Not All Data is Created Equal
My last article discussed Fannie and Freddie’s underwriting reforms. Refer to that summary for a high-level summary of those reforms and how it may affect deal architecture moving forward.
Today, I want to focus more on valuations and what two particular cases of fraud say about the market value of a property. Specifically, what kind of data should undergird valuations? If appraisal experts utilized and prioritized the proper data, the risk of fraud being perpetrated – as in the following two cases – may not be entirely eliminated but greatly reduced.
Case 1 – Michigan Technology Park
CoStar reports that a group conspired to perpetrate fraud in the purchase of Troy Technology Park in 2020, according to CoStar and public records. Here is what we know, according to CoStar (1):
The fraudsters bought the subject property for $42.7 million.
“[T]o support an inflated purchase price of $70 million, [the conspirators] submitted to the lender and appraiser a fraudulent letter of intent to purchase the property from another party for $68.8 million.”
JPMorgan issued a $45 million loan on that property.
The loan remains past due for the December 2023 installment.
Note: “submitted to the lender and appraiser a fraudulent letter of intent” (1). Implicit is that the LOI played some role in the appraisal of the property. This raises the question: What role does an LOI play in the integrous valuation of a property? None.
Let’s talk about why an LOI would be poor data, first from a legal perspective and then from a formal appraisal point of view.
First, a letter of intent (LOI) is not legally binding. Rather, it lays out a roadmap for what a legally binding transaction may look like. The terms articulated in the LOI not only can be altered and negotiated but most certainly will before the consummation of the transaction. Thus, it would be highly improper for the terms in such a document to bear any significant influence on a property’s valuation.
From a formal appraisal perspective, the picture is no less clear. The Uniform Standard of Professional Appraisal Practice (USPAP) is a national standard to which all appraisers must hold (2). These standards include definitions of value that are instructive to this case.
The term market value – which would be the applicable definition of value for a potential purchase – is pulled from the Code of Federal Regulations (3):
“The most probable price which a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently and knowledgeably, and assuming the price is not affected by undue stimulus. Implicit in this definition is the consummation of a sale as of a specified date and the passing of title from seller to buyer under conditions whereby:
(1) Buyer and seller are typically motivated;
(2) Both parties are well informed or well advised, and acting in what they consider their own best interests;
(3) A reasonable time is allowed for exposure in the open market;
(4) Payment is made in terms of cash in U.S. dollars or in terms of financial arrangements comparable thereto; and
(5) The price represents the normal consideration for the property sold unaffected by special or creative financing or sales concessions granted by anyone associated with the sale.”
Note that this definition itself states that, “Implicit in this definition is the consummation of a sale as of a specified date and the passing of title from seller to buyer under [arms-length] conditions” (3). Under this definition, use of an LOI as influential data would be totally inappropriate and a breach of USPAP standards.
To be clear, we do not know the exact role that the LOI played in the assessed value of $70 million. We do know that CoStar’s reporting links the two. Fannie and Freddie are also linking the two by instituting reforms that raise appraisal standards for loans of this nature.
Case 2 – Ohio Multifamily
CoStar also reports an $18M offset to JLL’s reported Second Quarter Earnings as a consequence of fraud perpetrated by the same conspirators. Here is what we know about the case(1):
In March 2019, the same defendants from the Michigan case acquired a 976-unit complex – Williamsburg of Cincinnati Apartments & Townhomes – for $70 million.
The conspirators obtained a $74.25 million loan funded by JLL and Fannie Mae.
Using a stolen identity, the conspirators submitted a fraudulent PSA for $95.85 million among other fraudulent documents.
“The property was appraised at $99 million when the loan was originated in 2019, according to CoStar data.”
“The property was reappraised in March at $34 million.”
The loan is 90+ days delinquent.
There is so much one could address, but I want to focus on the delta between the 2019 assessment and the 2024 assessment. What happened? How could the assessed value of a property fall 65.7%?
According to WLWT5, the property suffers from large-scale deferred maintenance: “Specifically, rodent infestation, broken sewage lines, mold, poor plumbing and the list goes on from there” (4). This could account for at least part of the collapse in appraised value. Poor living conditions may have downstream effects on valuation, increasing vacancies or slowing absorption.
The degree and effects of deferred maintenance could possibly account for all of the 66% drop in appraised value, but not plausibly. I do not currently have details pertaining to the original appraisal of the property, but I suspect that the integrity of the appraisal was lacking as may be evidenced by the conspirator’s shady appraisal of Troy Technology Park and the specific underwriting reforms of Fannie and Freddie.
Lessons For Us
Integrous appraisers could have stymied both fraud attempts by utilizing data relevant to the subject properties and reflective of market conditions. Using malleable terms, as may be found in an LOI, to support inflated prices lacks ethical consideration, legal sense, and professional integrity. Even in a volatile market, 50%+ swings in assessed value should not be taking place outside cases of natural disasters.
Valuation is tiresome and lacks the sparkle of deal architecture attributed to the brokers, bankers, and investors. It must not, however, be given priority proportionate to its sexiness. When it does, bad people are allowed to hurt good people.
Sources
CoStar
The Appraisal Foundation
Code of Federal Regulations, Title 12, Part 34, Subpart C, § 34.42(g).
WLWT5
