Appraisal Clarity Returning in 2021
The COVID-19 pandemic created market volatility, ambiguity, and complexity. Given the sudden changes in the market, valuing commercial real estate property became a challenge that vexed commercial real estate appraisers and investors throughout 2020. The pandemic threw the U.S. economy into a recession in the second quarter. As in past recessions, the number of commercial transactions declined, which then limited the number of comparable sales available for appraisers to utilize. However, the cause of this recession was an extraneous shock, very different from previous recessions as it was more akin to a natural disaster.
The pandemic caused tenants to request shorter-term leases and rent reductions while others sought alternative types of forbearance. Landlords faced fading lease renewals, lower effective rents, and increasing operational costs to ensure the safety of tenants and compliance with health regulations. All of these factors placed downward pressure on property cash flows and negatively impacted property values. The duration of these trends is a very important component to consider as real estate is a longer-term hold.
The “art” of real estate appraisal is primarily based upon analyzing market data. The lack of recent market sales evidence has required appraisers to spend more time on market due diligence, outreach, and discussions regarding local market commentary. Market conditions in 2020 were too fluid to rely on monthly, quarterly, or annual sales reports to support opinions on the health of current property fundamentals and values.
When things fall out of equilibrium, estimating market value becomes more difficult and creates “appraisal lag” that may take several quarters, if not longer, before a clearer market picture emerges. There will also be different impacts on various property types and geographic areas as a result. Additionally, underwriters and appraisers need to look at the stability of property cash flow in terms of tenant exposure, credit quality, lease renewals, and short-term rollover risk in light of lower effective market rents and/or rising operating costs.