Risk Management and Best Practices for Lenders and Appraisers 2014 Appraisal Institute Annual Meeting August 5 2014 Current Trends in LendingFinancing of Commercial Real Estate P ressure from regulators ID: 330516
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Environmental
Risk Management and Best Practices for Lenders and Appraisers
2014 Appraisal Institute Annual Meeting
August 5, 2014Slide2
Current Trends in Lending/Financing of Commercial Real Estate
Pressure from regulatorsNew ASTM Standard for Phase I’s
New Transaction Screen Assessment (TSA) StandardSBA LendingLenders updating environmental/appraisal policies
More levels/forms of due diligence than ever before on more loansSeems to be a big push in the CRE market again…
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Other Fire Sales HappeningSlide4
How Environmental Issues Often SeemSlide5
Environmental & AppraisalsTypes of ContaminationBuilding ContaminationE.g., asbestos, lead paint, radon, formaldehyde
Encapsulate, Enclosure, RemovalSoil & Groundwater ContaminationE.g., hydrocarbons, solventsPhase I (initial review) through III (remediation) Slide6
Appraiser Poll
Question:Are environmental issues typically not looked at because of ignorance or apathy?Response:
We don’t know and we don’t care…Slide7Slide8
Comments from LinkedIn by Appraisers
I agree that hardly anyone outside the appraisal world reads USPAP. That includes AMC's and Lender's that often make requests to appraisers which are not compliant with USPAP. This leads to both appraiser and lender frustration.
If
USPAP is the governing document for appraisers, you would think at a minimum that underwriters would be required to understand the document.
I
dread taking the refresher every 2 years. It's definitely the most boring CE class. It usually turns into 8 hours of complaining about the profession
.
What is USPAP? Does any lender really care about USPAP anymore? Basically, lender guidelines appear to always over rule USPAP.
Professor Warren, your last comment it sooooo true. We all need to wake up to what is really happening vs debating appraisal methods among ourselves, as if the typical big boy lenders really care about appraisal methods or quality.
That being said, it seems a bit ridiculous that we create and enforce rules that many lenders could care less about.Slide9
Comments from LinkedIn by Environmental Consultants
You will always have a problem until lenders start rejecting sub-standard Phase I ESA's. When lenders are accepting Phase I's that have zero historical research and records reviews that cost $1200 and were done in five days, it will not matter who does the site visit.
Unfortunately, a significant part of the industry has a product mentality rather than one of service. The result is a business solely driven by price, thus tempting the industry shortcomings.
Professor Warren, your last comment it sooooo true. We all need to wake up to what is really happening vs debating appraisal methods among ourselves, as if the typical big boy lenders really care about appraisal methods or quality.
That being said, it seems a bit ridiculous that we create and enforce rules that many lenders could care less about.Slide10
Appraisal Institute Survey - 2013Slide11
CRE Appraiser ConcernsFee pressure & expanding scope of work
Formulary approach (forms, checklists, ratios, indices) gaining more prominenceGreater liability
Increasing barriers to direct communication with lenders resulting in appraisal report acceptance and/or perceived report quality issues Over regulation of appraisal profession
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Concerns of Appraiser Clients
Long turnaround timesCost of appraisalsMisunderstandings concerning the scope of work in engagement letters
Compliance with standards/regulation Sufficiently supported value conclusions
Quality work product Shortage of qualified appraisers
Concise valuations (do not want lengthy reports)
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Hottest Topics for Staff Appraisers
Inadequate market analyses Appraisal compliance with bank regulations Not recognizing or appreciating clients’ needs
Insufficient details on market conditions and trends affecting real property Going concern valuations (different methodologies causing confusion)
Reluctance to interact with client out of fear of violating appraiser/client “firewall”
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Appraiser ChallengesSlide15
Take Aways
Communication BreakdownsTough and uncertain regulatory environmentUnsatisfied clients and frustrated service providers
Clear need (and opportunity) to bridge the gap
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Moving Forward
Higher risk transactionsCommission appraisal and environmental together
Appraisal prepared for as-is market valueEnvironmental assessment returned to bank and information provided to appraiser to determine value as-impaired
“As is impaired” may not = “as-is clean” – cost to cure because of potential market resistanceSlide17
Challenges that Appraisers Face
ChallengesPressure on bank appraisal/environmental departments
Cost to cure calculationsNot all appraisers are competent to assess environmental impacts (might have to call one in)
Bidding process – appraisers would need to know this upfront because the as-is impaired is a different kind of assignment
Potential project delay/cost increaseSlide18
Lenders’ Reaction to Environmental Issues…Slide19
Issues Important to Lenders Collateral Devaluation
Direct Liability - Loan origination to foreclosure Reputational Risk (Brand and Image) Operational & Enterprise Risk Credit & Trust Risk
…but at the end of the day, the primary issue for lenders is Business RiskSlide20
Risk Management Challenge“…Information is more available than it has ever been, but the ability to know what is pertinent and what is true is more challenging today.”Martha Cummings – head of Risk, Banco SantanderSlide21
Key Changes to Phase I’s - 2013Slide22
Who Qualifies as an Environmental Professional?
Professional/Educational Qualifications
Relevant
Experience
Professional engineer or professional geologist license/registration
3 years
Federal or state license/certification to perform environmental inquiries
3 years
B.A./B.S. degree or higher in any science or engineering field
5 years
No B.A./B.S. degree
10 years
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Key Changes:Simplified “Recognized Environmental Condition”
Definition
More closely aligned with the EPA’s All Appropriate Inquiries (AAI) “objective”de minimis extracted as a stand-alone definitionSome instructional language added to historical and site visit sectionsSlide24
New: HREC Split
Redefined Historical Recognized Environmental ConditionPast releases addressed to unrestricted residential useMust consider current regulatory framework (rules change)HRECs are not RECs
Created new Controlled Recognized Environmental Condition termPast releases addressed to non-residential standard, subject to some type of controlCRECs are RECs and must be included in the conclusions section of the reportde minimis”
CAN be used to describe an HRECde minimis” CAN NOT be used to describe a CRECSlide25
Agency File/Records Reviews
Clients thought it was already being doneConsistency needed
New language:Should be conducted for property and adjoining propertiesIf not conducted, explain whyAlternate sources okSlide26
E1527 has been silent on vaporEPA recommended the task group not ignore the vapor pathway
2013 revision acknowledges the vapor pathway in “migration” definitionClarifies “Indoor Air” non-scope
VaporSlide27
Vapor IntrusionSlide28
Task group split about 50/50
Ultimately agreed that:Recommendations are not required by the standard.
User should consider whether recommendations are desired. Recommendations are an additional service
REALLY??
RecommendationsSlide29
How Did AAI Affect Lenders
For the first time, there was a federal statutory authority saying what is needed for a Phase I environmental site assessment Biggest impact of AAI on lenders were the changes to regulatory and government agencies – specifically FDIC guidelines and the SBASlide30
Regulators Are Now Talking About Environmental
http://www.occ.gov/publications/publications-by-type/comptrollers-handbook/cre.pdfSlide31
NCUA Environmental GuidanceSlide32
FDIC Highlights
FDIC emphasizes process and consistency. Training Policies and Procedures should be established;
Environmental Risk Analysis should be conducted; Document due diligence; Track changes to policy and consistent application of policy. Monitoring
Lenders must avoid “participating in management” of the business and thereby assuming liability under CERCLA.
Most attorneys recommend a Phase I ESA in the event of
foreclosure.Slide33
OCC Updates
Develop policies and procedures that reflect potential environmental risks associated with lendingProvide for receipt and evaluation of environmental reports prior to making final commitment.
Ensure that persons responsible for evaluating environmental risk possess relevant knowledge, skill and competence.
A bank’s policy should reflect the EPA’s AAI rule.Slide34
OCC Updates
The policy should include:Analysis of current laws and due diligence requirements;
A level of due diligence internally required on all real estate transactionsRisk thresholds based on property type, use and loan amount for determining when and what type of due diligence is used;Varying due diligence methods depending on the type of loan, the loan amount and the risk category, including questionnaire or screening, site visit, government records review, historical records review, etc.Slide35
OCC Updates
The policy should include:The potential for impacts from asbestos and lead based paint;
Appraisal requirements for disclosing and taking into consideration any environmental risk factors;Criteria for evaluating environmental risk factors and costs in the loan approval process;Criteria for evaluating environmental risk factors and costs in the loan approval process;
Environmental documentation for commitment letters, reps and warranty, etc.
A means of evaluating potential environmental liabilities for foreclosures.Slide36
Small Business Administration Update
SBA updated its Environmental PolicyEffective August 1, 2008 and updated six times since (most recently in January 2014).Especially important for institutions with preferred status who do SBA underwriting.
7A and 504 lenders must adhere to this policy.Has become default policy for many lenders.Slide37
SBA Environmental Due Diligence Policy
2 levels of Environmental Due Diligence for SBA
Phase I – for high risk propertiesIf property type/use matches the list of NAICS codes for Environmentally Sensitive Conditions
Records Search with Risk Assessment – low risk properties
Includes a search of the government databases (compliant with AAI);
A search of historical use records, and;
A risk assessment by an environmental professional determining whether the site is “High”, “Elevated” or “Low” risk
New Gas Station/Dry Cleaner Requirements Slide38
Sample SBA Policy Matrix
Minimum Due Diligence Requirements
Real Estate Loan Type
<$150K
$150K < $5MM
Low Risk Loans
Questionnaire
RSRA/TSA
High Risk* Loans – NAICS Codes
Phase I
Phase I
Gas Station
Phase I + Evidence of UST Compliance
Phase I + Evidence of UST Compliance
Dry Cleaners
Phase I
Phase I
Dry Cleaner (older than 5 years old)
Phase I and Phase II
Phase I and Phase II
Special Use Facilities (i.e. Daycare)
More specific requirements (i.e. Lead Paint Testing, Lead in Drinking Water, etc)
More specific requirements (i.e. Lead Paint Testing, Lead in Drinking Water, etc)Slide39
Dry CleanersSlide40
The Trouble with Dry CleanersSlide41
Size has Mattered (but that doesn’t have to be the case)
Regional & National LendersResources in place to understand environmental issues on the propertyScreen all loans by an EP
Have staff/internal resources to manage environmental riskCredit Unions/Regional & Community BanksNo on-staff environmental expertise (typically)
Not as sophisticated with regard to environmental issues or due diligence options available
Often rely only on environmental questionnaires and/or proceed without accurate knowledge of environmental condition of property
Rely on external guidance to dictate their practicesSlide42
Environmental Due Diligence Options
Environmental questionnaire (EQ)Desktop due diligence (various levels)
Transaction Screen Assessment (TSA)Phase I Environmental Site AssessmentsPhase II, III, Remediation, etc.
Storm water Issues
Sustainability/Green Issues
Environmental Insurance
OthersSlide43
Policy Matrix
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Minimum Due Diligence Requirements
Real Estate Loan Type
<$250K
$250K < $1M
>$1M
Low Risk Loan - new
Questionnaire/Desktop
Desktop/Transaction Screen
Phase I
High Risk* Loans - new
Phase I/Transaction Screen
Phase I/Transaction Screen
Phase I
Renewals -Low Risk
Questionnaire/Desktop
Questionnaire/Desktop
Questionnaire/Desktop
Renewals -High Risk
Questionnaire/Desktop
Questionnaire/Desktop
Desktop/Transaction Screen
Multi-Family
Questionnaire/Desktop
Desktop/Transaction Screen
Desktop/Transaction Screen
Outdated Phase I
Questionnaire/Desktop
Questionnaire/Desktop
Desktop/Phase I updateSlide44
Common Commercial Issues
USTs Fuel Oil Tanks Spills Storage/disposal of Hazardous Waste
Vapor Intrusion Mold
Gas Stations Dry Cleaners Lead, asbestos
Radon
Storm water Runoff
SuperfundSlide45
What the Seller Sees Slide46
What the Buyer/Lender Should SeeSlide47Slide48Slide49
Best Practices/TakeawaysCreate and follow environmental policies and procedures;
Use commitment fees from borrowers to cover the costs of the due diligence;At a minimum, obtain an environmental questionnaire and some form of government environmental records for each commercial transaction;Different types of properties require different levels of due diligence;
Start the process as early as possible to allow enough time for evaluation and follow-up work that may be required.Work with a company or expert that has experience in this area and consider outsourcing the review process similar to other functions that are not “core-competencies” of the bank .Slide50
Summary
Lenders have unique processes and reasons for conducting due diligence. Market pressures have reinforced long-term trend to increased due diligence.
Regulators enforcing risk management due to a perceived over-concentration of risk regarding commercial real state. Risk Management (Credit, Collateral, Environmental, etc.) is as critical as ever to lenders.
Environmental and appraisals are both pieces of the puzzle that are being revised under the current environment.Slide51
How Much and How Long??Slide52
ORMS OverviewORMS was founded with credit unions, community and regional banks as its primary focus;
ORMS serves as natural extension of our lender clients;ORMS helps lenders develop and execute environmental policies and procedures;ORMS helps lenders focus on the low level due diligence needs;
ORMS helps lenders review and make decisions on existing environmental reports and information;ORMS helps lenders do more risk management in a cost-effective manner by outsourcing the environmental risk management process.Slide53
ORMS helps with the 5 Steps of Risk ManagementIdentify Risk
Assess Risk Develop Controls or Risk StrategyImplement policy/controls
Evaluate policy/controlsSlide54
Product and Services
ORMS EnviroFlash™ – current data review and opinion designed for low risk loansORMS Desktop Review (RSRA)
– current data + historical research + opinionORMS Property File Review3rd Party Reviews/Phase I Updates
Assistance with selection of environmental consultants on behalf of clients
Policy Development and Evaluation
Training ProgramsSlide55
How ORMS is DifferentORMS doesn’t do Phase I’s/Phase II’s (although we can help you manage through the process).
ORMS is set up to be a business advisor with our clients, not a data driven product.We evaluate each situation and help select the most effective solution.ORMS makes sense of the issues so that you can make a informed
risk-based decisions.ORMS provides services nationwide.Slide56
How ORMS is DifferentORMS provides solutions/strategies to resolve environmental issues;
We do more research:Property cardsInternet SearchWe utilize environmental risk management professionalsWe provide follow up help
Our program includes data + so much more.WE CAN WORK WITH YOU AND YOUR BORROWERS TO HELP FIGURE OUT SOLUTIONS TO THE ISSUESSlide57
Upcoming EBA MeetingsJanuary 2015 – Charleston, SCJune 2015 – Denver, CO
January 2016 – Long Beach, CAJune 2016 – Fort Worth, TXSlide58
Convergence of Appraisal and Environmental Services within Financial Institutions
Eric Schwartz, MAI, SRAChief AppraiserAppraisal Review DepartmentAmegy Bank of TexasAugust 2014Disclaimer: The opinions expressed are solely those of the author and are not necessarily the opinions of the management or employees of Amegy Bank.
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Vendor PoolQualifications – Who is “qualified”?Professional CredentialsGeographic competencyProperty competency
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Database ManagementIn-housePros-Easily tailored to individual requirementsUse of existing resources
CustomizableIntegration into other databasesAugust 5, 2014
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Database ManagementIn-house (continued)Cons:Reallocation of limited resourcesFunctional requirements may not be understood by staff
ASTM standards may seem “foreign” to appraisers/reviewersAugust 5, 2014
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On-line database management toolsReal Estate Management Information Service – (eg. RIMS)Web based project management systemProcurement and tracking
Vendor managementPerformancePros:Reasonably low costAutomated credential monitoringSecure report upload/download/storage
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Features to look for:Online service requestEase of interface for vendor and managementAutomated task and project trackingVendor Performance reports
Contact database management system24/7 accessibilityAugust 5, 2014
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Synergies of task typesAppraisals and environmental reports must be tied to the same project. Requires a hierarchical management system similar to:ProjectTask
External InternalReportingExternalInternal
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Environmental due diligenceLeast stringent to most stringentEnvironmental Questionnaire
Desktop Due Diligence/ScreeningASTM Transaction ScreenAAI/ASTM Phase I ESAPhase I “Plus”
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Bank personnel and appraisers should possess some level of competency with:
ASTM E-1527-13: Standard Practice for Environmental Site Assessments: Phase I Environmental Site Assessment Process (known as ESA)ASTM E-1528-14: Standard Practice for Environmental Site Assessments: Transaction Screen Process
Reference: www.astm.orgAugust 5, 2014
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Process Management Within the appraisal/real estate unit?Maintain database of appropriate service providersUnderstand qualifications of service providersInternal reviews of Desktop Reports, Transaction
Screens, and Phase IRecommendations may need to be outsourced to qualified environmental experts/attorneysAugust 5, 2014
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The appraiser’s roleEyes, ears and nose of the lenderRecognize your limitationsYou are likely not an environmental professional, but…
Tell us what you see/smell and hear (the contact say)Why?.....................
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August 5, 2014
70Management of Environmental ServicesTell the client what you observed. If you don’t tell the client early the assignment process, you might get a reaction like the following from the Chief Appraiser.Slide71
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Some banks ask you to note if you observed any of the following:Storage tanksCollection SitesDrums/containers and/or pesticides/chemicals
AsbestosMiscellaneousSoil contaminationWater leaksWater damageMold
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August 5, 2014
74Management of Environmental ServicesScope of Work - The appraiser is to contact the Client in cases of extraordinary assignment or limitations (e.g., restricted subject access, lack of lease information for known key tenants,
discovery of significant environmental impairment, etc.) to consider possible adjustments to the scope of work. In such cases, while the bank account officer’s input may be useful, adjustments to the scope of work for any appraisal assignment must approved by the Client.Environmental Issues
- It is recognized that appraisers are not qualified to detect hazardous waste and toxic materials. Moreover, it is recognized that any comments made that may suggest the possibility of the presence of such substance is not confirmation of the presence of hazardous waste and/or toxic materials. Such determination would require investigation by a qualified expert in the field of environmental assessment. The appraiser observation is important in revealing the possibility of “red flag” environmental situations or conditions. For this reason, the appraiser is required to complete the Environmental Site Inspection form.Slide75
Appraisal Institute Guide Note 6: Consideration of Hazardous Substances in the Appraisal Process Guide notes are not part of the standards of professional practice but instead provide guidance on how the standards may apply to specific issues.
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Highlights of Guide Note 6Explains the differences between the existence of hazardous substance(s) and environmental contamination;Consideration of the Competency Rule and Scope of Work RuleExtraordinary assumptions and hypothetical conditions
DefinitionsBasis of proper valuationAugust 5, 2014
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Guide Note 6-Consideration of environmental conditions along with social, economic and governmental conditions is fundamental to the appraisal of real property. (Introduction to Guide Note 6).
Need for special consideration to the impact of hazardous substance on the valuation of real property.Hazardous substances are considered environmental contamination when their concentrations exceed appropriate regulatory standards. (see definitions in GN6)
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Guide Note 6- CompetencyCompetency rule in USPAPProperly identify the problem to be addressed and have the knowledge and experience necessary to complete the assignment; or
Disclose the appraiser’s lack of knowledge or experience to the client before accepting the assignment….take all steps necessary…and describe the steps take; orWithdraw from the assignment
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Guide Note 6- Competency (continued)If the assignment calls for the appraiser to take into account the effects on value of hazardous substances, most appraisers rely on other professionals for assistance.
If the appraiser lacks the knowledge and expertise they have to disclose that lack of knowledge and experience prior to the acceptance of the assignment.August 5, 2014
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Guide Note 6 – Scope of WorkHow and to what extent the appraisal problem will address known or suspected hazardous materials that may impact the property.
Assignment conditions cannot limit the scope of work such that the assignment results are not credible for the intended use.Cannot allow the client’s objectives or the intended use to cause assignment results to be biased.
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Guide Note 6 – Extraordinary Assumptions and Hypothetical ConditionsExtraordinary assumptions would be employed when you are relying on the work of others.
Hypothetical conditions are used when the appraiser estimates the value of the property known to be contaminated in an unimpaired or uncontaminated condition.
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Guide Note 6 – Basis for Property ValuationImpaired value – The “as is” value of the propertyUnimpaired value – The market value developed of the contaminated property employing a hypothetical condition the property is not contaminated
Diminution of value – Effects of costs to remediate plus use costs plus risk (stigma too).August 5, 2014
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What’s the appraiser to do?If you see it….report it.Call the client/email the clientTake photos and send them to the client
Write it up in your report/Put it in the letter of transmittalCalculate diminution in value if appropriateEmploy a hypothetical condition or extraordinary assumption if appropriateEnsure your results are credible
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84Management of Environmental ServicesWhat steps would you take if you saw this during the property inspection?Slide85
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Appraisal Report LanguageAce Appraisal Services is not qualified to detect the existence of potentially hazardous material or underground storage tanks (USTs) which may be present or, or near, the subject site. The existence of hazardous materials or USTs may affect the value and marketability of the subject property. For the purposes of this appraisal assignment, Ace Appraisal Services has assumed that the subject property is not affected by hazardous materials which may be present on or in proximity to the subject property.
Unless otherwise stated in this report, any value conclusions are predicated on the assumption that the subject property is free of contamination, environmental impairment or hazardous materials. Unless otherwise stated in the appraisal report, the existence of hazardous material was not observed by the appraiser(s) and the appraiser(s) has no knowledge of the existence of such materials on or in the property. The appraiser(s), however, is/are not qualified to detect such substances. The presence of substances such as asbestos, urea-formaldehyde foam insulation or other potentially hazardous materials may affect the value of the property. No responsibility is assumed for any such conditions, or for any expertise or engineering knowledge required for discovery. The client is urged to retain an expert in this field, if desired.
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Appraisal Report LanguageUnless otherwise stated in this report, the existence of hazardous material, which may or may not be present on the property was not observed by the appraisers. Ace Appraisal Services has
no knowledge of the existence of such materials on or in the property. Ace Appraisal Services, however, is not qualified to detect such substances. The presence of substances such as asbestos, urea formaldehyde foam insulation, contaminated groundwater or other potentially hazardous materials may affect the value of the property. The value estimate is predicated on the assumption that there is no such material on or in the property that would cause a loss in value. No responsibility is assumed for any such conditions, or for any expertise or engineering knowledge required to discover them. The client is urged to retain an expert in this field, if desired
.We have inspected, as thoroughly as possible by observation, the land; however, it was impossible to personally inspect conditions beneath the soil. Therefore, no representation is made as to these matters unless specifically considered in the appraisal.
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Appraisal Report LanguageSample of Extraordinary Assumptions when appraising convenience stores, auto dealerships and similar property types.
REALLY ACE APPRAISAL SERVICES has not observed, yet is not qualified to detect, the existence of potentially hazardous material or underground storage tanks, which may be present on or near the site. The existence of hazardous materials or underground storage tanks may have an effect on the value of the property. For this appraisal, REALLY ACE APPRAISAL SERVICES has specifically assumed that the property is not affected by any hazardous materials and/or underground storage tanks that may be present on or near the property. It is an extraordinary assumption of this report that the subject property is environmentally clean
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If FNMA, SBA, HUD and the bank are concerned about environmental conditions….shouldn’t you be?What is your client’s policy?Do they determine what level of due diligence based on transaction amount and/or property type?
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ResourcesGuide Note 6 Analyzing the Effects of Environmental Contamination on Real Property (AI Seminar)USPAP – Competency Rule; Advisory Opinion 9
SBA SOP 50 10 5(F) Subpart B, Chapter 4 for 7A loans and Subpart C, Chapter 3 for 504 loansNAICS Codes of Environmentally sensitive industries August 5, 2014
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Q&A
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Contact Info: Derek Ezovski
860.838.5388dezovski@orms.com