The Gap Between Appraisals and Environmental Site Assessments

NOTE TO READERS: Appraisals and environmental due diligence have traditionally been treated in silos, but forces are driving these functions closer together. This article was published in this week’s New England Real Estate Journal and is reprinted below in its entirety.

As part of a commercial real estate transaction, lenders, investors and borrowers often consider real estate appraisals and environmental due diligence as standard practice. Each brings value to the transactions, but traditionally, these two functions have been conducted independently of each other. Yet, in response to a number of factors, including market pressures, regulatory guidance and technological advances, the gap between appraisals and environmental due diligence is narrowing.

Intersection of Appraisals and Environmental Due Diligence

Property appraisals and environmental due diligence have many attributes in common. Broadly speaking, both shed light on whether a property’s asking price accurately reflects its value. Both typically involve a site visit, a search of public records and the professional judgment of an outside expert, and both highlight issues at the property that could adversely affect its value. The appraiser is responsible for estimating a property’s value based on factors like structural condition and recent sales of similar properties nearby. Due diligence consultants seek to identify any environmental conditions on or around the property that could present liability to the purchaser. The findings of one function can impact the findings of the other.

“Combined data can be evaluated together to obtain a more complete picture of the history and usage of the subject property. Many data points have value to both types of analyses,” noted Elizabeth Krol, PG and Boston-based national client manager, Partner Engineering and Sciences, Inc. “As an example, lien searches can reveal activity and use limitations or other deed restrictions that reflect the presence of an environmental hazard, which could in turn, adversely impact the property’s value during the appraisal.”

The appraiser has the ability to, not only through direct observations of the property during an inspection, but also through research, determine if there may be an environmental hazard and then has the responsibility to indicate when there is an impact. Too often, however, appraisers are not addressing environmental risks during appraisals by assuming it away and determining only the property’s value “as if clean.” There are a number of possible reasons for this, including a perceived lack of guidance, lack of awareness, intense time and cost pressures, potential fear of liability, resistance to change and a reluctance on the part of the appraiser to bring “bad news” to a client out of fear of being removed from a preferred vendor list. The good news is that the market is moving past these perceptions thanks to data improvements, more guidance, technological advances and industry experience.

More Data, More Awareness

One important development that makes it easier for appraisals to consider environmental conditions is data availability. Today, it is easier to obtain environmental risk information on any property in the U.S. than ever before. Tens of millions of property contamination records now exist on properties across the U.S., documenting former Superfund sites, brownfields, former gas stations, landfills, state hazardous waste sites and other impacted areas—and the universe of records will only grow. On the appraisal side, there is more quantitative data on how a property remediation impacts its value, and sales comps on properties with current or past environmental conditions. This means that information that was once expensive or difficult to obtain is now just a click away. The dramatic increase in property records allow scrutiny to happen in ways not possible 5, 10 or 20 years ago. Some appraisers are already starting to access a property’s environmental data before conducting the appraisal. Others are building their own databases of sales comps in their areas of focus.

Regulations and Guidance Exist

In terms of regulatory and industry guidance, numerous resources exist regarding the intersection between environmental contamination and property value. For example, in August 2013, the OCC significantly ramped up the guidance given to institutions for managing risk when the agency updated its Commercial Real Estate Lending Booklet. One of the OCC’s list of 18 elements that form an effective environmental policy is “appraisal requirements for disclosing and taking into consideration any environmental risk factors.” Likewise, the appraisal guidance from the OCC recommends that banks establish criteria for assessing whether an existing appraisal is valid based on the consideration of 10 factors, including “environmental contamination.” Simple words. Complex issues.

The most-cited industry resource for appraisers on this front is the Appraisal Standards Board/USPAP Advisory Opinion 9 (AO-9), “Appraisal of Real Property That May Be Impacted by Environmental Contamination,” which outlines guidance regarding environmental disclosure due diligence. More recently, the Appraisal Institute’s Guide Note 6 (GN-6), Consideration of Hazardous Substances in the Appraisal Process, addresses the appraiser’s role in considering environmental hazards.

Observed Thomas Jackson, Ph.D., MAI, CRE at Real Property Analytics, Inc. and the principal author of AO-9 and GN-6:

“The concepts and framework for valuing contaminated properties are now in the mainstream. Now that they know the guidance is out there, appraisers may try to comply with AO-9, but aren’t necessarily following through perhaps because of a lack of data or time. This puts clients such as lenders in a difficult situation of getting an appraisal report of the ‘unimpaired value’ of the property, assuming ‘as if clean,’ and then an environmental report that identifies contamination. The lender is then left trying to reconcile the two reports, and essentially determining the ‘impaired’ value of the property.”

The good news is that the sales data available for appraisers to comply with guidance like AO9 are now available in public records and various databases with a little digging. Due to more available information on contaminated properties and potential comparable sales, assignments to conduct appraisals that account for environmental risk are becoming more common.Jackson noted that he is “seeing more appraisers addressing environmental hazards in their valuations compared to a long time ago when no one was touching it. I expect this will only continue.”

Benefits of Synergistic Approach

The list of regulatory risk management requirements hitting lenders in the post-Dodd-Frank world is a long one. All signs now point to disclosure, transparency and efficiency. Meeting these requirements back in the 1990s would have been costly and time consuming. Technological improvements and the proliferation of property risk data has changed the landscape quite dramatically, allowing previously separate functions to occur more holistically.

“There are synergies between environmental risk and appraisals that can lead to more efficient underwriting,” according to Susan Peck, environmental risk director/VP at Santander Bank, NA. “For instance, it may be prudent to leverage historic appraisal and environmental information to ensure that the appropriate level of valuation, environmental due diligence, and flood review is complete, and is completed on the appropriate collateral.”

The use of platforms that allow for centralized management of all types of underwriting, vendor management, and the integration of real estate risk records in one integrated system is growing and will facilitate information sharing among functions like appraisals and due diligence that were once conducted independently.

Best practices are changing and the bar of expectation is being raised. As the evolution of the appraisal and environmental due diligence fields continues, lenders would do well to ensure they are working with outside experts who are experienced, who proactively look for information on environmental impairment and are knowledgeable about the latest industry and regulatory guidance.

ABOUT THE AUTHOR

profilepic_May2016Dianne Crocker is the principal analyst with EDR Insight, the analytical research division of EDR Inc., Shelton, Conn. Crocker provides strategic data on market trends to environmental consultants, commercial real estate lenders and other parties involved in real estate transactions.