Tuesday, May 28, 2013

Residential Appraisals Need to Change--or Go

Appraisals may not be the make-or-brake on a buyer's home loan, and they may not be the central factor in how the real estate market is performing. But they certainly grease the skids, and in my view, we need to come up with another way of doing things.

Here is the National Residential Appraisers Institute's (and Fannie Mae's) 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, knowledgeably and assuming the price is not affected by undue stimulus." Read the entire definition here.

That being the case, why do so many transactions in today's recovering market fall apart because of appraisals? And why, during the bubble years, did appraisals support the loan applications with their absurd values?

When I was first licensed in 2006, I performed a competitive market analysis for a homeowner. Lots of nearby comps were available, so it was pretty easy. I came up with a price range whose upper limit was $375,000. The owner was, to say the least, displeased. She'd recently refinanced her home with a pick-a-payment loan, where borrowers pay whatever they want. The lender's appraiser had come up with a value of $525,000.

I looked at his comparable sales, and they were all out of area. The homeowner's house, while well-located, was old and in poor condition, with the garage roof nearly caving in. Yet one or two of the comps the appraiser had used were brand new homes. You'll have to take this on faith, but this kind of situation was not uncommon.

I recently bought a home in Denver Metro for $310,000. The appraisal came in at $267,000. I'd done my own comps (which you can do with sites like Redfin) and felt the comps supported a $300,000 price--making us overpaying by $10,000--but we accepted that because of the tight market. But an appraised value of $267,000? What planet was this guy on?

The very first page of his (or any) report noted normal market conditions--no undersupply of homes, a normal ratio of buyers and sellers, normal market time and so on. Again, I wondered what this guy was doing. It was anything BUT a normal market. Homes were selling so quickly and with multiple offers that many local Realtors weren't even listing the homes, because either they or someone in their office had buyers in the wings. To call this a normal market was nuts.

Not only had I done extensive BPO (Broker Price Opinion) work for several lenders, but I'd also analyzed appraisals for them. If you fill out the lender forms and check anything other than "normal market conditions" boxes, it will not only increase the work you have to do, but the work will be more difficult. Anything you say about market conditions not being normal has to be researched and justified with pretty hard data.

I wouldn't say the problem is all due to lazy appraisers, but some of it is. An even greater problem, though, is that appraisers are always stuck in last year' market. Buyers are making what they think are offers without "undue stimulus" all over the place. Most brokers I know counsel buyers not to overpay, and likewise counsel sellers to go for the highest price possible. When a buyer and seller agree on a price under these conditions, isn't the agreed-on price, by definition, market value?

My own experience is typical, and I'm hearing from my former colleagues over and over about how appraisals are impacting transactions

When the appraiser's report comes in low, no one is served. Not the buyer, not the seller and not the lender. The house I just bought will now show up as a recent comp for some new buyer's appraisal. What does that mean? Will the appraiser note on the report that my comp doesn't count because I overpaid? Will the comps used for my appraisal no longer be valid? 

And if those are so, and they are, what is the intrinsic value of a comparable sale anyway?

Out-of-area appraisers add to the problem. Micro markets are as unique as people and need adjusting for hyper-local conditions. As part of the financial reforms governing mortgage loans, lenders use an Appraisal Management Company (AMC), who in turn selects the appraiser (and takes a hefty cut of the appraiser's fee). But your chances of getting an out-of-market appraiser is pretty high.

It's the lenders' money, so they can do whatever they want. In my view, however, they need to come up with a new way of valuing property. The above examples are typical for both boom markets and recovering markets, and any real estate broker you ask will have many similar war stories.

My first experience with real estate appraisers and appraisals occurred early on, in the late 1970s. It was with appraisers holding the MAI (Member Appraisal Institute) designation, a status held by a select few who do commercial appraisals. These guys and gals all have business degrees and are sometimes MBA's. They are, for the most part, very, very good and have an enormous range of metrics at their disposal for use in deriving market value.

Most residential appraisers hold the SRA (Senior Residential Appraiser) designation if they hold any at all. As with so many others in real estate (brokers, property managers, etc.), these initials after one's name don't mean anything to lay people. Check them out the Appraisal Institute's website.

I've discussed the situation with several appraisers over the years, and you know what? They agree, for the most part. They don't like being labeled "deal killers," and they often decry the limitations placed on them. They don't have much use for some of their colleagues and most of them feel the AMC system moved things a step backwards.

The residential appraisal system, designed for the market of the 1980s, is broken, and it needs to be fixed or dumped.