What You Need to Know About Foreclosure
Or Understanding Risk and Reward
As Billy Preston said, “Nothing from nothing leaves nothing.” At times, the most important time for an appraisal isn’t when it’s submitted, but rather when a problematic loan enters a state of duress.
Properties need to be appraised using best standards and practices. This will most likely have a material impact on the overall valuation of the bank’s portfolio (positively or negatively). Portfolios are regularly reviewed by the bank and FDIC. “Troubled loans lead to troubled banks, which lead to closed banks,” says Argianas and Associate’s Chief Appraiser Charles Argianas.
A great deal of information we gather and report upon is to assist our bank clients to manage their risks. Some key questions to ask include:
- Is the borrower spending too much money on upgrades? This quandary can be addressed in an appraisal’s Cost Approach.
- Does a pending sale price make sense? Is it at arm’s length, or are there shenanigans afoot? Are cash equivalency adjustments warranted to a pending price? These issues should be addressed in the first few pages of the appraisal (in the transmittal) and adjustments, if warranted, should be reflected in the Sales Comparison Approach.
- Are the appraiser’s pro-forma income and expense numbers consistent with a property’s actual leases and actual performance over the years? If not, why? Are all rents at or near market value? Are the leases month to month? These issues can be addressed in an appraisal’s Income Capitalization Approach.
It’s not me, it’s you!
Life doesn’t happen in a vacuum, and neither does finance. Values can shift dramatically for various property classes as we’ve seen during the COVID-19 pandemic. Costs can increase considerably for the sourcing of materials and tenants sometimes lose their ability to pay rent, therefore disrupting revenue streams. In these instances, banks are forced to take action as they owe a duty to their shareholders. Loan portfolios must be properly managed.
Foreclosure can be segmented into 6 phases: 1) payment default, 2) notice of default, 3) notice of trustee’s sale, 4) trustee’s sale, 5) REO (real estate owned), and 6) eviction.
Our firm is often brought in prior to foreclosure proceedings, during loan monitoring, and again afterward (to assess the value of the property following the acquisition by the bank).
who does foreclosure hurt? everyone
Foreclosure is unfortunate for both borrowers and their lenders. Loan failures have consequences, and the foreclosure process can be resource and labor-intensive not to mention emotionally taxing on all.
misery loves company
The stability of markets in part relies on rationally based lending decisions. The 2008 financial crises exemplified residential foreclosures and contagion throughout financial markets as home sales decreased and values (and prices) dropped precipitously. We’ve discussed in previous blogs the difference between cost, price, market value, liquidation value, and disposition values.
market value in foreclosure | chicken or the egg
When a foreclosure is carried out, the lender takes possession of the property. This property transfer is made under duress and is not reflective of a market value sale. In some instances, the sale price recorded is simply the exact amount of the outstanding mortgage. In contrast, a REO sale refers to the sale of a property by the bank via auction. Properties sold by a bank are often REOs; however, not all REOs are foreclosures. For this reason, REO sales are sometimes an indicator of market value.
are we in the clear?
We’ve learned a lot from the savings and loan crisis experienced in the 1980s and again in the late 2000s. Appraisers who have weathered downturns are better poised to assess distressed property values. Experienced appraisers think critically about the differences between cost, price, and value and the COVID pandemic is the type of black swan that disrupts market stability.
While we do not claim to have a crystal ball, Argianas appraisers have weathered a recession or two. We look forward to sharing our experiences with you on your property portfolio. You can contact us by filling out this form or call us at 630.390.0113.