Evaluation vs. Appraisal: Which Does Your Deal Need?

Most of the credit officers we work with know the thresholds. The harder questions come later. Does this renewal count as new money? Is this owner-occupied loan really a business loan? Is an evaluation enough for a property this unusual, even if the rule allows it?

Here’s how the federal rules sort a deal, and where judgment still matters.

Which appraisal thresholds apply?

The federal banking agencies (the FDIC, OCC, and Federal Reserve) each have an appraisal regulation, and the thresholds match. An appraisal by a state certified or licensed appraiser is required for a real estate-related financial transaction unless an exemption applies. The ones lenders use most:

• Commercial real estate, $500,000 or less. Raised from $250,000 in April 2018. “Commercial” here means anything not secured by a single 1-to-4 family residential property.
• Residential real estate, $400,000 or less. Raised from $250,000 in October 2019.
• Qualifying business loans, $1 million or less. The loan must be a business loan that is not dependent on the sale of, or rental income from, real estate as the primary source of repayment.
• Existing extensions of credit. A renewal, refinancing, or other change to an existing loan at your institution can go without a new appraisal if there’s no new money beyond reasonable closing costs, or if there’s been no obvious and material change in the market or the property that threatens your collateral protection.

For each of those exemptions, the regulation says the institution must get an appropriate evaluation instead. Below the threshold does not mean no valuation. It means a different kind.

When an appraisal is required on a commercial deal, it must come from a state certified appraiser. The same goes for any transaction of $1 million or more.

What is an evaluation, and what is it not?

An appraisal follows the Uniform Standards of Professional Appraisal Practice (USPAP). An evaluation is not required to comply with USPAP or to be prepared by a licensed or certified appraiser. Its standards come from the 2010 Interagency Appraisal and Evaluation Guidelines.

That doesn’t make an evaluation a formality. Under the Guidelines, an evaluation should:

• Identify the property’s location and describe it, including its current and projected use.
• Give an estimate of market value in the property’s actual physical condition, use, and zoning as of the effective date.
• Describe how physical condition was confirmed and how far any inspection went.
• Show the analysis and the supporting information, and cite the sources.
• Identify who prepared it.

The Guidelines also expect evaluators to be independent of loan production and to have no interest in the property or the deal. They should have education and experience relevant to the property type. When a credentialed appraiser does the evaluation, that appraiser is still bound by USPAP. That’s one reason many lenders like having an appraiser do the work: the product is an evaluation, but the discipline behind it is the same.

When does the $1 million business loan exemption apply?

The $1 million exemption gets misapplied more than any other. The test is the primary source of repayment. A contractor who owns the shop and repays from operating income usually fits. An investor who repays from tenant rent usually doesn’t, even if the borrower is an operating company.

The agencies’ FAQs make this point with farmland. If repayment comes mainly from renting the land to a non-affiliated operator, the loan doesn’t qualify for the business loan threshold. In Montana, where plenty of ag ground is leased out, that distinction comes up often.

When should you order an appraisal anyway?

The Guidelines tell institutions to set policies for when to get an appraisal even where an evaluation is allowed, especially as portfolio risk rises or for higher-risk transactions. These are the situations where that decision deserves a second look:

• Special-purpose or thinly traded property with few comparable sales, which describes a lot of rural Montana commercial real estate.
• Income property where the value depends on a lease, a tenant, or a projected rent.
• Properties with meaningful land value, water, or access issues that need real analysis.
• Loans that may be sold, participated, or scrutinized later.
• Markets that have moved since the last valuation.

A thin evaluation on a complicated property saves a few days now and costs more at renewal, in a workout, or in an exam.

Before ordering, ask four questions in order. Is the transaction exempt from the appraisal requirement? If so, which exemption, and is it documented in the file? Is an evaluation appropriate for this property and this risk, or would an appraisal be the prudent choice? And who will do the work, and are they independent and qualified for the property type?

Your institution’s credit policy governs, and it may be stricter than the regulation.

Where we fit

Rove Valuations prepares both appraisals and evaluations for commercial property in all 56 Montana counties. We’re an independent firm, and we bring the same care to an evaluation that we bring to a full appraisal. If you’re not sure which product a deal needs, send us the basics and we’ll tell you what we’d recommend and why.