The impact of COVID-19 on the appraisal industry

The spread of COVID-19 is impacting all industries and markets, and that includes the appraisal space. That said, it is wise for appraisers to avoid trying to make long-term assumptions about the impact the virus will have on real estate values. The Appraisal Institute succinctly explains why, in their recent memo:

• An important part of any appraisal assignment is an analysis of market conditions. The coronavirus threat may be impacting market conditions. However, in most markets, it is not yet clear to what extent, if any, market conditions are affected. Related, complicating factors include fluctuations in the stock market and changes in mortgage interest rates.
• A market analysis includes observing market reactions. This analysis becomes more complicated when market participants themselves are facing uncertainty.
• Appraisal reports should include a discussion of market conditions and should mention the Coronavirus outbreak and its possible impact. However, it is not appropriate to include a disclaimer or extraordinary assumption that suggests the appraiser is not taking responsibility for the analysis of market conditions.

While it is important that we – as appraisers – do not jump to conclusions and make long-term predictions we must understand the different ways in which COVID-19 is currently impacting the commercial real estate market. It is also important that we understand how the virus  impacts the appraisal process, so we can better communicate with our clients.

Our team has compiled a list of four categories that are, or could be affected by the virus:

A change in expenses

This should come as no shock: there will likely be an increase in cleaning expenses as additional sterilization methods are employed into the foreseeable future. Keeping residents healthy is of the utmost importance, which means common spaces still in use – such as elevators and laundry facilities – need to be cleaned with a much higher frequency. Many common areas such as fitness centers and community rooms have been closed during the past month.

Depending upon the longer term unemployment numbers, landlords could see an increase in legal costs in 2020 as they work through the eviction process and impact of the new COVID-19 relief regulations.

A change in how inspections are conducted

In light of the pandemic, the CDC has indicated that the best way to prevent illness is to avoid being exposed to the virus. In our opinion, an interior inspection unnecessarily increases the risk of exposure to both the inspector and the residents/staff. Our recommendation: Exterior inspections only. If interior inspections are deemed necessary and the client or ownership representatives request that we view interiors, then we inspect common areas and vacant units and avoid occupied units.

In our opinion, an exterior inspection in conjunction with recent photographs/video tour provided by ownership as well as an analysis of the historical actual rents and occupancy trends provide an adequate representation of the subject’s physical condition. As such, in most cases, this level of inspection is sufficient to produce a credible appraisal report and assists the nation with preventing the spread of the virus.

A change in income

Our current surveys indicate that more renters are likely to renew their leases as they are less inclined to go through the cumbersome moving process in today’s environment. This means there could be less of an opportunity for owners to increase rents to full market levels in the event they are lagging. This could also mean, however, less downtime and reduced turnover costs.

There could also be a short-term increase in credit loss and/or bad debt. We are hopeful, though, that a stimulus package from the federal government could mitigate at least some of the risk here, depending on the longevity of the isolation period. For example, HUD has suspended all foreclosure and evictions for the next 60 days for FHA-insured single-family properties; and Freddie Mac is requiring landlords not to evict any tenant based solely on non-payment of rent during the recently released Nationwide COVID-19 Relief Plan forbearance period. Additionally, some state and local courts are reportedly postponing evictions 60+ days, which could add to the increase in collection loss in the near term.

A change in overall market activity

In the near term, we are fully expecting that transaction volume will sharply decline until authorities lift self-isolation and present a path forward for testing and control of COVID-19’s spread.

On a positive note though, we believe reduction in the new construction pipeline will benefit existing supply in the future. Early or planning stage deals may not come to fruition, which could help markets that had already been struggling with oversupply. This reduction in supply, in turn, would lead to an increase in occupancy and rental rates in select markets that were beginning to experience softening.

In conclusion

Our team is closely tracking the spread of COVID-19 and analyzing the short-term impacts while keeping an eye out for potential risks and opportunities moving forward. If you have any questions or concerns, a member of our team would be happy to discuss our thoughts in greater detail.