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Welcome to the Self-Storage University Podcast, where you will learn the correct way to identify, evaluate, negotiate, perform due diligence on, renegotiate, finance, turn-around and operate self-storage facilities. And your host is a partner in one of the largest real estate portfolios in the U.S. with nearly $1 billion of holdings, Frank Rolfe.
Webster's Dictionary defines appraisal as an expert opinion of value, but what happens when the expert gets it all wrong? This is Frank Rolfe, The Self Storage University Podcast, we're gonna talk about what happens when you get a bad appraisal. Now, why do you need an appraisal? Appraisals are typically required when you get a loan, whether you're just buying that self-storage facility or refinancing the self-storage facility. The appraisal is what gives the bank comfort that the amount of the loan is accurate. So a bank is gonna wanna see the property appraised is at least what you're paying and hopefully even more. Therefore, when they get the appraisal, it affirms what they thought the price should be, and therefore they'll go ahead and make the loan, but sometimes the appraisal comes in too low. What do you do when the bank calls you and says, "well, we got the appraisal back, but unfortunately the property came in lower on the appraisal than what you're paying, and therefore we can't do the loan."
Well, the first thing you have to find out is, why? Why did that appraisal come in low? Because appraisers typically try and triangulate a value based on several items, there's an income approach, comparable sale and replacement cost and between those three methods, they try and come in with the price. So for you to come in low, something must be amiss. You know what the income is, did they write down the amount of the income? Do they not believe it? Did they apply a cap rate that is a lot higher than what you thought it should be? Did they find comparable sales down the street that were cheaper? This is all important information to you, and in some cases, when you find out why the appraisal is bad, why it came in at the number that it came in, it will perhaps save your life 'cause you'll say, "well, I don't wanna buy the property after all. I had no idea the self-storage facility four doors down sold recently for half of what I'm paying. What a fool I was, I'm canceling my contract." And you would probably be smart to do so, but sometimes when you look through the methodology of the appraiser, you suddenly say, "wait a minute, this is completely wrong."
"This appraiser does not have any idea what they're doing." We once got an appraisal on a property and they appraised it as though it was simply raw farm land plus the value of all the depreciated parts to build the property. That's insane, right? You'd say, wait a minute, that has nothing to do with commercial real estate or income investing or anything. Why would the appraiser even do that? Well, it's because that appraiser was a single family appraiser, and they had hired the wrong guy to do the job, they had a guy who did not know how to appraise any kind of income property, but simply was going out there and making appraisals for Century 21 realtors and people selling single family dwellings. So it didn't shock us that he made a horrible mistake, but yet now it's going to derail our bank loan, so then what are your options as the borrower when the appraisal is bad and it's unjust that it'd be bad? Well, you can immediately go to the bank and say, "bank, this appraisal is wrong, you know this is wrong, you know that this appraiser has not done the correct methodology to come up with the value, and this value is way, way, way too low." And if you're convincing in that argument the bank may allow there to be another appraisal. We've had that happen before.
So the bank says, okay, you're right, that guy wasn't a very good choice, we'll go ahead and go with another guy and see what he comes up with. Then he comes up with a higher value, you ignore the original one, throw it in the trash, and the loan goes forward. Now, if you fail the second one, well then obviously the loan is a goner. But most importantly is the bank suddenly is at a crossroads, because if they really, really wanna do the deal, they might allow you to get the second appraisal, but also this appraisal may give them the ability to get out, maybe it turns out that the owner of the bank really didn't wanna do a storage facility, but he didn't know how to say no, 'cause you'd gone too far down the road, and this gave them the perfect opening to get out. So really when it comes to working around the bad appraisal, it's really gonna depend on your bank, and if your bank really wants your loan or not. Now, sometimes you as the buyer and the borrower have lost track of the real market values. Ever since the first quarter of 2022, we've seen nothing but increase in interest rates from Jerome Powell over at the Fed, we've seen the Fed funds rate grow from 0.25 to about 5.5, that's the fastest rise and the biggest rise in 40 years.
So as a result, one thing you have to look at is, are you really being fair and accurate yourself on what the valuation may be? And there's a lot of people who've been caught off guard, particularly on refinancing, because they weren't aware of what cap rates had adjusted to. Also, they may be unaware of what interest rates currently are. It's very possible you could see a self-storage loan today on a refinancing where the value of your property is half of what it was when you bought it, because you might have bought it back when the cap rate could have been as low as 4% and today it may have readjusted to 8%. Now, in those cases where you're gonna have appraisals on refinancing, not new purchases, not something where you can cancel, it's very, very important that you be nimble and get well ahead of the game as your loan approaches.
You typically wanna refinance a couple of years ahead, giving you plenty of time to get a loan, and if you can't, to go ahead and get the property sold, and right now with interest rates starting to decline, they've already gone down a half a point on the Fed funds rate, you should see even properties that appraise poorly, that can be fixed with time, but the essential thing is you be honest about where you stand, and if you can't get the appraisal that you hoped for, either refinance, work with your existing lender, see if it's possible to go ahead and extend the loan due date further down the road, giving you time to react to market forces.
But it's very important when it comes to appraisals, and what happens when you have those appraisals that you be the active participant, you've gotta be the quarterback, you have to take the power, you have to convince the lender that, hey, this appraisal is good, this appraisal is bad, and if it is accurate, you have to be the catalyst to proactively get that loan fixed. Now, we've had so much consistency in markets for so long, ever since the Great Recession of 2007/2008, we saw interest rates at a very stable basis for well over a decade, but now times have changed, hopefully soon things will go back to some better degree of normalcy, but in the interim, you as the borrower have to be very, very vigilant on all appraisals, make sure you fully understand those values and you act accordingly. This is Frank Rolfe, The Self Storage University Podcast. Hope you enjoyed this. Talk to you again soon.