Articles

The Inter-Relationship Between The Environmental and Appraisal Reports

Robert Szustakowski, The Lotis Engineering Group, PC

First and foremost, I am NOT an appraiser. I have worked in appraisal departments, for the Chief Appraiser, at different banks and have worked closely with many bank appraisers. In my role, it was important that I understood at least the basics of how properties are valued by appraisers. Based on that experience, I have learned how the environmental study and the appraisal report are inter-related.

Background

Let’s face it, most appraisal reports include the following, or similar, statement:

The value opinion reflects the property as though the subject site is not contaminated on the date of value.
I have heard arguments from appraisers that they must make this assumption and, 90% of the time, I fully agree with it. Unless the appraiser was provided information contrary by the bank, the appraiser likely has no idea if the property is “clean” or not.

However, if the field appraiser is aware of environmental impact (not that uncommon if the appraiser is familiar with their work area) or is informed by the bank otherwise, an appraisal cannot be completed with this statement. I would argue that we just crossed the line from an extraordinary assumption to a hypothetical situation, using the appraiser’s vernacular. That is, if the site were clean, this is the value. But we know this not to be true. And can a bank accept a hypothetical value for closing?

Timing

This leads us to the order that the appraisal and environmental reports be ordered. I can tell you by experience, and based on the experience of others involved in these services at banks, that the appraisal almost always gets ordered first. Everyone wants to know “will it appraise out?” before spending more time and money on the project by ordering the environmental study.

In most situations, this is not a problem (except to the environmental consultant who is told that “we are just waiting on you to close”). However, if you have a Brownfield, a manufacturing facility, a gasoline station, etc., it would likely be more practical to complete the environmental study first. Should there be an issue, further environmental study may be required. The appraiser cannot technically complete his/her study until the extent of the impact and remedial costs are known.

The Banker’s Approach to Assessing Environmental Impact to Value

I have seen numerous RMs, credit approvers and even in-house appraisers attempt to quickly address environmental impacts to the value of a piece of real estate. Here is a summary of three methods that I have seen.

  • Minimal Remedial Costs – This solution is limited to situations where the value of the property far exceeds potential remedial costs. For example, an environmental consultant estimates that there may be a $10,000 cleanup of a minor release on a multi-million dollar property. The impact to value is considered so minimal that it is not formally considered in the appraisal. I have been involved in numerous projects like this and I consider it the “forest through the trees” approach where we try to be reasonable.
  • Deduct Remedial Costs From Value – This is pretty straight forward; if the property is worth $450,000 and there is a $50,000 remedial effort, reduce the value by $50,000 with the thought that “well we will have more equity if we have to do the cleanup.” On one hand, this may be a conservative approach, as the cost for remediation may not reduce value dollar for dollar. But it may ignore other potential related impacts to value (discussed below).
  • Stigma – This is likely the most difficult to assess. Impact may or may not create a stigma to a property, depending on the nature of the impact, the property, etc. I’ve heard “it’s a 15% reduction to value” with no further discussion or rationale. This likely is not the appropriate technique.

If you do go the “quick and easy” route and move forward with a loan closing before remedial efforts are done, without establishing escrow to complete the work later due to the lower loan amount, there should be a requirement in the loan documents that the work will still be completed by the borrower post-closing. While reducing the loan amount to account for the remedial work may make sense at closing, it causes problems later. I have seen problems at the time of re-fi, as the cleanup costs may have gone up, potentially significantly with changes in regulation. If the property gets into Special Assets, any potential purchaser will tell you that the remedial costs are 10 times what they are to get a lower purchase price. It’s just easier to get the impact addressed as quickly as possible.

The Appraiser’s Approach to Assessing Environmental Impacts to Value

Generally, there are four broad categories of items that an appraiser needs to consider when assessing value of an environmentally impacted property.

  • “Clean” Value – This is what the property would be valued at if there were no environmental issues.
  • Remediation Costs – This is the cost to remediate the property to meet regulatory requirements. This sounds simple but even once an environmental consultant determines what needs to be done and associated costs, the remedial work may take years. In addition to the cost of money over time, this may create lost opportunities, loss of use of parts of the property during certain phases of the work, etc. Further, many remedial programs require significant legal, filing and government oversight costs that need to be factored into the equation.
  • Impacts to Use – All appraisals discuss the “highest and best use” for a piece of property. However, many remedial programs allow and/or require what we call “Engineering” and/or “Institutional” controls. An engineering control could include a requirement to maintain a building slab in place; removal for new development would require regulatory approval. An institutional control often means restrictions on future use, recorded into the deed. For example, that up and coming residential loft neighborhood may well include a building that cannot legally be used for residential living.
  • Environmental Risk and Stigma – Environmental consultants deal with environmental risks all the time relative to future owners and potential third party liabilities. Commonly, potential purchasers request/expect price reductions due to these unknowns. The appraiser needs to objectively quantify such a value, not just guess.While this is a gross simplification of the process, the appraiser would take the unimpacted value and subtract the other values to determine an appropriate appraised value.

Conclusions

Experience suggests that many lenders do not spend the appropriate resources to obtain an appropriate appraisal of an environmentally impacted property. It is obviously a complex process to be completed by specialized appraisers. At the very least, keep in mind that the appraisal report should be reviewed in conjunction with the environmental report; they are inter-related. If an environmental report suggests that the “clean” property value is now a “hypothetical” value, consider how that value may need to be adjusted. Your review appraiser and your environmental staff should be able to help you out but on a complex site, the use of a specialty appraiser may be warranted.

About the Author

Bob has been completing environmental due diligence for lenders for 30 years. He has developed and managed environmental programs, as a consultant and bank employee, for some of the largest and smallest banks in the country. He has also devised bank programs for construction monitoring and routine property inspections.