Appraising Mold Contamination

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http://www.dreamstime.com/royalty-free-stock-photos-mildew-mould-living-room-water-damage-house-full-image36525878Losses due to mold contamination for your property–owning clients may not be limited to the cost of repairs aka cost to cure. Stigmatized properties can take months, even years, to recover from a blighted image. In fact the Uniform Standards of Professional Appraisal Practice (USPAP) states in provision AO9:

“The value of an interest in impacted or contaminated real estate may not be measurable simply by deducting the remediation or compliance cost estimate from the opinion of value as if the property is unaffected. Other factors may influence value, including any positive or negative impact on marketability (stigma) and the possibility of change in highest and best use.”

Every appraiser utilizes the same methodology when developing an opinion of value or, in other words, when estimating the market value of a property. The techniques used by appraisers are very specific. Every appraiser must consider three methods to value on every appraisal assignment, unless otherwise requested by their client. The three methods to value are the market approach, also known as the comparable sales analysis method, the cost approach and the income approach.

Market Approach

The most common method used for residential real estate is the market approach, or comparable sales analysis method. The cost approach can also play an important role in appraising residential properties contaminated with mold.

When using the market approach to value, the appraiser scours the market place for properties of similar size, design and construction situated in the same or a similar neighborhood as the subject property. These are called comparable sales or comps. Comps typically have sold within the last year of the appraisal assignment. Usually three comps are adequate to establish an opinion of value for the subject.

How many homes in the neighborhood are contaminated with mold? The search for mold contaminated properties may take the appraiser to other geographic regions.

The appraiser may need to conduct four appraisals using comparable sales analysis in order to accurately derive a value of a property rendered uninhabitable by microbial amplification. All four may be in different geographic markets.

First, similar properties suffering from the same type of contamination must be located. Similar contamination can be identified by the type of bioaerosal contamination, the health effects suffered by the residents attributable to mold and also the cost estimates to cure the defect. This is not as difficult as it sounds. This is a big country with more and more of these contaminated homes emerging daily. However, this process may be expensive.

The next step is to establish a base line value for each property. The base line is derived as if the properties were not contaminated and basically involves conducting an appraisal on each comp. The appraiser needs to search for three unaffected comps from each primary comp’s region. The ideal comp is located on the same street. If the appraiser is too far from a familiar market place, he or she may need to work with an appraiser from that market place to create the baseline values.

Once the appraiser has established the hypothetical value of the comps as if they were not contaminated, the rest is simple math. The actual sale price of the comp is compared to the comp’s value [as?] if it was not contaminated to develop a percentage ratio for the diminution suffered. A weighted average for the percentage of loss is created from this data.

The average percentage of value loss is then factored against the uncontaminated theoretical value of the subject property. This provides the market approach estimated value for a mold contaminated property.

Cost Approach

Having arrived at an estimate via the market approach, the appraiser now needs to employ the cost approach to support these findings.
When employing the cost approach, the appraiser estimates the cost to build the subject property at today’s building prices. Based on visual observation of the readily accessible areas, the appraiser determines how much overall depreciation has taken place. The significant indicator of depreciation is deterioration of major components like the roof, siding, walls, windows and heating/cooling systems. The depreciation is determined utilizing the “Age Life Depreciation Method” or by subtracting the overall percentage of depreciation from the cost to build new.

In a property contaminated by mold, the cost to remediate would be referred to as “cost to cure.” The cost to cure is subtracted from the depreciated value of the subject property. This estimate of value should be very close to the value arrived at by the market approach, thereby lending strong credibility to the results.

Income Approach

The income approach is seldom used for residential properties, but can be relied on heavily for commercial properties. As the name implies, income is the primary data utilized for the determination of market value in this approach. The gross income is factored against all of the expenses intrinsic in the ownership and operation of the subject property. The amount remaining, or the net revenue, is then multiplied by the local capitalization rate. The capitalization rate is extracted from comparable sales analysis and varies from region to region with market trends.

When appraising a mold contaminated commercial property, the appraiser will amortize the cost to cure and deduct it along with any ongoing testing and monitoring costs as if they were expenses from the gross revenues.

To identify the actual value loss, the appraiser will take the total of the amortized costs to cure and the ongoing compliance costs and factor that total against the capitalization rate. For example, if monitoring costs are $2,000 per year and the capitalization rate is 10 percent, the loss in value attributable to that expense is $200,000. Other factors can come into play as well, such as the length of time that monitoring might be required.
Another issue that must be addressed is that of “highest and best use” for the subject property.

Environmental contamination can result in a change of the property’s highest and best use. If that occurs, and the new highest and best use for the subject property projects a market value that is less than the highest and best use prior to contamination, the appraiser will consider those factors and how they impact the ultimate value loss suffered by the property.

Stigma

Stigma can be measured by comparing the amount of time a contaminated property stays on the market compared to the amount of time a non–contaminated property was exposed to the market place before selling. Stigma can last for months or even years.

Another way to gauge stigma is to write letters to lending institutions querying their interest in financing a theoretical property, a “virtual subject” similar to the subject. Letters can also be written to local realtors asking if they are interested in listing the virtual subject property and to insurance companies about insuring the virtual subject property.

Case in point, I was appraising a mildly contaminated commercial property in Vermont. To help support the assertion that stigma existed, I wrote three letters to lending institutions describing a financially strong borrower who already owned a property. I described conditions similar to those of the subject and asked the financial institutions if they would be interested in further exploring a loan with my client. The responses were polite, yet all declined the opportunity at that time and gave no indication of when in the future they might be interested. Ironically, one of the lending institutions already held the mortgage for the subject.

Conclusion

To effectively complete an appraisal assignment of this sort costs thousands of dollars. Even with its high price tag, however, there are many cases that would benefit from this level of professional endeavor. Utilizing this series of approaches, a strong argument can be made for the estimated loss of value. Conversely, if an appraiser does not go to these lengths to research, document, calculate and prove the accuracy of his or her opinion of value, it would be wise to examine the process used to develop that estimate.

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