Reviewing an Apartment Appraisal With an Unsupportable Cap Rate
An appraiser is asked to review a narrative appraisal of a 12-unit apartment building. The report concludes a market value of $1,850,000 as of 90 days ago. It uses direct capitalization with NOI of $142,000 and a 7.68% cap rate. The report says the 7.68% rate is conservative because comparable sales show 6.20% to 6.80% cap rates. It includes no highest and best use section, no sales comparison approach, and four sales from 16 to 20 months ago with no adjustment grid. The rent roll shows three units rented at $950/month while the report's market rent is $1,150/month; vacancy is 5%. Operating expenses are reported at 22% of effective gross income; the appraiser's own market data indicate 35% for similar properties. The report states there is no external obsolescence because the neighborhood is stable. The client asks the reviewer to just confirm the value for a loan renewal.
1. Identify the material deficiencies and determine whether the value conclusion is adequately supported.
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The value conclusion is not adequately supported. The 7.68% cap rate is materially above the 6.20% to 6.80% comparable range, and calling it conservative does not explain the premium. If the NOI were reliable, a 6.50% rate would indicate about $2,184,615, so the stated value appears understated by the cap-rate choice. But the NOI is also suspect: operating expenses at 22% of effective gross income are far below the appraiser's own 35% market indicator, which overstates NOI and value. The three units at $950 versus $1,150 market rent may understate income, but the direction of the net error is not obvious without normalizing both income and expenses.
The report also lacks a highest and best use analysis, omits the sales comparison approach without justification, and relies on stale sales with no adjustment grid. The statement that there is no external obsolescence is unsupported. The report does not reconcile the approaches or explain the cap-rate selection. A reviewer cannot simply confirm the value; the review must identify these deficiencies and either develop an independent conclusion or state that the appraisal is not adequately supported.
2. What review options and report language are appropriate, and how should the reviewer respond to the client's request to confirm the value?
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The reviewer should first define the review scope. An administrative or compliance review may check completeness and consistency without developing a new value. A value review may test the appraisal and, if the scope includes it, develop the reviewer's own opinion. The reviewer should not accept a preordained conclusion. In the review report, the reviewer can state that the appraisal is not adequately supported and that the value conclusion cannot be confirmed as presented. That is different from simply disagreeing with the number.
The reviewer should explain the specific deficiencies, quantify the effects where possible, and state what additional information is needed: a supported cap rate, normalized operating expenses, market rent and vacancy support, current sales with adjustments, a highest and best use analysis, and a reconciliation. If the reviewer develops an independent value, the report must disclose the scope, data, and any extraordinary assumptions, and must comply with review reporting requirements. The reviewer should also avoid using the client's loan-renewal pressure to soften the conclusion.