As published in Scotsman Guide's Commercial Edition, July 2005.
The residential-lending and valuation arena has long been ahead of the commercial world in terms of automated-valuation models (AVMs), electronic submission of reports and insured-value opinions. With the advent of commercial-property AVMs and the availability of lender-purchased insured values on a deal-by-deal basis, that is about to change.
Although AVMs generally are riskier for lenders than are conventionally prepared appraisals from an “on-the-ground” appraiser, they do have advantages. AVMs present significant cost savings, faster turnaround and increased reliability, as more data becomes available.
The U.S. Office of the Comptroller of the Currency’s Bulletin on Risk Modeling from May 2000 says computer models “are playing a progressively more important role in the banking industry. The tools are now routinely used for credit scoring, asset-liability management, trading-risk management and for valuation estimates of financial instruments.” Only so much risk can be underwritten by a lender, and inevitably, some borrowers will default on their loans regardless of the value placed on the security by an AVM or appraisal.
If a problem loan was based upon a faulty, negligent or unsupported value opinion at the loan’s inception, lenders historically sought restitution from the appraisal company through their errors and omissions insurance (E&O). As those familiar with this process can attest, it can be lengthy, uncertain and depending on the outcome, costly. Many claims against appraisers through their E&O carriers end up in courts or in binding arbitrations.
Valuation professionals in the commercial-appraisal market now are working to bridge deficiencies between E&O and the actual protection lenders need to minimize risks on commercial loans.
Commercial-real-estate valuation firms, for example, have gained the opportunity to add an option for a lender to purchase an insured-value opinion on its evaluation products or traditional appraisal services. Each valuation is insured separately for five years from the original date of value. Loans eligible for insured-value coverage have a maximum property value of $5 million and must be one of the following property types: industrial/warehouse, retail, office, multifamily (more than four units) or special-purpose land, such as agricultural.
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