By Kimberlee S. Knopf, Esq.
As part of the underwriting process for most SBA loans, lenders are required to obtain appraisals on real estate, equipment and/or a business as a going concern. It is imperative that lenders comply with the appraisal requirements described in the SOP and critically evaluate the results. Otherwise, the SBA loan guaranty will be jeopardized, either at the time of guaranty purchase or when the Office of the Inspector General conducts a post purchase review, which review can occur up to six (6) years after the SBA purchase date.
The SOP requires an appraisal of commercial real estate if the value of such property is greater than $250,000. In the event the commercial real estate is estimated to be $250,000 or less, an appraisal may be required if further evaluation of the collateral is required in order to make an informed credit decision or if a lender’s regulatory requirements otherwise require an appraisal.
In all instances, the appraisal must be requested by and prepared for the lender and the appraisal should be addressed to both the lender and the SBA. A recent existing appraisal may be updated and extended to the lender and the SBA; however, if an appraiser is unwilling to update or extend the appraisal in this manner then the lender is required to obtain either a new appraisal or a review of the existing appraisal by a different appraiser.
The appraiser must be independent and without conflict of interest and either State-licensed or State-certified, (if the estimated value of the commercial real estate is in excess of $1,000,000, the appraiser is required to be State-certified.) The appraisal itself should be in compliance with Uniform Standards of Professional Appraisal Practice and be delivered in either a self-contained or summary appraisal format.
If the loan proceeds will be used to finance new construction or substantially renovate (renovations are greater than 1/3 of the purchase price or fair market value of the real estate) an existing building, the appraisal must estimate the market value of the commercial real estate upon completion of construction, as set forth in the plans and specifications. Upon completion of construction, the appraiser must submit a statement to the lender that the building was built with only minor (if any) deviation from the plans and specifications that formed the basis of the market value appraisal. If the appraiser will not issue this statement, then the loan can not be closed without the prior written permission of the SBA.
If the loan proceeds are to fund the purchase of an existing building not requiring renovation or other construction, the appraiser should estimate the market value of the commercial real estate on an “as is” basis or, if the appraiser utilizes another basis for valuation, then the narrative must explain the rationale for such alternate valuation.
In September 2008, the Office of Inspector General issued a report based upon an audit of six (6) SBA guaranteed loans of a PLP lender where the Inspector General recommended full denial of the guaranty due to “Inadequate Appraisal”. In this instance, the loan authorization required a real estate appraisal showing a fair market value of at least $1,650,000 and the lender’s files contained an “as-is” market value appraisal of $1,750,000. Approximately $265,000 of the “as-is” value was attributable to the going concern value of the real property which therefore reduced the amount allocated to the real estate to $1,485,000. In addition to this deficiency, the real estate sold for $925,000 approximately two years after the date of the appraisal which provided further support for the Inspector General’s assertion that the appraisal was significantly overstated. See U.S. Small Business Administration, Office of Inspector General, Audit of Six SBA Guaranteed Loans, Report Number: 8-18, issued September 8, 2008, at pages 9-10.
For a business acquisition, and so long as it is not contrary to a lender’s policies and procedures, a lender may perform its own valuation of the business being sold if the amount of the loan (including any 7(a), 504, seller, or other financing) less the appraised value of the real estate and/or equipment being financed, is less than or equal to $250,000. In the event the amount of the loan (including any 7(a), 504, seller, or other financing) less the appraised value of real estate and/or equipment being financed, is greater than $250,000 or it is not an arm’s length transaction (i.e. the buyer and seller are related or are current business partners), then the lender must obtain an independent business valuation. In this instance, the appraiser must allocate separate values to the various components of the transaction including land, building, equipment and business (including goodwill and other intangible assets).
Recently, the Office of Inspector General reviewed four early-defaulted loans and found an improper payment of $37,696 by the SBA due to inadequate business valuations. The Office of Inspector General determined that the borrower paid more for the business than it was worth and reiterated that “determining the value of a business is a key component to the analysis of any loan application for a change in ownership.” In this case, the lender obtained a combined real estate appraisal and business valuation that valued the land at $775,000 and the business at $160,000. As the total project cost was $1,032,000 there was an obvious deficiency of $97,000. The loan officer ignored the independent appraisal and claimed that the appraiser was too conservative in its approach and therefore relied upon its in-house valuation. Interestingly, two days after approval of this loan, an executive vice president of the lender accepted the independent appraisal and specifically acknowledged that the in-house valuation was overstated, providing further support for the Office of Inspector General’s conclusion that there was an inadequate business valuation. See U.S. Small Business Administration, Office of Inspector General, Material Deficiencies Identified in Four 7(A) Recovery Act Loans Resulted in $3.2 Million of Questioned Costs, Report Number: ROM 11-05, issued June 29, 2011, at
As the above examples illustrate, SBA lenders must carefully analyze appraisals in order to assure that the results conform to the Loan Authorization and the SBA’s rules and regulations.