The New York Times Business Section of October 13, 2012 contained an article by Shalia Dewan entitled “Which House is Worth More?” The article is timely and interesting in that it highlights perceived problems of home sales facing the real estate appraisal process. The general complaint is that failure of a home to appraise at or close to its sale price will “torpedo” the deal. The article suggests that the “problem is so widespread” that the National Association of Realtors blamed faulty appraisals for holding back the housing recovery.

An example cited was one of a seller receiving multiple offers against an asking price of $197,500 and accepting one at $210,000 only to be faced with an appraisal of $195,000 causing a compromise price of $205,000. The seller commented “The part that blew me away – the appraisal can be such an arbitrary personal decision and there is no appeal process”. Further, adding to his indignation, according to the article, was the fact that a similar home two doors away sold for $225,000.

An analysis of this example suggests that the complaints may arise out of a lack of understanding what the appraisal is and what it isn’t and how appraisers work. First and most importantly licensed appraisers (appraisers of residential property for loan purposes are required to be State licensed) are bound by the Uniform Standards of Professional Appraisal Practice (USPAP) and those standards prohibit basing value on “arbitrary personal decisions”. USPAP recognizes that the final value conclusion is an “opinion” but an “opinion” arbitrarily reached or one based on a personal decision unsupported by facts and data would fail to be within required USPAP compliance. This doesn’t mean that no appraiser has ever been arbitrary or lacked proper evidence before concluding value. It just means that such would be the exception and not the rule.  If an appraisal fails to comply with USPAP a complaint can be filed against the appraiser with the State licensing board, which if sustained could lead to a loss of license. It may not resurrect the transaction but would provide satisfaction. Also, if fault is found with an appraisal based on data or process errors, most lenders will take another look.  It is foolish to believe that the lender doesn’t want to make the loan and lenders may reopen a file if convinced that an error was made.

The complaint that a home two doors away from the subject sold for $225,000 (while the subject was appraised for only $195,000) may or may not b a valid complaint. It is indicated that the home two doors away had $30,000 worth of upgrades that were not present in the subject house.  Assuming that the appraiser included the $225,000 sale in the comparable sales used and adjusted the comparable price downward to $195,000 to reflect the value of the upgrades, any complaint would be unfounded. However, if the appraiser did not include a similar home sale two doors away in the list of comparables, such omission might justify a valid complaint.

The National Association of Realtors in blaming “faulty appraisals” for holding back the recovery of the housing market cited unidentified member reports that more than a third of all deals were cancelled, delayed or renegotiated at a lower price because of a “low appraisal”.  The National Association of Realtors (NAR) is a Trade Association with a primary interest in promoting the real estate brokerage business (the business of a majority of its members). Their comments and criticisms are for the most part biased rather than objective and should be treated with suspicion absent supporting empirical evidence. There comments need to be carefully examined:

What do the complaints of “low appraisals” really mean?  Are they appraisals that fall short of objective market value measures? Or, is a “low appraisal” just an appraisal that did not report a value equal to or greater than the sale price.  It is most probably the latter.

The NAR report (the report) indicates that appraisers use previous sales of comparable houses to “help” value a home and if prices are just starting to climb, with sales taking two to three months to close, there can be a lag before the change in prices can be observed.  This statement is partially correct.  Appraisers do use sales to “help” value a home and it can take two to three months before a sale closes.  But, that causes a lag in closed sales prices but not a lag in the observation of sales.  Part of the appraisal process includes studying the market and being aware of shifts in demand for homes vs. the supply of homes available for sale. Part of the process also includes maintaining relationships with brokers (market makers) from whom the appraiser can learn whether or not asking prices are rising, demand is increasing and the spread between ask price and selling price is diminishing.  The multiple listing services report sales under contract so even though a lag time to close can be protracted, the data is there to be used. Using these kinds of information the appraiser can and usually does adjust older sales for change in market conditions rather than depending on the old sales as the entire basis for the value conclusion.

The report suggests that appraisers were improperly using foreclosures and neglected properties as comparable homes as well as failing to account for market conditions like scarce inventory and bidding wars. Using foreclosures and neglected properties of similar homes as “comparable” properties is not, in and of itself, wrong.  What would be wrong would be the failure of the appraiser to make proper adjustments to those comparables to reflect, if such is the case, the superior condition of the home being appraised and/or the negative impact of a foreclosure on value.  In the case of “neglected properties” the appraiser should adjust for the cost of putting the property in equal condition to the home being appraised. And, if market conditions have improved and/or there are bidding wars, that kind of information would also call for an adjustment in the comparable property. Further, the report faulted banks for using “inexperienced appraisers” and for creating unrealistic requirements like “six comparable sales instead of three” as well as criticizing lenders for using appraisers lacking local expertise.

USPAP contains a competency requirement.  If an appraiser, knowingly lacks the experience necessary to appraise a property because of unfamiliarity with the city, neighborhood or specific subdivision, then the appraiser risks being charged with a USPAP violation that could cause a loss of license. What is not said is that lenders usually require competitive bids or use appraisal management firms to select the appraiser and this process risks failing to retain the best appraiser for a property in favor of the cheapest one.

It is foolish to complain about a lender requiring six sales versus three.  The residential form appraisals appear to “require” three comparables and that has caused furnishing only three to be the norm.  However, if there are six or eight truly comparable properties, there is no prohibition against analyzing all of them and reporting based on all rather than three. A competent appraiser would look at all of the data in estimating value. One of the problems is that supplying only three sales became the norm and it is easy visualize how an appraiser might “cherry pick” the sales to select the easiest ones for use rather than sales requiring substantial work to analyze.  Instead of lenders requiring three or six sales, they should require appraisers to report sales data in whatever depth is necessary to accurately portray the market.

The report quotes the NAR Director of Research as saying “It’s (the appraisers being hired) holding sellers off the marker” and “Sales volume could probably be an additional 10 to 15 percent higher if we had normal lending practices and if we had normal appraisal practices”. These comments are totally self serving as the goal of NAR is to create more business for the Realtors who are their members and making loans easier to get would certainly do that. But, otherwise, the comments do not make any sense when logically analyzed.  First, what does the word “normal” mean in the context used above? Does it mean a return to the pre 2008 financing market that caused the financial meltdown? One would certainly hope not but, there is no recollection of NAR sounding any warnings, pre 2008 that what was going on in the market might well lead to destabilization in the market. Many professionals recognized as early as 2006 that prevailing market practices (speculative purchasing and lending without standard documentation) would lead to problems.  They just didn’t know when the problems would surface.

The notions that appraisal practices would hold sellers off of the market or that a “normalized” market could increase sales volume by 10 to 15 percent are speculative at best and completely lacking any kind of empirical evidence or proof.  At worst, they are misleading and delusional notions perhaps designed to involve the political process in the perceived problems. It is more probable that sellers under no particular compulsion to sell would, in their own self-interest, hold their property off of the market if they truly believed that market conditions were improving leading to a potentially higher price in the immediately foreseeable future. On the other side of the coin, sales volume would increase dramatically if buyers became convinced that prices were beginning to rise and that, by waiting too long to buy an opportunity would be missed. Whatever appraisers may or may not do has absolutely no impact on the law of supply and demand.  If supply is shrinking and demand is increasing, prices will rise.  If the converse is true, prices will fall. If sales volume is not at the level needed to push prices up, it is because buyers are unconvinced that the market is rising and they prefer to wait.  That decision may be wrong but it is what moves the market.

Are lenders more cautious?  Certainly.  Any lender that survived 2008 wants to be satisfied that newly originated loans are sound and not at risk of failing. It should be realized that, back in the dark ages, when 25% down payments were required and lenders retained loans in their own investment portfolio, there were few appraisal problems. However, when loans of 90% to 95% of sales price are involved, over estimating value can result in a loan being “under water” the day the deal closes with particular risk to the lender because the borrower has a very small stake in the property.

To the degree that the lending problems cited by NAR might be realistic, good agents (not all agents/brokers are good) can take steps to avoid the problems. Once a transaction is agreed the agent can put together a detailed description of the house including all special and distinguishing features as well as detailed information on all sales of similar property that have sold recently.  In addition, the agent can provide a listing of similar homes that are currently on the market or under contract as well as an overview of the current market. This process removes guess work from the appraisal process as it makes sure that the appraiser has all of the relevant information necessary to analyze value. Agents belonging to a multiple listing service have easy access to all of this information while appraisers may not have that access. There is no prohibition against making the job of the appraiser easier by eliminating the expenditure of time searching for otherwise readily available data and information. Real estate sales commissions are very high in relation to the service provided and laziness by an agent should not be acceptable by a client.

Finally, in some instances an agent will represent both seller and buyer.  Under the laws of many states, in these instances the agent is obligated to represent the interests of the seller while the buyer signs off on this relationship. If the agent is a “dual agent” it is doubtful that they would advise a potential buyer that the asking price was too high and that value was probably around $X. For this reason, buyers should select an agent to represent them as buyers.  That agent would have the obligation of advising the buyer as to price and terms without worrying about the best interests of the seller which can be left to the sellers agent.

What is most interesting is that whenever there is market “dislocation” the appraiser is blamed for market problems. The Appraisal Journal (Published by the Appraisal Institute) published an article by me in October of 1991 entitled “Appraisers Under Fire – Again”. Re-reading it suggests that nothing ever changes. If any reader is interested in that article a copy can be requested via a comment to this article.

(c) 2012 by Lloyd D. Hanford, Jr., MAI

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