The Surreal Estate

Perspectives on Tenant Organizing from the Urban Homesteading Assistance Board

The Real Deal: “Multi-billion dollar private-equity fund targets local appraisers in lawsuits”

Yesterday, the Real Deal published an article reporting that Lone Star, a Texas-based Private Equity group, is suing local New York appraisers. We are familiar with Lone Star as a lender on a number of large, Predatory Equity portfolios we have been tracking for many years. Now, Lone Star is arguing that during the housing boom, appraisers acted “fraudulently and negligently” when valuing properties, and as a result Lone Star mis-lent.

As we have previously asserted on this blog, we believe that banks have a pivotal role to play in breaking the cycle of Predatory Equity. Despite how we may sometimes feel, banks do not arbitrarily set a price for their distressed assets, nor do they arbitrarily decide how much they are willing to lend on a property.  As we understand it, third party building appraisers are hired by banks to determine the real value of a particular asset, and lending levels are supposed to reflect this value. It’s interesting that a major Predatory Equity lender is suing real estate appraisers for property evaluations during the housing boom. Though we are not appraisal experts, we certainly have a few thoughts.

  • According to at least one bank we work with, appraisers are not taking building conditions into account when determining value of a property. This is a huge problem.  How can buildings be bought and sold for the right price if the repair needs – potentially millions of dollars — are ignored?  To us, it’s a no-brainer that the cost to stabilize a distressed property must be taken out of the total value when determining the cost of acquisition. Otherwise, the building is doomed for shoddy repairs and another round of neglect.

Another aspect of this article which is particularly strange is that Lone Star is the group driving these cases. We haven’t seen specific examples, but would likely agree with them that pre-2008 home values were highly inflated.  However, it’s odd for us to uncritically side ourselves with a Predatory Equity company, so we have some follow-up thoughts:

  • The article quotes Matthew Parrott, an independent attorney. He says “the cases appear to be a way for Lone Star to generate revenue from distressed loans.”  We don’t fully understand how this works. Has Lone Star determined that they paid too much for a distressed asset, and are now trying to sue other parties to recoup their losses?
  • Banks hire independent appraisers but those appraisers do not hold a guns to banks’ heads commanding them to lend at a particular level. We believe that the lenders’ eagerness to maximize profit encouraged them to believe the perhaps-inflated appraisals. Lone Star still made the loan. It seems that Lone Star is attempting to place blame for their own mistakes on other parties.

The question of appraisal seems to be linked to how much faith one puts in the free market: do you believe that the value of an asset is what someone will pay for it? Or is the value linked to the actual income potential (in NYC: regulated rents) and conditions (cost of repair)? We certainly believe that it is the latter.  Any bank making loans should hire appraisers that know building details like rent roll, and have been inside of apartments,  and have checked out the boiler, the roof, and other systems.

We leave you with one last question: what would it take to reform the way that appraisers value buildings? We intend to continue to thinking about this issue, and flush out potential answers to that question. Stay tuned!

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2 responses to “The Real Deal: “Multi-billion dollar private-equity fund targets local appraisers in lawsuits”

  1. nbh May 2, 2012 at 10:09 pm

    I suspect that most appraisers during the boom were using an income capitalization rate that was deeply flawed by market conditions. Big time research firms put out these numbers regularly based on recent sales data. When purchase prices are high for modest, rent regulated buildings, the cap rate will be low and the building will be overvalued.

    However, on the predatory equity side, if the predators have irrational expectations about how much income can be derived from a building post-rehab (as in, they don’t understand rent stabilization law and think they can jack up the rents), they would pay more for a building than they could possibly ever earn back, end up underwater, and there goes the building.

    All this is to say, income capitalization approach is super sensitive to assumptions (I mean– watch, $10/6%=$166 vs. $10/8%=$125…cap rate for below 96th street right now is 6% and the bronx is around 8%..add some zeroes and you got a big problem). It’s only one approach, and a good appraisal uses several different valuation methods, but ultimately it’s the banks who decide which valuation method they will support.

  2. Pingback: Overvalued Appraisals Leads to Overleveraging | The SurRealEstate

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