Be proactive and provide solid expense-saving documentation to get a fair valuation for high performance buildings.
The appraisal and financing process for owners of high-performance real estate that has been upgraded with energy generation (like solar PV), energy efficiency (EE) or other design features can be disappointing if the upgrades are not sufficiently recognized in the appraisal. Here is an overview of the process and recommended “dos and don’ts” to get the best chance at a fair valuation. Savings via lower utility costs is often what motivates an owner to invest in building performance upgrades, so proving these savings to the appraiser is paramount. My focus here is on commercial/investment real estate, but much of the following also applies to residential (1-4 units) property.
Differentiate Between “Market Value” And “Investment Value”
The word “value” to investors and appraisers is like the word “cheese” to Wisconsinites. There are lots of versions and to proceed safely, clarity is needed. “Market value” is a statutory definition for appraisal reports used with bank loans and is the “value in exchange” to the next typical buyer. “Investment value” on the other hand is specific to an individual owner and property and is used by investors in feasibility studies. It includes short term benefits like accelerated depreciation, income tax deductions or the reputation value of “green” to the business/occupant. The difference between market value and investment value can be significant because they use different assumptions.
Early Delivery Of Documents And Information
The key to a credible valuation hangs substantially on the quantity and quality of data provided by the owner documenting net annual savings. Ideally, the appraisal process mimics the actions used by typical buyers and sellers to determine a fair price. An owner should prepare for an appraisal as they would for the building sale. Thinking that the “appraiser can figure it out” is like selling a car and assuming the car buyer will “figure out” that you spent $5,800 on a new transmission three weeks ago. Owners should recognize their unique knowledge of their property and pass it on, embracing the “help them help you” credo.
Actors In The “Mortgage Chain”
There are many handoffs and participants involved between the initial loan application and a loan getting funded. The process is highly regulated and policy driven, putting unusual loan information at a disadvantage – but ultimately, banks do want to lend money. So the property owner needs to make it easy for those in the mortgage chain to understand the advantages of high-performance easily and quickly. The good news is that valuing high-performance building features involves no “new” or “creative” valuation techniques; it is just old school, sharp pencil cash flow with a data density twist.
The Property Owner – It’s All About The Data
Documenting utility cost savings can involve many pages, so for quick digestion by those in the mortgage chain, include a cover page “quick read” list briefly summarizing upgrades with the when, what, cost and, ideally, the net annual expense saving per item. It is also helpful to list titles of supporting documents such as an energy audit, solar PV installation contract and financial/payback analysis, LEED point list, recent utility bills or the payback analysis of an LED lighting retrofit. In this approach, the key number is the annual net dollar savings for use (after appraiser verification). Also important are any expenditures desirable to prospective buyers that lower the overall property risk – even if it’s difficult to demonstrate an annual net income impact, – like durability, resilience or improved interior environmental quality.
Quantitative And Qualitative Upgrades
Federal bank regulators expect credible proof of loan collateral value, so not all upgrades have the same opportunity to fit into the appraisal process, which is constrained by both dollars and time. “Green”/HP upgrades fall into three basic categories. The first category includes “hard,” or easily measured benefits impacting net operating income (NOI), like the annual “solar NOI” from a solar PV system.
The second category of upgrades can be more difficult to track and includes calculating energy conservation measures (ECMs), like insulation or HVAC upgrades, each of which might produce an annual “EE NOI.” This NOI requires not one, but two measures, so the impact of EE is the net present value today for a stream of future benefits of events that do not happen (the delta between what happened and what did not). Determining this typically requires an investment grade energy audit – money well spent.
The third, and most challenging, upgrade group comprises features whose benefits are very hard to quantify, like occupant health as related to improved interior environmental quality (air quality, daylighting, nature views), the impact of using sustainable materials or benefits that flow outside the property line (social/political benefits, stormwater control). This last group contains large potential wins and progress is being made to quantify them. Research on healthful design shows huge worker health and productivity impacts, helped by certifications like Well Building Standard or Passive House. But proving the specific dollar impact flowing to the building and long term durability is complex. One option I have used is to settle on a “not less than” value (like 50% discount of expected savings) that can hit a reliability and ease-of-execution sweet spot that banks can get behind.
The Banker, Initial Loan Application
At the initial loan meeting, the owner should deliver a hard copy document pack to the banker and follow up with digital versions. Digital documents allow easy delivery to those along the mortgage chain. Specifically, the owner should ask the banker (both in person and via email) to include the most vital high-performance property information when posting for bids to select a qualified appraiser. Banker comments such as, “the appraiser will take care of gathering that information later” is a recipe for disaster as the appraiser bids received and appraiser selection will be based on incomplete property knowledge.
Posting The Appraisal Assignment For Bid
After the loan application has been accepted, the next step is engaging the appraiser. Typically, an online RFP about the property is posted to the bank’s approved appraiser list. Because the RFP postings are often done by loan processor staff, specific property details may be omitted. Far too often, appraisal assignment postings do not include references to high-performance building features, which, when discovered later, can trigger a host of bid revisions, alternative appraiser selection and delays.
Appraiser Selection
After the RFP closes, the bank selects the “best” appraiser from the submitted bids. Ideally, this involves weighing fee, timing and ability rather than just going to the lowest cost option “to save the borrower money.” This entire process of posting the RFP, appraiser replies, and appraiser selection is a rapid-fire affair. An owner should emphasize to the banker at an early stage that they are happy to pay extra and allow more time (typically a 10 -15% fee premium and an extra few days to a week) to obtain a competent valuation from an appraiser experienced with high-performance features.
Appraiser Contact With Owner
When the appraiser contacts the owner for the property inspection, the owner should immediately confirm that the appraiser was aware of the property’s high-performance features at the time of the bid and can competently consider those high-performance features in the value. If the appraiser is unaware of the performance upgrades or is lacking the necessary skills, the owner should immediately go back to the bank and insist on a new, more qualified appraiser. A revised appraisal fee and slight delay may result, but it is far better to start over now, rather than trying to resolve incorrect information later in the process.
Subject Property Inspection
The owner (or a knowledgeable representative) should plan to accompany the appraiser during the inspection to identify and explain the high-performance features at the property. Check that the appraiser has the entire property document pack. Don’t assume that all the information you supplied to the banker was forwarded to the appraiser. Email the information package directly to the appraiser yourself to be on the safe side.
The Review Appraiser
Once delivered, all appraisals are read by a second pair of eyes during the appraisal review.
The key to a credible valuation hangs substantially on the quantity and quality of data provided by the owner documenting net annual savings.
The review appraiser checks math, the analysis logic, and determines if the conclusion is credible. A review appraiser not familiar with high-performance building features can be a potential hurdle during this step. Reviewers and appraisers both work on production schedules so accurate, clearly laid out support from the owner for the annual net cost savings as credible (“worthy of belief”) is once again essential.
The Final Appraisal Delivery To The Property Owner
After the appraisal review, the final report is released, and, in most jurisdictions, the property owner has a right to a copy. The report should discuss upgrades, include an analysis, and conclude the value impact for the high-performance features supported by market data. A survey of local real estate professionals might have been done, which is a valid way to support the conclusion. The appraisal is typically final at this point unless there is an obvious error or the report is incomplete – or if it completely ignored the high-performance features.
Issues With The Appraisal
A report containing no meaningful discussion or value analysis of the high-performance features is cause for concern. If the report discusses the performance features, but states that there are no comparable sales to establish value, the report is most likely applying the Sales Comparison Approach, which is the wrong appraisal methodology.
Lack of discussion or emphasis on the Sales Comparison Approach indicates a possible competency violation of the Uniform Standards of Professional Appraisal Practice (USPAP)4. USPAP compliance is required for all appraisals used in federally guaranteed loans. Be sure to exercise tact and caution when discussing a potential USPAP violation – a serious matter that no banker wants flagged.
Final Thoughts
Delivering solid documentation of reliable utility savings and being proactive at the initial appraisal stages are the best ways to get a fair and competent valuation. For additional insight into the appraisal process, two recent documents to consider are The Valuation of Green Commercial Real Estate, by Timothy Runde MAI and Stacey Thoyre, published by the Appraisal Institute, and Valuation of Green and the High-Performance Property, Commercial, Multifamily and Institutional Properties, one of several free advisories on green building valuations distributed by The Appraisal Foundation.
James Finlay, MRICS was a review appraiser at Wells Fargo Bank for 15 years and became active in the US Green Building Council in 2001. In 2006, he joined the newly formed Wells Fargo Environmental Affairs group as valuation specialist, becoming the bank’s principal appraisal reviewer for high-performance real estate loan collateral. Since 2014 he has worked as a consultant helping banks and investors recognize the value impact of solar PV and distributed energy systems. He recently joined Bruce Wiley at US Solar Value, specializing in utility scale solar PV appraisal. Finlay is an advisor to the National Institute of Building Science, Yale Clean Energy Finance Forum, and The Appraisal Foundation.
This piece originally appeared in BUILDINGENERGY MAGAZINE published by the Northeast Sustainable Energy Association and is reprinted with permission.
