Martin A. Skolnik, MAI (Marty) Director, Multifamily Appraisals Freddie Mac Richard Meyer (Rich)

1. Valuation of Multifamily Properties: Perspectives from the End UserTechniques, Procedures, and GuidancePresentation to the Appraisal InstituteIndianapolis, IndianaJuly 2013 Martin A. Skolnik, MAI (Marty) Director, Multifamily Appraisals Freddie Mac Richard Meyer (Rich) Director, Real Estate Services/Physical Risk Freddie Mac

2. Introduction 2

3. Speakers Martin A. Skolnik, MAI (Marty) Director, Multifamily Appraisals Martin_Skolnik@FreddieMac.com Richard Meyer (Rich) Director, Real Estate Services/Physical Risk Richard_Meyer@FreddieMac.com 3

4. Perspectives for this morning….. 4 "In a conversation, keep in mind that you are more interested in what you have to say than anyone else is."- Andy Rooney “In a conversation, the other person is spending most of their time thinking about what they are going to say next, rather than listening to what you are saying now…” - Anonymous 4

5. Multifamily Real Estate Market in General,and Freddie Mac in Particular 5

6. Freddie Mac Corporate Overview 6 Freddie Mac is a government-sponsored enterprise (GSE), and we are now in conservatorship as managed by the Federal Housing Finance Administration (FHFA) since September 2008 Our public mission is to provide liquidity, stability and affordability to the housing market We operate in the secondary mortgage market, buying loans through a network of seller/servicers noted on FreddieMac.com 6

7. Multifamily Overview 7 • Our Seller/Servicer network delivers conventional loans to our four regional offices in McLean (Virginia), New York, Chicago and Los Angeles • Our Multifamily Seller/Servicer Guide (Guide), published on AllRegs, outlines our lending parameters and conditions of purchase; • All third party report requirements are contained in the Guide 7

8. Multifamily Overview 8 We are a prior approval lender and fully underwrite each loan prior to purchase We began shifting in 2009 from a “buy and hold” to a “buy and sell” model and are currently securitizing more than 90% of the loans we purchase 8

9. Importance of Third Party Reporting 9 9

10. Market Metrics 10

11. Background Information: Multifamily Real Estate Market 11 Apartment prices have increased by 12.5% over the last 12 months, driving the 6.2% year-over-year gain in the national all-property index. Source: Moody’s Investor Service 11

12. How life imitates art… 12 12

13. Background Information: Multifamily Real Estate Market 13

14. Background Information: Multifamily Real Estate Market Source: REIS 14 14

15. Background Information: Multifamily Real Estate Market Freddie Mac Multifamily Loan Volume 15

16. Pre-Discussion Warm-up 16

17. How many appraisers are needed to change a light bulb? • Answer: Three One to research it, one to inspect it, and one to call the client to ask exactly what number wattage they want the appraiser to use. 17

18. How many appraisers are needed to change a light bulb? • Answer: One If, in the appraiser’s opinion, the original light bulb should be changed, the appraiser must identify and set forth any data considered and relied upon, and the reasoning and basis for installing a new light bulb. 18

19. How many appraisers are needed to change a light bulb? • Answer: Appraisers do not change light bulbs. Instead, they make an assumption that the light bulb needs to be changed, then they do a Discounted Cash Flow to estimate the use of the light over the next ten years, even if the new bulb won’t last for ten years. 19

20. How many appraisers are needed to change a light bulb? • Answer: Appraisers do not change light bulbs. They make assumptions about why other people change light bulbs, and then write a report about other people’s light bulb purchases. 20

21. How many appraisers are needed to change a light bulb? Answer: Twelve … • One to take the light bulb order from the client; • One to sign the engagement letter with the client about how quickly the light bulb is going to be changed and to specify the fee to change the light bulb (including a penalty if the light bulb is changed late); • One to research how much light bulbs cost in a minimum of three separate stores including, hopefully, the store across the street from the subject; • One to verify the comparable sales price data; • One to write about the history of light bulbs, how many light bulbs come into the local port, and how many passenger miles the local airport handles; • One to re-read USPAP for regulations about light bulbs; • One to figure out why the Cost Approach can’t be used in changing the bulb; • Two to write the report (a senior appraiser and a trainee); • One to review the report; • One to deliver the report; and • One to tell the client why the appraiser won’t change the light bulb analysis after report delivery, even though they got the wattage wrong in the report. 21

22. How many appraisers are needed to change a light bulb? Answer: It depends. 22

23. Issues in Multifamily Appraisals 23

24. Introduction The underlying exercise of a Freddie Mac review of a third-party real estate appraisal review is to determine if the appraiser has adequately supported his/her opinion of market value. So, the point of this presentation is to: • Talk about the risk factors that would indicate that an appraiser has or has not adequately supported his/her opinion of market value, and • Discuss suggested solutions to the issues we most commonly find in appraisal reports 24

25. Introduction (continued) Appraisers are generally good at extracting data from the market and analyzing that data in each of the three approaches to value. But, many appraisal reports we see lack a narrative thread that relates how the appraiser’s observations and findings impact the value of the subject property. 25

26. Introduction (continued) • A well-written appraisal anticipates and addresses a reviewer’s questions in advance. • We have found that the difference between a reasonably well-written appraisal and a below average appraisal is usually the addition of a short/concise summary at the conclusion of each section. • Typically, the addition of this verbiage can dramatically improve the efficiency of our review process by reducing the need for “go-backs” to clarify the appraiser’s narrative. 26

27. Introduction (continued) Quick refreshers and “ground rules”: • Appraisals on multifamily properties come to Freddie Mac from two directions: • Purchases of loans • The appraiser is the vendor of the Seller (a/k/a lender), not of Freddie Mac, but Freddie Mac is an intended user • FM’s underwriters are the primary reviewer • Asset Management issues • Freddie Mac is the client • FM’s Real Estate Valuaton unit is the primary reviewer 27

28. Introduction (continued) • Quick refreshers and “ground rules” (cont): • The appraisal report should contain sufficient analyses, discussion, data, and conclusions by the appraiser for the reviewer to render an opinion as to the adequacy of the value • Freddie Mac’s underwriters use the appraisal conclusions, discussions, and data to assist them in their derivation of an underwritten value 28

29. General Appraisal Issues To be acceptable to support the Freddie Mac underwriting or asset management processes, the appraisal report’s content, discussion, analyses, and data: • Must support the appraiser’s estimate of value • Should comply with Chapter 12 of the Seller/Servicer Guide • Shouldcomply with Freddie Mac’s appraisal Best Practices 29

30. Introduction (continued) • Definition of Market Value The most probable price which a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently and knowledgeably, and assuming the price is not affected by undue stimulus. Implicit in this definition is the consummation of a sale as of a specified date and the passing of the title from seller to buyer under conditions whereby: • Buyer and seller are typically motivated. • Both parties are well informed or well advised, and acting in what they consider their best interests. • Reasonable time is allowed for exposure in the open market. • Payment is made in terms of cash in U.S. dollars or in terms of financial arrangements comparable thereto. • The price represents the normal consideration for the property sold unaffected by special or creative financing or sales concessions granted by anyone associated with the sale. 30

31. General Appraisal Issues 31

32. Introduction (continued) A fundamental problem in multifamily appraisals: Property Interest Being Appraised is Wrong Many times, an appraiser will state that the appraisal is the valuation is of the “fee simple” interest. • The Appraisal of Real Estate (13th edition, page 114) states that leased fee ownership is the ownership interest held by the lessor regardless of the duration of the lease or of the specified rent. • Specifically, “a leased property, even one with rent that is consistent with market rent, is appraised as a leased fee interest, not as a fee simple interest.” 32

33. Introduction (continued) Property Interest Being Appraised is Wrong (cont.) • The sales in the Sales Comparison Approach are all leased fee transactions. That is, the sales price is based on the income at each property. • Additionally, the capitalization rates derived from these sales are also leased fee capitalization rates 33

34. Introduction (continued) Property Interest Being Appraised is Wrong (cont.) • Real life example: A property with short-term leases at market rent levels is required to be appraised as a leased fee property. 34

35. General Appraisal Issues History of the Subject Property • Previous history of a sale of the subject property • If there is a recent purchase of the subject property, is the price similar to the value? • If not, why not? True to life example: The listing price for the Subject property is approximately $13,600,000. As a result of our analysis contained in this appraisal report, we have concluded to an “as is” value of approximately $21,700,000 for the Subject property, which is above the current listing price. The discrepancy between our concluded value and the listing price is partly attributed to the fact the Subject is currently being marketed as a part of a portfolio of assets, which may not reflect the true value of each individual asset. More importantly, we believe the property could be operated at a lower expense level relative to the historical data. 35

36. General Appraisal Issues (continued) Property Inspections: • Which units did you inspect? • What was their condition, configuration, and utility? 36

37. General Appraisal Issues (continued) Focus your inspection on particular issues: • Down units • Vacant units • A sample of each unit type • Top floors and bottom floors 37

38. General Appraisal Issues (continued) Speaking of Property Inspections… This is my favorite description of on-site conditions, taken from the appraisal of a 50%-occupied seniors housing property: “In addition to significant turnover in the senior management team, we observed during our inspection that the Director of Marketing kept confusing assisted living with independent living and was not sure what the asking rates were or how the additional fees for care were assessed or charged. There were no brochures or any kind of promotional materials available for any prospective residents or family members. The Assisted Living Manager was too busy texting to look up or introduce herself while we stood in her office. The Executive Director had been there only a few days and represents at least the third ED in as many years. In fact, the only person who seemed to have a handle on the subject and its operations was the Maintenance Director." 38

39. General Appraisal Issues (continued) • Everyone who signs the appraisal must have inspected the property • Everyone who signs the appraisal must be licensed/certified in the state in which the property is located! 39

40. General Appraisal Issues (continued) • Photos • Current? • Internet photos?? • Maps • Market Area Discussion • What are the drivers of multifamily occupancy and rents? 40

41. General Appraisal Issues (continued) Required Regulatory Language(in Section 12.12 of the Seller/Servicer Guide): The Seller/Servicer must direct the appraiser to include the following language in the letter of transmittal above the appraiser’s signature and/or on the appraiser’s Certification page above the appraiser's signature: “This report is for the use and benefit of, and may be relied upon by, a) The Seller/Servicer, Freddie Mac and any successors and assigns (“Lender”); b) Independent auditors, accountants, attorneys and other professionals acting on behalf of Lender; c) Governmental agencies having regulatory authority over Lender; d) Designated persons pursuant to an order or legal process of any court or governmental agency; e) Prospective purchasers of the Mortgage; and f) With respect to any debt (or portion thereof) and/or securities secured, directly or indirectly, by the Property which is the subject of this report, the following parties and their respective successors and assigns: • Any placement agent or broker/dealer and any of their respective affiliates, agents and advisors; • Any initial purchaser or subsequent holder of such debt and/or securities; • Any Servicer or other agent acting on behalf of the holders of such debt and/or securities; • Any indenture trustee; • Any rating agency; and • Any institutional provider from time to time of any liquidity facility or credit support for such financings In addition, this report, or a reference to this report, may be included or quoted in any offering circular, information circular, offering memorandum, registration statement, private placement memorandum, prospectus or sales brochure (in either electronic or hard copy format) in connection with a securitization or transaction involving such debt (or portion thereof) and/or securities.” 41

42. General Appraisal Issues (continued) • Third-party reports are typically available from the Lender • Environmental • Engineering / Property Condition Assessment • Zoning • Flood Hazard 42

43. General Appraisal Issues (continued) • The appraiser needs to reference any material issues raised by the third-party consultant and state their impact on value. • For properties in where the third-party consultant has identified issues, it is not sufficient for the appraiser to just state that there is “no impact on value” without sufficient support for this conclusion 43

44. General Appraisal Issues (continued) • If there are issues on the property that might impact value but for which the appraiser says that there is no value impact (i.e., location within a flood zone, hazardous material remediation), the appraiser should discuss the reasoning for its non-impact and provide market support for his/her rationale. 44

45. General Appraisal Issues (continued) The appraiser’s zoning discussion should address: • Is the subject’s use a legal use? If not, why? • Are there an adequate number of parking spaces for its occupancy? (This could be based on zoning and/or based on market expectations & comparables) • Does the developed density comply with current zoning requirements? • Does the subject comply with the current floor-area-ratio (FAR) requirements? • Can the property be rebuilt to its current inventory of units if there is a casualty loss? • What is the impact on value? 45

46. General Appraisal Issues (continued) Parking -- Real life example #1: The appraiser states, “We requested, but were not provided an exact number of parking spaces.” Solution:Count them…! • Walk the site, or • Plat or survey, or • Aerial photograph (Google or Bing) 46

47. General Appraisal Issues (continued) Parking -- Real life zoning example #2: The appraiser says that parking is “assumed adequate.” • There was no discussion of: • the actual number of spaces at the property, • the ratio of spaces per unit, and/or • the local zoning requirement • Questions that the appraiser must answer in the appraisal: • Is the parking ratio in compliance with local zoning regulations? • Is the parking ratio/number of spaces adequate in this market? If the answer to either or both questions is “no”, then what is the impact on value? 47

48. General Appraisal Issues (continued) • Property taxes • Does the appraisal have current, correct tax assessment and property taxes? • Is the tax assessment value similar to the appraiser’s value estimate? • If not, why not? • California issues • Tax comparables • Risk of reassessment at the appraiser’s value • It is not appropriate to estimate the risk of reassessment by merely applying an unsupported bump to the capitalization rate 48

49. General Appraisal Issues (continued) Suggested methodologies for incorporating risk of reassessment: • Select several multifamily sales within the same or similar taxing jurisdiction that have been reassessed after the sale • A comparability chart can be constructed to compare each sales price with the new tax assessment • So, if other comparable/similar properties were reassessed at an average of, say, 75% of the sales price, then it would be reasonable to assume that the subject would be also be reassessed at that amount 49

50. General Appraisal Issues (continued) Suggested methodologies for incorporating risk of reassessment(continued): • If the appraiser’s sales comparables were mostly chosen from the same or a similar taxing jurisdiction, then the market’s measurement of the uncertainty of reassessment could already be built into the capitalization rate • There would be no need for an adjustment to the appraiser’s capitalization rate. 50