret the economic recession of 2008 had a devastating impact on the real estate market – both residential and commercial. In fact, some of the effects of the 2008 collapse are still being felt in the real estate market to this day, seven years later. Unlike the collapse, which seemed to happen almost overnight, the recovery has been a long, slow, shallow climb. Let’s review a chain reaction of events that originated during the recession and resulted in a cycle that is still inhibiting market growth and recovery.
 
Domino 1 – The Recession
 
Yes, we could go back in time and identify many previous dominos that fell and ultimately led to the recession of 2008. However, for this article, let’s start in the pits of the recession and label the recession itself as representative of the first domino. So the recession flooded in like a hurricane storm surge at high tide. Businesses closed and people lost their jobs and found themselves unable to pay their bills and debts.
 
Domino 2 – The Property Pileup
 
A lot of people lost their homes and many commercial real estate owners had to give up their properties as well. Who ended up owning all of these homes and businesses? The banks and lenders that financed them, of course. These properties that were taken back by the banks were (and still are) known as:

  • REOs: Real Estate Owned
  • CREOs: Commercial Real Estate Owned
  • OREOs: Other Real Estate Owned
From 2008 to 2010, banks and lending institutions accumulated a huge quantity of REOs, CREOs and OREOs.
 
Domino 3 – Bye-Bye Bunches of Banks
 
Banks are required by FDIC regulations to maintain a certain cash-to-lending ratio. With so many foreclosures and defaulted loans on their books (Domino 2), many banks were unable to maintain that ratio and simply could not survive the recession. Most of the drowning banks, along with their bad loans and foreclosed real estate, were swallowed up by stronger banks that were supported by cash in the vault.
 
Domino 4 – The Bailout
 
Now in possession of even larger quantities of foreclosed properties and defaulted loans, the stronger banks found themselves trying to manage large portfolios that they needed to get off of their books. The FDIC made it possible with a bailout that guaranteed 80 cents on the dollar of the loans that the strong banks assumed.
 
Domino 5 – The Artificial Market
 
So the bank-owned properties that were put back into the market had purchase histories that reflected high prices from the peak of the glory days. However, the banks, through the help of the FDIC, were able to sell these properties at exceedingly low prices and get them off of their books. Although this was very good for the banking industry, as banks were able to clean up their messes, these artificially low prices made things worse for the real estate market.
 
Domino 6 – The Market Value–Appraiser Gap
 
Homebuyers, agents and brokers look at current values and future probabilities to determine market value for real estate – it’s a subjective perspective. Appraisers look back at historical data to determine real estate values – it’s an objective perspective. While this objective approach is the way that appraisers are required to calculate real estate value, the method does not account for market changes, trends and projections. There is a gap between what the market will bear and the appraisal values.
 
Domino 7 – The Skewed LTV
 
Since the recession, the market has been on a steady incline, albeit a very slow one. The market is no longer depressed, but appraisals are still being based on historical data that reflects a depressed market and is no longer an accurate reflection of the current, recovering market. In fact, the market value–appraisal gap (Domino 6) is even larger than normal, and historical data is even more skewed than normal, because of the artificial market (Domino 5) that resulted from the bank bailout (Domino 4) during the recession. When banks are deciding how much to loan, they use loan-to-value (LTV) calculations, which are based on appraisals. As you might imagine, LTV calculations today are not aligned with what the market demands or what the market will pay.
 
Domino 8 – The Need for More Cash

If a seller is listing a property for $1 million, which is at or near current market value, you may be counting on the bank to loan you 80 percent of the cost ($800,000), which means you need $200,000 in cash. However, if the appraisal (which is based on artificially low historical data) comes in at $750,000, then (based on 80 percent LTV) the bank will only approve a loan of $600,000. That means you have to come up with twice as much cash - $400,000.
 
We are going through some very serious adjustments that need to be recognized in the process of buying property. One, values are up. Two, the prices were too high before the crash, but were too low after the crash. The FDIC and the lending institutions had influences that were outside of normal market conditions driving sales prices. Three, appraisers are going to have a hard time justifying today’s sales prices with yesterday’s prices.
 
As we move forward, the real estate market will reach equilibrium; it just may take a little while.
 
Grayson Powell is a Managing Partner at Coldwell Banker Commercial Sun Coast Partners (CBCSCP). CBCSCP leverages the vast experience of highly-skilled real estate professionals and developers and specialize in selling, leasing and managing retail, commercial, and investment property. To learn more about CBCSCP, visit www.cbcwilmington.com or call 910-350-1200.

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