Following some common-sense steps will help owners steer clear of misunderstandings and disagreements about what their property is worth.
By Bendix Anderson
Potential trouble lurks in the series of questions posed by many appraisers to property owners and managers — a first step in the process of determining the value of a seniors housing property. A seemingly straightforward request can turn into a jungle of misunderstandings and confusion.
Determining the expenses at a senior housing property can open up a can of worms, for example. And trying to establish the income from a property can feel like falling in quicksand.
“I’ve heard horror stories where deals blew up because of a bad appraisal,” says Charles Bissell, executive director with Integra Realty Resources speaking from his office in Richardson, Texas. “Closings were delayed or deals fell apart.”
Often, disagreements about what a property is worth come at the critical moment when investors or stakeholders are about to close a deal. Even relatively routine appraisals matter to stakeholders — let alone appraisals for contentious matters like litigation.
“For 52 minutes in the life of a deal, the appraisers are the most important part of the deal,” says Alan Plush, senior partner with Sarasota, Fla.-based HealthTrust. “Appraisers become very important when things go wrong with the appraisal.”
Seniors housing owners and investors can avoid most problems tied to the appraisal process by following these common-sense steps.
Request a seasoned appraiser in your niche
An appraiser should have solid familiarity with the kind of property that needs to be appraised — especially for seniors housing communities. The property will receive the best appraisal from an expert who has appraised similar properties within the last 12 months, according to industry experts.
An office wall full of certifications and licenses is no substitute. While an appraiser may be a member of the Appraisal Institute (MAI) or hold a certification from the American Society of Appraisers (ASA), such designations don’t necessarily mean that the appraiser is knowledgeable about all types of seniors housing.
The business plan and operating budgets for a memory care property differ greatly from an independent living property, which differ substantially from a continuing care retirement community (CCRC).
Stakeholders such as lenders or equity partners also typically require full appraisals by state-certified appraisers trained in the rigorous standards set out by the Uniform Standards of Professional Appraisal Practice.
Property owners are often left on the sidelines when stakeholders such as lenders, equity partners or litigants hire an appraiser. Because the stakeholders are seeking an unbiased appraisal, they may avoid an appraiser suggested by the property owner.
These stakeholders typically pay for the appraisal themselves, then add the cost of the appraisal to the closing costs they charge for the loan or otherwise bill the cost back to the property. The cost of an appraisal — which typically starts at a few thousand dollars — can vary greatly depending on the goal of the appraisal, the size of the property and the depth of reporting required.
As new lenders and investors enter the seniors housing business, they may not have a Rolodex full of seniors housing appraisers. “They are going to really need to find firms that they can trust that specialize in seniors housing,” says Lisa Widmier, executive vice president for CBRE’s National Seniors Housing Group, based in San Diego.
A property owner can gently encourage a potential lender or equity investor to hire an appraiser who has experience in seniors housing. But the property owner has no control, and often won’t find out who will appraise his property until the appraiser contacts the owner. The questions the appraiser asks will quickly reveal whether the appraiser understands the seniors housing business.
“The owner might have to do a little handholding . . . may have to provide some data on comparable sales, for example,” says Bissell.
Provide documentation, embrace communication
Even appraisers who are experienced in seniors housing will need a lot of information to appraise a property.
“Property owners sometimes ask: ‘Why do you need to know all this? You’re getting into my business,’” says Bissell. “That’s the point.”
Property owners should bend over backwards to make sure the appraiser has as much information about the property and the business plan as possible. The owner should accompany the appraiser on a tour of the property.
If any part of the property’s business seems difficult to understand, the owners should offer supplemental information that helps explain, for example, unusual expenditures or uneven revenues. If the appraiser offers, owners should take the opportunity to review the final draft of the report, according to Bissell.
Bone up on appraisal methods
The appraisal can take several different forms, depending on the purpose of the appraisal. For example, an appraisal can project how a property is likely to perform after a renovation or the completion of construction.
A complete appraisal will consider the net income the facility generates, sales of comparable properties and the replacement value of the property. Experts say a quality appraisal is like a three-legged stool, and rests on all three of these considerations.
“A really robust appraisal will use all three approaches,” says Beth Burnham Mace, chief economist for the National Investment Center for Seniors Housing & Care based in Annapolis, Md.
Sales of comparable properties help show what potential buyers might be willing to pay for a property. If the property being appraised is still under construction, other properties in the area can show what the features at the property might eventually be worth to potential buyers.
The cost to replace a seniors housing property can also provide an important reality check for an appraiser.
For example, if an appraisal reveals that the cost of a stabilized property is much higher than the replacement cost to develop a comparable new property, then one would expect developers to flock to the area unless some other barrier keeps them away. If developers are avoiding the market instead, there might be something wrong with the appraisal.
Appraisers generally spend most of their time analyzing the net operating income produced by a property — including both the income and expenses.
Expenses can often create confusion. Owners should do as much as they can to help appraisers differentiate between unusual expenses unlikely to repeat themselves and the regular expenses that are likely to matter most to a potential buyer.
“Owners will often provide information without detail,” says Bissell.
For example, an owner might clean up a property before selling it. Such a capital expenditure should be noted for the unusual expense that it is. Historical data can help appraisers create an average for such expenses.
Smaller operators of seniors housing sometimes don’t charge the property a management fee. Instead, they make their money from properties through other line items in their budgets.
This business practice could cause problems. If an appraiser doesn’t see an expense for a management fee, the appraiser will sometimes fill in the blank himself. “You don’t want appraisers to add management fees,” says Imran Javaid, managing director of Health Care Real Estate at Capital One.
Appraisers will also compare expenses at the properties they appraise — such as the cost of serving meals to seniors — to the costs at similar properties in the area. If an expense seems either too low or too high, they may adjust it, unless the operator can provide a reason their expenses are so different.
“Normalizing expenses is the key,” says Javaid.
Recognize it’s part art, part science
Revenues can also lead to disagreements in the appraisal process. A well-managed seniors housing property may have a year in which it has an unusually large number of empty apartments due to the passing of several residents.
Because elderly people often take months to decide to move into a seniors housing community, a half-dozen vacant seniors housing units can take a long time to fill, digging a deep hole in the property’s operating income for the year.
A seasoned appraiser will apply an occupancy rate to a seniors housing property that is likely to continue in the future and is neither too high nor too low. The occupancy rate in the surrounding market often acts as a guide, once an appraiser takes into account the strengths of the individual property. That means an appraiser will sometimes assume that the occupancy rate will fall at a fully occupied property.
“It’s not realistic for a property that is 100 percent occupied to stay 100 percent occupied,” says Alan Ursillo, senior vice president specializing in the sale of seniors housing properties for the Los Angeles office of Jones Lang LaSalle. Eventually a certain number of residents will move on, and their apartments will take time to fill.
If a property is in transition, it’s possible for different appraisers to reach very different conclusions. For example, a seniors housing property sold out of foreclosure may have a low occupancy rate. Its operating income in the future is likely to be much better than its recent history.
Stated another way, no one buys a half-empty property intending to keep it half-empty. In this case, an appraiser will need to assess a detailed business plan for the future of the property
“Have that turnaround plan completely thought out,” says Capital One’s Javaid. “Bring your own comparable properties.”
CCRCs can also have a highly uneven revenue profile because residents pay a large entrance fee in exchange for a long stay. That means the property receives a huge burst of income when the property first fills up, followed by a few years of relatively low income as the relatively young residents at the community gradually age. “There’s a lot of lumpiness to the income until the first generation of folks have cycled through,” says Javaid.
Understand role of broker versus appraiser
Appraisers can also deliver a shock when an appraisal is different than the opinion of value given by a property broker — especially if the property is offered for sale at a high price but the appraiser hired by a lender puts the value of the property lower.
A broker’s opinion of value is simply a property broker’s estimate of what a property is worth. A formal appraisal provides a rigorous analysis of the latest available evidence to assess the worth of a property.
However, the prices that buyers are willing to pay can sometimes change quickly. During boom times, optimism pushes prices higher. During crashes, fear of the future forces prices down, even for stabilized properties that have a strong income stream. The mood swings of the market can get ahead of any available evidence — and brokers can sometimes be sensitive to these moods.
“A broker’s opinion of value tends to be on the forefront of market trends,” says CBRE’s Widmier. “An MAI appraisal is going to be very conservative — it tends to lag the market.”
Appraisers have a slightly different take on the situation. “A good broker tends to be optimistic,” says Plush. “A good appraiser tends to be realistic.”
An appraisal determines the property’s value if sold in the current market — not what the property might be worth in some future property market, even if the trends that may affect the property markets seem clear.
“Adjust for the future? That’s way outside my mandate,” says Plush. “We are not in the business of telling people that interest rates will rise in a year.”
Appraisals might, however, include some narrative describing the trends that appraisers believe may be affecting property values now and may change in the future. For example, when interest rates finally rise to historical norms, cap rates for seniors housing properties are also likely to rise. Such a move would have an immediate effect on valuations.
“There’s a risk of a valuation change,” says NIC’s Mace. “The threat of rising interest rates is more likely today than at any time in the past few years.”