'You Can Imagine The Pressure': Commercial Appraisers At The Center Of CRE's Price Reckoning

Commercial appraisers find their work at the center of one of the largest real estate stories of the moment: the fate of the office market. Their decisions of value will have enormous sway on when properties sell, how and when transaction volume restarts and even who controls key assets. 

“There’s a lot of money and control rights at stake, all depending upon the appraiser’s determination,” said Joseph Cioffi, chair of the Bankruptcy, Creditors' Rights and Finance Practice Group at Davis+Gilbert in New York City. “So you can imagine the pressure.”

Trying to find out when things have hit bottom and when sales may restart in earnest has kept many appraisers busy. While transaction activity has plummeted, there is a client base of institutional investors and large property owners keenly interested in where the market is headed, according to Adam Dembowitz, JLL’s senior managing director of value and risk advisory in the U.S. 

In this office market, where valuations can be tough to figure out because bedrock facts are in flux, appraisers find themselves in high demand. Yearly appraisals have become quarterly, and “the information can't come fast enough,” Dembowitz said.

But better access to market data alone can’t solve the contemporary challenge of calculating the value of office spaces. An aging building stock, financing challenges and a rush to Class-A space mean the values of second- and third-tier offices appear to be in freefall. Cushman & Wakefield Senior Director of Valuation and Advisory Trevor G. Chapman said he has seen some office values drop 70% from their last purchase price.

The appraisal industry operates fundamentally as it did decades ago. But like any part of real estate, it has been sped up by technology. Dembowitz remembers, during the early days of his career in Chicago in the mid-2000s, that an office appraisal meant stopping by the city zoning department to get sales and blueprint info, taking and developing photos, gluing them into a binder, then sending off finished appraisal packets to clients via bike messenger. 

The biggest shift has been the improved availability and accuracy of data, said University of San Diego business professor Norm Miller, who studies the industry. Decades ago, appraisers relied on sharing data and swapping sales info with industry contacts. Today, numerous websites and industry-specific software platforms can parse the market instantaneously.

Different forms of data carry more weight at moments like these, Miller said. With office vacancy rates near or above 25% in many markets, tenant quality becomes a bigger issue, since it is harder to find replacements when someone moves out. Sublease rates also factor in amid such a down market. In this environment, he said he sees every building as unique.

“Appraisers really need to look at every office facility, tenant by tenant, lease by lease,” he said. 

Dembowitz said he focuses on nailing the inputs, specifically a property’s discounted cash flow, to determine value. That is where value can be gleaned and where appraisers differ in their analysis, he said. It isn't uncommon for two appraisers' valuations to differ by 1%, which can be an impactful change. 

That figure will ultimately determine the financing an owner can get when they need to refinance, an especially important consideration when approximately $117B in office loans come due later this year.

“If you specialize in office, you're probably very busy right now,” Chapman said. “When loans get close to going into default and banks think that value might be under the actual mortgage amount, they require either quarterly or even monthly valuations just to keep track because they can't lend any money if they're underwater on their other loans.”

Like other industries, there has been significant consolidation, but small shops and independent firms still play a key role. Lance Doré, president of The Doré Group, a San Diego-based firm focused on real estate consultation and valuation, says the market bifurcated into two main groups, the large national firms and boutique firms like his that zero in on niches and subsectors in commercial real estate. 

Miller said he sees this moment as a test for commercial appraisers since these values are so crucial to larger business decisions in a beleaguered market. Banks want to forestall defaults and don’t want to own or operate buildings. Lenders want to see cash flow projections. 

Owners may not want to face the reality of declining asset value and a slow-motion move toward potential default. For all their importance, appraisals, by their nature, are an art and a science, Miller said.

“There are appraisers who will use data not to lie so much as to skew and bias results,” he said. “Some of them are optimistic about the market, some of them are pessimistic. Sometimes you want a property tax appeal and you want a low appraisal. And so you can find appraisers whose inclinations match up with what you want.” 

The tendency to inflate values and for appraisers to lag current market conditions because of a reliance on historical data may be prolonging the market’s state of limbo. 

Green Street analyst Harsh Hemnani said the office market is overvalued by 15%. That might seem like a good thing for an individual property. But the inflated value still has a ways to fall before hitting what Green Street believes is the correct one — historically, Hemnani said, appraisal values lag his firm’s analysis by a year — which means months of uncertainty, bad headlines and reluctance to deal.

This dissonance means fewer sales, as buyers believe they are waiting for prices to drop and sellers don’t want to take a markdown in their books.

“In 2024, there is going to be a very big difference between the reality on the ground and what appraisers say is happening,” Hemnani said. 

He sees this as indicative of a larger issue. Appraisals and appraisers need to be more focused on value for investment purposes instead of risk management and fulfilling legal and official obligations such as mortgages. The issue going forward becomes paradoxical: Appraisers need transactions to mark values down, but sellers, convinced their assets are worth more, won’t sell at discounts until appraised values fall.

And if all the sales are distressed, that might create its own comps challenge. Chapman said he had heard of a broker talking about going to “price per pound,” meaning just a low cost per square foot, say $60 per SF for a building that may cost $500 per SF to build. In this case, it is a land banking play. These distressed sales can really drive down market value across the board, he said. But it is also a matter of time before too many distressed sales become the actual market.

“Two, three sales, that’s not the market, some might say,” Doré said. “But when you start getting to eight, 10 sales, you can’t call them distressed anymore.”

Because appraisals at this moment are so fraught, others fear that they will inevitably become the subject of lawsuits and legal bickering. Cioffi’s firm has been involved in major litigation around residential mortgage-backed securitization coming out of the Global Financial Crisis.

These cases have focused in part on questions of value, with past appraisals coming into question, plaintiffs and defendants bickering and in some cases hiring their own appraisers to dispute past valuations. He expects similar situations to play out in the coming years around commercial appraisals and valuations from this period. 

“Years down the road, these appraisals might become the subject of litigation, and the credibility and methodologies used would follow the same path,” he said. 

Miller said if he were an appraiser at a large firm, he would be especially cautious in his judgment and analysis. 

“A lot of the commercial work is done by really major firms,” Miller said. “They make themselves easier targets. So if you're a national firm or a major accounting firm that does appraisal, you're going to have to be extremely careful.”

Many appraisers would likely scoff at the idea they can move markets or change the fortunes of their clients. Integrity and accuracy are the most important parts of their job, regardless of the pressures of the moment. They don't assign value. They understand it. 

“We don't make the market,” Dembowitz said. “We just report on what we see.”