Commercial real estate appraisals are usually very expensive. You will seldom see a commercial appraisal for less than $2,000; and $4,000 is probably the most common cost these days for commercial real estate loans of around $1 million. Some commercial real estate appraisals for very large projects can cost as much as $10,000 to $25,000. Yikes!

As a result, the borrower definitely does not want to have to pay for more than one appraisal. The wise borrower will therefore wait until the lender has issued an acceptable term sheet before paying for the appraisal.

A term sheet - also known as a conditional commitment letter, a proposal letter or a good faith letter - is a written expression of interest by a lender in making a commercial real estate loan and a good faith estimate of the eventual terms. A term sheet is not a commitment letter. It is not legally binding on the lender, but in practice it is a very positive and encouraging statement. If your borrower receives a term sheet, it generally means that his loan is going to be approved, assuming the property appraises for enough money and the toxic report comes back clear.

It is very important that neither the borrower nor his mortgage broker orders the appraisal on his own. In fact, under Federal law, a bank is not allowed to accept an appraisal ordered by either the borrower or his mortgage broker.

Do you remember the savings and loan crisis of the 1980's? When the Resolution Trust Corporation (RTC) looked at the loan files for all of those foreclosed commercial properties, they found that the appraisals used by the banks were garbage. Most of the appraisals were grossly over-inflated.

How did this happen? The borrowers and mortgage brokers had learned in the early 1980's to only hire commercial appraisers who consistently brought their appraisals in very high. The appraisers appreciated the repeat business of the borrowers and brokers, and in return they stretched their appraisals to bring their values in high. There was also outright appraisal fraud, where borrowers and brokers bribed unscrupulous appraisers to over-inflate their appraisals. The result was that the S&L's lost hundreds of billions of dollars.

In response, the Federal government passed the Federal Institutions Reform, Recovery and Enforcement Act (pronounced FIRE-E-A, like diarrhea). Under the terms of FIRREA, banks were no longer allowed to rely on any commercial appraisal ordered by the borrower or a mortgage broker. Private lenders, even though they were not covered by FIRREA, soon adopted the same principal.

Any commercial appraisal ordered by the borrower or broker is now assumed to be over-inflated and unreliable, even if the lender is familiar with the work of the appraiser.

Bottom line: Always allow the lender to order the commercial appraisal, and never agree to pay for the appraisal until the commercial lender has issued a term sheet.

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