February 1, 2019 What’s it worth? Depends who’s asking Inflated commercial valuations are increasingly distorting markets and hurting investors, as appraisers are under pressure to come up with favorable numbers By Will Parker, Konrad Putzier and Kevin Sun

Starwood Capital Group securitized loan backed by five made a big bet on the U.S. retail The commercial side of the seven malls came due. market in November 2013. Starwood had to find a new Barry Sternlicht’s private equity is still the Wild West,” source of financing or risk losing firm bought a 90 percent stake the properties, so it decided to in seven malls from Westfield said Brian Mahany, sell bonds in Israel. Group for $1.6 billion through an affiliated company. a fraud recovery To get a cheap interest rate, though, it needed to convince Located in towns like Toledo, investors that the malls were Ohio, and Olympia, Washington, and whistleblower lucrative and the risk of default the malls were filled with was minuscule. The company national brands and boasted an claims attorney who tapped appraisal firm NPV average occupancy rate of 96 Advisors to assess the value percent — the kind of properties has brought civil of the properties, and NPV considered a very safe bet at the conveniently found that the time. cases against CMBS seven malls had barely seen a loss over the past five years. But the retail market was special servicers. Their combined value of $1.74 rapidly changing as e-commerce billion — down from $1.78 continued to push hundreds “The pressure on billion in 2014 — implied they of brick-and-mortar stores out were low-risk investments, per of business, and Class B malls appraisers, if they the appraiser. in midsized cities increasingly found themselves in hot water. want to continue So Starwood sold $244 million At the malls Starwood had in bonds to more than 60 bought from Westfield, net having business, is investors on the Tel Aviv Stock operating income fell more than Exchange last March. But many 8 percent over the next four to have the highest would soon regret their decision. years, regulatory filings show. The malls’ combined income fell possible value. by another 4.8 percent between Then in 2018, a $760 million the third quarters of 2017 and

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2018. And by mid-December, the price of the bonds had fallen by 42 percent, the Wall Street Journal reported. Representatives for Starwood and NPV declined to comment.

“Israelis were suckered into investing in those projects without understanding how they work,” a bank executive in Israel, who has helped other property owners raise money in Tel Aviv, said on condition of worst possible outcomes over in their respective securities anonymity. the course of a 10-year loan offerings, which mitigated the when they give a valuation, risk on each building. That And Starwood isn’t the only said Moody’s CMBS analyst points to a broader issue: company that has been able to Kevin Fagan. And, according Appraisals, meant to reflect a raise debt thanks, in part, to a to a recent Moody’s report, the property’s value as accurately favorable appraisal. Kushner larger the discrepancy between as possible, are often divorced Companies’ retail condo at 229 appraiser values and ratings from market reality. West 43rd Street had an initial agency values, the more likely appraisal of $470 million. Just the chance of default. 40 WALL STREET five months later, however, S&P “The commercial side is still valued it at $230 million — less “For appraisers, the market the Wild West,” said Brian than the amount of its loan. valuation is about one point Mahany, a fraud recovery and And the Trump Organization’s in time — often tied to a sales whistleblower claims attorney office building at 40 Wall Street price,” Fagan said. “For ratings who has brought civil cases was appraised by Cushman & agencies, we’re looking for against CMBS special servicers. Wakefield at a value of $540 the very stressed version of “The pressure on appraisers, if million in 2015, but was later what may happen in the event they want to continue having pegged at just $260 million by of default of these loans that business, is to have the highest S& P. results in a bond loss … the possible value.” higher the rating, the lower our An analysis of large commercial assumed stress value.” mortgage-backed securities The issue of questionable deals by The Real Deal found THE BIG DISCONNECT commercial appraisal practices that ratings agencies routinely surfaced in a recent New York shave more than 20 percent off Compared to residential Times investigation of the bank appraisals in the lead-up to assessments, the commercial Trumps’ real estate empire, bond offerings. In more notable appraisal process is far more looking at the use of several cases, the shaves are 40 to 50 complicated and subjective, schemes to reduce tax liability percent. industry sources said. across the family’s New York portfolio. Part of the difference is that Both 40 Wall Street and 229 ratings agencies look at the West 43rd Street were bundled Among the most successful with dozens of other properties were the lowball appraisals

2 Continued on next page Continued from previous page they received from Robert Von Valuation & Advisory Services becoming the norm. Ancken, who valued more than and current president of two dozen large multifamily the Appraisal Institute. “An “I can remember getting on buildings at just $94 million appraiser has to have a thick the phone and saying, ‘OK, this — including some buildings he skin.” property is worth $200 million,’ said were worth less than zero. and he said, ‘Oh no, we’ve A decade later, the Trumps sold FEELING THE PRESSURE already committed $250 million as our share of the consortium,’” off the properties for more than While subprime residential Williams recounted. After $700 million. mortgages were the main culprit a brief back-and-forth, he in the last financial crisis, flawed The manipulation of building concluded that he wouldn’t appraisals in the commercial values is widespread and be able to come up with an debt market also played a role. ongoing, sources said. In some appraisal to justify the lender’s Appraisers, working for banks cases, the victims of unbalanced commitment. and building owners, began appraisals are investors who devising numbers based on buy bonds based on inflated “They hired somebody else to do projected values rather than valuations. In other cases, the assignment,” Williams said. actual figures like cash flow and the general public takes a hit, “We couldn’t do it. But we still debt service. losing out on tax revenue when had to bill them because we had already done the work.” property owners contort tax A $225 million CMBS loan on assessments with the help of Stellar Management’s rent- appraisers. In other cases, appraisers have stabilized Riverton apartment allegedly been tapped to help complex in Harlem went into The root of the problem, deflate securitized mortgage default in 2009, for example, according to several insiders, values. Numerous lawsuits have because its value had been is a conflict of interest. been filed over the years alleging estimated based on ambitious Appraisers are supposed to be that senior bondholders and plans to raise the rents. In impartial. But they are hired special servicers, who control that case, lenders and ratings and compensated by people CMBS loans, conspired to agencies were willing to see the who aren’t, which makes them devalue the underlying assets so business plan as viable. vulnerable to pressure. the bondholders could buy the debt at fire-sale prices. And at Stuyvesant Town–Peter Virtually everyone in the real Cooper Village, a 2009 court estate business insists that One of the more notable decision meant the deregulation most commercial appraisers do examples involved an $85 of hundreds of apartments their jobs diligently, and don’t million loan on the Bryant Hotel would no longer be legal, leading fudge numbers just because in New York, which was part of Fitch Ratings to downgrade someone tells them to. But many a CMBS offering that defaulted three CMBS deals backed by the acknowledge that resisting during the downturn. The buildings. clients’ demands to come up senior bondholder, Mission Peak Capital, was able to buy the debt with the right numbers is a daily Steve Williams, an executive at at a discount in 2014 after the struggle. the real estate data company loan’s special servicer landed Real Capital Analytics and “That’s just a fact of our life,” an appraisal of just $75 million former appraiser, recalled said James Murrett, head of from Cushman & Wakefield, assessing a property for a appraisal standards and audit according to a 2016 lawsuit. lender in 2006, at a time when services at Colliers International Investors were enraged, and one speculative appraisals were

3 Continued on next page Continued from previous page decided to sue Mission Peak in lenders were required to keep a couple of times, the client 2016, losing on appeal last year. their appraisers at arm’s length, can determine who’s right and the appraisal process on the mark, who’s a little bit CMBS trusts now operate under became more data-intensive. optimistic, who’s pessimistic,” terms less favorable to senior The changes also included more Miller said. “That hasn’t been debt holders, according to federal oversight of appraisal regulated away. It’s much harder multiple people familiar with problems. now than it was, but it’s still the matter. But investors have there. There’s still plenty of struggled to get the courts or But reforms centered on the pressure.” regulators to recognize appraisal commercial appraisal process problems in older CMBS deals, were far less robust. When appraisers feel pressured Mahany said. by banks, they can contact the In theory, banks are supposed Treasury Department’s Office of And state courts have previously to ensure that their loan officers the Comptroller of the Currency, ruled that borrowers and aren’t involved in choosing a which handles appraisal building owners do not have property’s appraiser, to prevent complaints. But in practice, few standing to bring fraud claims them from trying to influence ever do, since complaining about against a loan’s special servicer the assessment. And sources say a bank to its regulator likely and senior bondholders — only the firewall between the lending means losing a client, according the other bondholders do. and underwriting departments to several people in the business. at most banks has grown One New York attorney, who stronger since the financial Another theoretical safeguard is has worked on CMBS litigation, crisis. that appraisers whose valuations speculated that there have not have no basis in reality can been more lawsuits like the In many cases, however, lose their license. But that also Mission Peak case because appraisers don’t need to be rarely happens. A TRD review small-time bond investors are directly influenced to know of New York Department of typically afraid to get involved what’s expected of them. State records found that while in major commercial litigation. Jonathan Miller, who runs residential license revocation or the New York residential penalties were not uncommon, “My view is that more people appraisal firm Miller Samuel, no commercial appraisal don’t make an issue of it because said pressure on appraisers has professionals have lost their it’s a small industry and nobody become more “indirect” since licenses since 2014. wants to muck things up,” the crisis. the attorney said. “Because The problem, many say, is that everyone’s involved to one Mortgage lenders usually appraisal is a highly subjective extent or another, and they don’t commission appraisals on form of analysis. Most people want to be suing their fellow buildings that they intend to in the business try to predict a bondholders.” finance through a bidding property’s future income and process. Appraisers can win the the return that investors will FEDERAL CRACKDOWN job by offering lower fees, or by be willing to accept years from Following the crisis, Congress demonstrating a track record of now. Even small changes in made substantial reforms to the coming up with numbers that these figures can lead to a huge appraisal rules for residential satisfy their clients. difference in valuation, and two properties, as well as securities appraisers can come up with “Appraisers are asked to bid backed by them. Mortgage completely different numbers on jobs every day. And after for the same property — even if

4 Continued on next page Continued from previous page they both technically follow the anonymity, said the company valuation. rulebook. is known for being particularly forceful in its attempts to “If people say that an appraisal That offers a lot of leeway for influence appraisals. is wrong, I often come back in appraisers to work in their a respectful manner and say, client’s favor. “Look, they’re tough. They are ‘Well, why is it that you are the epitome of ‘we do whatever automatically right?,’” Murrett Ed Lombardo, a commercial we have to do to get what we said. “I don’t want to condemn real estate loan officer at want,’” the source said. “That’s the industry. I also don’t want to Quontic Bank and a former how a lot of the successful say that there are no problems appraiser, said property owners developers operate. For lack of — there are. But I think we’re often ask appraisers to come up a better word, they really push, doing far more good than not.” with low numbers to keep their strong-arm or even bully their tax bill down. But sometimes it’s way through. There are some the other way around. people who are going to go along with that, and some people who “That same [appraiser] can go are not.” to the same marketplace, do the same research and use the Levine said the Trumps and upper end of the range that other New York landlords own they could defend,” Lombardo properties that can be difficult said. “Is that a prejudice? Yes. It to appraise because many use happens in all professions.” outside management companies, which means a lot of a building’s Marty Levine, a commercial revenue ends up in other appraiser at the New York firm accounts. “You take the money Metropolitan Valuation Services, out of the property, you have said appraisers are being pushed less real estate income and more to do their jobs faster than ever, business income,” he noted. which leads to less thorough work across the industry. Colliers’ Murrett said pressure from property owners is so “When I started this business, it common that his firm often was an eight- to 10-week [job]. insists on upfront payment Now it’s three weeks,” he said. regardless of how the appraisal “You often don’t have time to turns out. “The art of a good think about it.” appraiser is telling your client INSIDE BASEBALL something they don’t want to hear” and still getting Unlike in banking, there is compensated, he said. little stopping landlords from influencing appraisers hired for But he and a handful of tax assessments. other commercial appraisers insisted that fraud cases are One appraiser, who has worked the exception, and that most with the Trump Organization professionals do the best they and spoke on condition of can to come up with an accurate

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