Collateral Assessment
Issues and Tools
By Charlie Elliott Jr., MAI, SRA

Whether it is for a pending sale on an entire portfolio of loans or the question of a position on a non-performing loan, assessing collateral on existing loans can be an onerous task. There are a number of issues, which make the task more difficult than that of a pre-loan evaluation. These issues may become compounded when dealing with large portfolios of loans.

There are a number of tools, which may be employed in establishing a value for such properties and some, but not all, require the use of certified appraisals. Fortunately today there are more of these collateral assessment tools available to the portfolio manager than ever before. The large number of tools available can be confusing and making the proper decision as to which should be used, will not always be easy.

Mark Twain once said, “I must have a prodigious quantity of mind; it takes me as much as a week, sometimes, to make it up.”

Contrary to the position of Mr. Twain, it is my intent for this article to assist one in not only making the right decision, but also, doing so in less than a week.

While the process can be varied, the primary challenges involved in assessing collateral for existing portfolio loans are generally limited to the cost of the process and the difficulty and degree of obtaining access to the property for inspection, when inspections are required.

The issue of cost may not be material if it is just a matter of evaluating one property, however, it may become significant in analyzing an entire portfolio. Cost per property may range from zero, in some cases where only public record data is needed, to hundreds or even thousands of dollars in others, where complete appraisals are required. Other costs may involve how much staff time is dedicated to an evaluation project. This may be avoided in large part by using a vendor management company.

Property access is another significant issue and it may be the point where the rubber meets the road with many projects. As all of us having experience with the disposing of foreclosed properties realize, the condition of the property can make or break a deal where a forced sale is required. Having had the experience of appraising and selling residential properties for many years it has been my experience that the condition of a property generally deteriorates at a much greater than normal rate when occupied by property owners who expect to be forced from the property. It is not unusual for the value of a foreclosed property to be reduced by 25 to 50 percent due to deferred maintenance and physical damage to the improvements. Some components and systems found to be most susceptible to repair and replacement are HVAC, electrical, plumbing, windows, doors, carpet, cabinets, roofing, painting, foundation, landscaping, well and septic systems. In cases of a vacant property the potential for further damage and destruction is even greater, stemming from angry former property owners as well as others. This damage cannot be properly assessed without a professional accessing the exterior and interior of the property.

After the owners have moved, this is usually not a problem, however in many cases it is important to access such damages prior to the tenant leaving. This is not always possible. Many property owners expecting to vacate and lose their property are not willing to allow an appraiser access to their home. In some cases the appraiser finds property owners under foreclosure circumstances to be hostile and see attempts to perform interior inspections as unsafe, therefore they are unwilling to even attempt to obtain permission to perform the inspection.

Be all of this as it may, the appraiser is the best resource the portfolio manager has for evaluating property and will be at a minimum, able to inspect and photograph the property exterior, although it may be from a distance in some cases.

While bearing in mind the issues of cost and property access, some of the more practical and popular evaluation tools available to the portfolio manager are listed below. Accompanied with each tool is a brief summary of the strength and weaknesses of each method and an estimated accuracy rating for each; 10 being best and highest and 1 being least and lowest. While admittedly, making collateral assessment tool selection decisions can place the decision maker in a “damned if you do and damned if you don’t” position, perhaps the following summary of options will make the task a bit more manageable.

Top Ten Collateral Assessment Tools

1. Property Tax and Multiple Listing Service Data:
   
   These are the cheapest and perhaps the least valuable tools within themselves. In many cases property tax records are free as a service of the local tax collecting authority. There has usually been no inspection of the property, particularly no interior inspection. MLS data for a given area is available only to members of each organization, which is usually sponsored by the local Realtors chapter in any give geographic area. Members pay dues for access to the system. These data services offer just that, data. For it to be of value it must be used by those trained and experienced in its use. Those usually most experienced with its use in any giver geographic are appraisers and Realtors.
   
   Strength: Cheap, if not free
   Weaknesses: Accuracy sometimes questionable, property condition unknown and professional evaluation required
   Author’s Rating: 1
    

2. Automated Valuation Models (AVMs):
   
   This tool is economical but usually not free. There are perhaps a few free sites on the Internet providing AVMs, however, they usually require the completion of lengthy access applications. Users of free services should be prepared for numerous contacts from lenders and Realtors using the service as a lead promotional vehicle. AVMs can be purchased for less than $50 each, depending upon the volume. Some AVMs provide a lot of subject and comparable sales data for properties located nearby, along with a computer-generated value estimate. Due to the origin of this data a professional familiar with property in this geographic area should evaluate each AVM prior to the acceptance and use of the data.
   
   Strength: Low cost
   Weaknesses: Accuracy questionable, property condition unknown and professional evaluation required
   Author’s Rating: 3
    

3. Inspection Reports – FNMA 2075:

1. 
   
   There is no appraisal prepared with this tool, only an exterior inspection with a confirmation of other data pertaining to the appraisal such as a photograph, address, legal description, type improvements, etc.
   
   Strengths: Known exterior property condition and some data confirmation
   Weaknesses: No value indication or estimate and unknown interior condition
   Author’s Rating: 3
    

2. Automated Appraisal – Proprietary Form:
   
   This tool is usually a desktop appraisal and, as the name implies, the appraiser prepares the appraisal without leaving his office to inspect properties or obtain data. Data is usually obtained through venders offering AVMs and the appraiser uses his or her judgment and experience to place a value on the property based upon the information at hand.
   
   Strengths: Moderate cost and appraiser value opinion
   Weaknesses: Accuracy somewhat questionable and unknown property condition
   Author’s Rating: 5
    

3. Desk Review Appraisal – FNMA 2000:
   
   This tool involves the appraiser preparing a current written review of the appraisal, which was performed at the time when the loan was made without any current inspections of the property. It would include the appraiser’s critique of the appraisal as well as his estimate of value of the subject as of the time it was prepared. This tool is most valuable for loans made recently; say within the past year or two.
   
   Strength: Moderate cost
   Weaknesses: Past value, unknown property condition
   Author’s Rating: 5
    

4. Field Review Appraisal – FNMA 2006:
   
   This tool involves the appraiser performing a current exterior inspection of the subject property and preparing a current written review of the appraisal, which was performed at the time when the loan was made. It would include the appraiser’s critique of the appraisal as well as his estimate of value of the subject as of the time it was prepared. It may also include comments as to the current condition of the property but this condition would not be reflected in the value conclusion of the appraisal. This tool is also most valuable for loans made within the past couple of years.
   
   Strengths: Moderate cost, exterior inspection
   Weaknesses: Past value, unknown interior property condition
   Authors Rating: 6
    

5. Limited Summary Appraisals / Exterior Inspection– FNMA 2055 or 2065:
   
   The Limited Appraisal includes all information and approaches necessary to provide a creditable appraisal given the scope of the assignment but is designed to be less comprehensive than the Complete Summary Appraisal. It comes complete with an exterior inspection of the property (no interior inspection) and may be used where access to the property is prohibited.
   
   Strengths: Known exterior condition and appraiser’s opinion
   Weaknesses: Less comprehensive than complete appraisal and unknown interior condition
   Author’s Rating: 7
    

6. Limited Summary Appraisals / Complete Inspection– FNMA 2055 or 2065:
   
   This appraisal is the same as the one above except that it includes an inspection of the interior. Therefore, the entire property is inspected.
   
   Strengths: Known exterior and interior condition and appraiser’s opinion
   Weakness: Less comprehensive than complete appraisal
   Author’s Rating: 8
    

7. Complete Summary Appraisals With Interior Inspections– FNMA 1004:
   
   This appraisal tool is the most comprehensive form appraisal available and should be adequate for evaluation collateral on most simple residential properties.
   
   Strengths: Best form appraisal, complete inspection and detail summary of all information
   Weakness: Expensive
   Author’s Rating: 9
    

8. Complete Self Contained Appraisal With Interior Inspection – Narrative:
   
   The Complete Self Contained Appraisal goes beyond that of the Complete Summary Appraisal in that it provides a more thorough explanation of the data, issues and opinions contained in the appraisal and pertaining to the property. This appraisal is superior to the needs of most service managers requiring information to make a decision relative to the collateral value of a simple residential property and is used most for complex residential and commercial properties where decisions are being made which require very specific information and opinions. It is not usually performed on a form but in narrative format allowing the appraiser ample discretion in approaching the appraisal problem.
   
   Strengths: Best appraisal available, complete inspection and detail explanation of all information
   Weakness: Very expensive
   Author’s Rating: 10

Selecting a proper evaluation medium is not a “one size fits all” proposition. The author’s highest rating is not necessarily intended to be the best rating or to provide the highest return on investment for all projects. Each project must be evaluated on its own merit giving careful consideration to the need for the evaluation verses the cost associated therewith.

Complete inspection and evaluation of the condition of property is necessary in cases where accuracy is critical and where it is possible to gain access.

In summary, today’s loan portfolio servicing manager is not at a loss for tools to evaluate collateral, whether it is for a single property or an entire portfolio. The selection of the proper tool, however, is critical to the success of the mission. The proper tool is the one that produces the largest benefit for the resources invested in preserving the value of the various assets in the portfolio.

Charlie W. Elliott Jr., MAI, SRA, is President of ELLIOTT® & Company Appraisers, a national real estate appraisal company. He can be reached at (800) 854-5889 or charlie@elliottco.com or through the company’s Web site at www.appraisalsanywhere.com.