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Lack Of Confidence In Data Provided

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Gobears81

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I posted not all that long ago about an appraisal that I did on an apartment in which the "audited" income statements were so clearly not reliable that they were disregarded entirely. I was trying to search for that thread, but could not find it. Hopefully, this thread is not of the same topic.

I am doing another appraisal in which the income statements, and perhaps rent roll, is not reliable, which is an understatement. I have requested audited income statements and tax returns, although the seller cited a reason for not providing both that the client seemed to buy into. My concerns have been conveyed to the client, but they have requested that I move forward with the data available.

In short, I don't like this. Yes, I have expense comparables and could appraise the property based solely on market metrics, but there is a wide variance for this property type/ market and the property has somewhat unique features relative to that used for expense comparables. People buy these types of properties based on verifying their historical performance and that the buyer is not insisting on a more credible financial statement is beyond me.

The data that I have examined seems to support the selling price, but if I had any confidence in the historical performance provided, I could be at a different value. Any advice on the best way to protect myself in this situation and/ or the best way to handle this?
 
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jay trotta

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Would a potential Buyer have their accountant review the books and provide assitance for value ?
 

Amy Perkins

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No one can tell you what your opinion of market rents are, maybe they are paying above it for some reason...
 

Michael S

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This sounds like a situation where an extraordinary assumption may be called for. You have information that is unreliable and you are making the extraordinary assumption that it is accurate.

The other alternatives are 1. use market rents and expenses 2. use actual rents and expenses but apply a higher cap rate to reflect the increased risk that the financials are not realistic.
 

J Grant

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If the subject were vacant with no owner provided income statements available, what would you appraise it for then? That's what I would suggest...

Trust your gut and market knowledge, you have no confidence in this guy's income statement because all the other market indicators tell you differently, and this guys' not willing to turn audited financials over confirms it. I would put most consideration on market rents and income of competing properties and say you gave less consideration to subject since for reasons unknown it appears above prevailing and owner would not provide audited financials when asked for them.

The MV definition references a well informed or well advised buyer acting prudently...wouldn't an informed buyer want verified financial statements, and how much would they trust them if the rest of the market were performing differently? RE, a current tenant might for some reason be paying higher than most, but if that tenant vacated, how probable would it be to get that same high rent from another tenant?
 
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Gobears81

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Would a potential Buyer have their accountant review the books and provide assitance for value ?
This specific buyer certainly isn't, otherwise they'd have audited financials or tax returns by now :) A typical purchaser of this type of property might have an in-house accountant, etc. look pretty closely at the financials though.
No one can tell you what your opinion of market rents are, maybe they are paying above it for some reason...
The reported rents aren't the primary problem, but the potential occupancy is. When I inspected it, it was reported by the manager as having two vacancies, but the rent roll dated roughly a week later listed it as being full. Obviously, that is just a snapshot in time, but the lack of trust in the historical P & Ls to ascertain how the property has performed in the past complicates this.The market for this property type is a good one right now, but it is in a location in which numerous properties of a similar type have struggled. Thus, there is conflicting information about what a market vacancy rate would be, although I have vacancy comps from a larger geographic area.
This sounds like a situation where an extraordinary assumption may be called for. You have information that is unreliable and you are making the extraordinary assumption that it is accurate.

The other alternatives are 1. use market rents and expenses 2. use actual rents and expenses but apply a higher cap rate to reflect the increased risk that the financials are not realistic.
Using an extraordinary assumption regarding the reliability of the historical financials is almost second nature, but although I put that in the (incomplete) report, I essentially said later that it is not reliable, so I'm wondering how that should be re-worded. There is a wide range of performance for this type of property, but I am finding that my expenses are more fixed than initially anticipated, so I am actually a little more concerned about determining the correct gross income. Regarding #2, if the historicals are accurate, which they aren't and I verified one expense as being incorrect, the property is pending sale for a 20% cap rate.

I am a little concerned that my appraisal could be used for ammunition in litigation later on, when the buyers finding out that the property has in fact an 80% - 85% expense ratio, rather than 55%. Or if my stabilized NOI ends up being rosier than their actuals, that could be another issue also.
 

J Grant

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Go Bears: 2773648, member: 144065"]This specific buyer certainly isn't, otherwise they'd have audited financials or tax returns by now :) A typical purchaser of this type of property might have an in-house accountant, etc. look pretty closely at the financials though.

The appraisers opinion of market value is not based on the specific contract sale buyer, especially if that buyer shows they are not well informed or acting prudently. The appraisers opinion of market value is to be based on the theoretical actions of the buyer as stated in the market value definition ( well informed or well advised and acting prudently. ) That is why our opinion of market value may end up different than what a contract sale buyer agreed to pay. A contract of course is a piece of information, but our research lets us decide how much to rely on it as a MV indicator piece of information.

The reported rents aren't the primary problem, but the potential occupancy is. When I inspected it, it was reported by the manager as having two vacancies, but the rent roll dated roughly a week later listed it as being full. Obviously, that is just a snapshot in time, but the lack of trust in the historical P & Ls to ascertain how the property has performed in the past complicates this.The market for this property type is a good one right now, but it is in a location in which numerous properties of a similar type have struggled. Thus, there is conflicting information about what a market vacancy rate would be, although I have vacancy comps from a larger geographic area.

How convenient, manager says two vacancies, magically a week later rent roll lists it as full? It's what the property could command as vacant as most probable rent in the market, isn't it?

Using an extraordinary assumption regarding the reliability of the historical financials is almost second nature, but although I put that in the (incomplete) report, I essentially said later that it is not reliable, so I'm wondering how that should be re-worded. There is a wide range of performance for this type of property, but I am finding that my expenses are more fixed than initially anticipated, so I am actually a little more concerned about determining the correct gross income. Regarding #2, if the historicals are accurate, which they aren't and I verified one expense as being incorrect, the property is pending sale for a 20% cap rate.

Why would you use an EA about reliability of historic financials when you believe they are not reliable?

I am a little concerned that my appraisal could be used for ammunition in litigation later on, when the buyers finding out that the property has in fact an 80% - 85% expense ratio, rather than 55%. Or if my stabilized NOI ends up being rosier than their actuals, that could be another issue also.

You should be a lot concerned. I think you know what the right thing to do is here but are trying to justify bringing in at SC price...sorry for bluntness but I can see you are conflicted (which is a good thing, a true number hitter has no conscience and no conflict and would just bring it in at SC price relying on BS inflated financials)
 

hastalavista

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California
So, we have an income property, somewhat atypical, and there is a question about the historical performance.

As to the recently rented spaces, I would request copies of those leases (I'd request copies of all the leases... hopefully this isn't a 43 tenant building!). You note that similar properties have "struggled". Struggled as far as their occupancy? If that is the case, the lease and tenant history becomes more important. In any event, a review of the quality of the tenants will help the report conclude what a realistic stabilization (rents and occupancy) level is.
So that would be my first step: Reconciling what I'm being told as far as rents and occupancy against what the market indicates should be the case.

As far as expenses go, I don't see any issue in completing a pro forma based on what you believe to be the reasonable expenses. You have the subject's historicals and you have comparable expenses. Reconciling those two sets of data will provide with a reasonable and credible expense forecast going forward. We do this all the time.

Historical performance of a property is typically a primary consideration. But only when that performance can reasonably be confirmed/verified. In cases where the historical performance is not sufficiently reliable, then "the market" would make its own forecasts based on more reliable data (market comps). Forecasting for atypical properties is not going to be as high confidence for a plain vanilla box. There are a lot of uncertainties and variances (I get that). Our job is to present the data, analyze it and then make are conclusions; those conclusions should be reasonable, logical, and have some support. You have market data that is superior to the historical data you have been provided. It is reasonable for that market data to have more consideration in your forecasts than the historicals given the difference in their quality.

This challenge can be resolved if the seller's information were of higher quality, such that you can rely on it with confidence. And, that is the issue here (and it isn't the appraiser; it is the data): The historical data you've been given doesn't jive with what the market seems to indicate. Unless that historical data can be confirmed/verified to the level where the appraiser can use it rather than the market data, the historical data's normal consideration (primary) falls in ranking and the market data (and appraiser's judgment) takes on a greater role. This doesn't mean to ignore the historical data; it just means that relying on the historical data 100% for the valuation analysis may be unreasonable.

Explaining the data challenge, the steps taken to try to raise the confirmation level of that data, and the the process of putting more emphasis on market data and appraiser's judgment vs. the historical data, provides the logic and rationale for constructing a pro forma which is different (and, more in line with the market) than what it would be if the historicals were relied upon 100%.

In my opinion, once this process is outlined, any additional liability-risk due to potential future litigation is significantly reduced (nearly eliminated, I'd say. Anyone can be sued, but the process outlined explains the shortcomings in what was provided and the logic and reasonableness of going with a forecast that isn't a mirror-image of the historical performance).


Historical data of a property is an important part of the data component; but depending on its reliability, its importance in our valuation analysis is lessened and we rely more on the market data and our judgment. In such a case, it would be expected that our valuation analysis concludes a different result than one that gave the historical data primacy in the analysis.

The old saying, "You have to play with the cards you are dealt" is partially true in this case. Here, we were originally dealt historical data; we are looking at our hand and we don't like what we see. Discard those data cards that don't work and draw new data cards from the deck (the market). That's how I'd play this hand.

Good luck!
 

Gobears81

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Certified General Appraiser
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Illinois
I think you know what the right thing to do is here but are trying to justify bringing in at SC price...sorry for bluntness but I can see you are conflicted (which is a good thing, a true number hitter has no conscience and no conflict and would just bring it in at SC price relying on BS inflated financials)
Well, most of this post was fine enough, but you completely whiffed on this statement. I'd encourage you to look into the analogy of the blind man and the elephant- perhaps it will save you from making such statements in the future.
My value IS coming out a bit higher than the selling price, and that makes me even more nervous. If I was coming in below the purchase price, the parties would go away and hopefully the seller would find someone that actually falls into the "prudent" category of a typical buyer. Who knows, maybe they have come along, but stood firm on demanding better data. This is a high risk property type and the buyers/ clients complacency with the data provided puts this specific deal into the red zone of high risk territory. There is more downside than upside, based on the situation. But simply going conservative to not "justify the SC price" because my historical data is poor and my lack of comfort with the situation goes against my ethics as an appraiser.

You note that similar properties have "struggled". Struggled as far as their occupancy? If that is the case, the lease and tenant history becomes more important. In any event, a review of the quality of the tenants will help the report conclude what a realistic stabilization (rents and occupancy) level is.
Thanks for the thoughts. I don't want to say too much about the situation due to the open forum, but occupancy for related properties, and to a lesser extent, is inferior to surrounding communities that would, from a demographic standpoint, suggest comparability. That is the primary reason that simply pulling occupancy comps from the larger area would potentially not lead to a accurate conclusion of market-based occupancy levels of this property. This problem is exacerbated as there are no properties in the community that are exactly like this one. With that said, I am fairly comfortable with the market rents being consistent with that portion of the rent roll provided.
 
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J Grant

Elite Member
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Dec 9, 2003
Professional Status
Certified Residential Appraiser
State
Florida
Go Bears-"My value IS coming out a bit higher than the selling price, and that makes me even more nervous. If I was coming in below the purchase price, the parties would go away and hopefully the seller would find someone that actually falls into the "prudent" category of a typical buyer. Who knows, maybe they have come along, but stood firm on demanding better data. This is a high risk property type and the buyers/ clients complacency with the data provided puts this specific deal into the red zone of high risk territory. There is more downside than upside, based on the situation. But simply going conservative to not "justify the SC price" because my historical data is poor and my lack of comfort with the situation goes against my ethics as an appraiser."

It's your appraisal and your decision and I might be missing some nuances of course. Just finding it hard to reconcile certain contradictions in the thread, such as stating the predominant market data for rents/income does not credibly support the owners atypical and unverified rental/income data, yet relying on owner's income data to opine on the higher side of value.

If this property were vacant with no owner provided statements, what would you appraise it for? I don't think it's a matter of going conservative to not justify the SC price, but whether to use predominant market data of rents/income vs what this owner represents..and if the buyer relied on inflated and possible false information, it puts into question if the SC price is reliable as a MV indicator. Does the subject possess any special qualities that would attract higher rents than other competing properties.

How long was this property on the market before going to contract? Any feedback from area commercial brokers on the property esp their feedback about the believability of owner's income statements .
 
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