We are continuing our discussion on low ball appraisals. Read the previous post here.
Let’s go over some of the other reasons appraisals are lower than expectations in this market. The primary reason could still be that expectations have not synced up with market reality, that values are indeed lower. However, given the constant news cycle of depressed national real estate markets and tightening of lending standards overall, it is perceivable that some appraisers have become more conservative than reality requires.
Monitoring of Appraisers: Appraisers do feel that they are under a much tighter scrutiny than before. Cops often talk about how car fronts dip as they approach, that everyone slows down even if they are well below the speed limit. It’s human nature to be more careful under scrutiny and appraisers can’t claim to be immune from that feeling. They may feel safety in lower numbers.
Tied Hands: Appraisers often claim that they have very rigid rules dictated by Fannie Mae, Freddie Mac, major players in the secondary loan market not to mention government entities and licensing commissions. The art, and with it freedom, has been taken out of their profession, so they claim.
Non Exclusion of Foreclosures: A foreclosure, especially if it is in market condition, is not excluded from comparables anymore. The reasoning behind this is that, it too enjoys the exposure that normal properties do. However, if foreclosures simply sold for market value and the banks recouped their costs, then this entire foreclosure situation would pose no problem. There will not be a real estate crisis. The fact that foreclosures are almost solely blamed for the downward spiral of real estate values, should clearly suggest that foreclosures are not normal comps regardless of their condition. A true market value sale requires parties to be “typically motivated”. A typical motivation for a seller is to get as much money for their property as possible and a typical motivation for a buyer is to get either a good deal or a “home of their dreams”. A bank who has to dispose off an asset that they are continually required to write down the value of, in addition to maintaining it is not a typically motivated seller. Note that if they had only provided 80% of the value when the loan was made and the borrower has made payments for a couple of years, then their motivation to sell at market value is almost non-existent. So regardless of condition a foreclosure is simply not reflective of true market value.
Substitution without Accommodation: Appraisers will take foreclosures as comps if other sufficient normal comps are not available. However, unless the foreclosure itself is in distressed condition, no accommodation is made for the fact that it is a foreclosure. If, such accommodation by way of price adjustment is not needed, then why treat foreclosures as secondary in the first place? Why not just take foreclosures as comps even if other normal comps are available? In some extreme cases appraisers take foreclosure comps in spite of normal sales comps as it “aids” the lender in establishing a possible sale value of the subject as a future foreclosure. This tendency to “favor the lender” is what precipitated the bubble in the first place.
Three Month Rule: Some appraisers claim that appraisal rules require comparables to be less than 90 days old. Neighborhoods where there are insufficient sales in the last 90 days are impacted negatively by this rule. The logic might be to claim that if nothing is selling in the last 90 days then, the market there should be down. That could be true, if and only if the appraiser can establish that there is adequate entry into the market of subject like property. That is, there is adequate supply and still no demand. There could be supply of other types of properties, smaller homes, older homes, homes with pools, what have you but unless there is adequate supply of subject like property, then the appraiser cannot hold lack of sufficient number of sales of subject like property as a negative when computing the value of the subject.
Let’s take another example. Say, there’s a gas station that sells both premium and regular gas. Given 80% of vehicles only use regular gas in that area, you cannot watch a premium pump for the same duration of time you watch the regular pump and conclude that premium gas must be cheaper than regular! The measurement window must be adjusted with the arrival and departure rate of what you are measuring. This application of the 90 day rule as a constant is a fundamental error in the so-claimed new appraisal rules.
It’s entirely possible that in a given subdivision, the frequency of a given type of home arriving and leaving the market might be higher than other types of homes. For example, smaller homes might be listed and sold more often than larger homes. Homes that don’t have a mortgage may stay on the market longer than mortgaged homes – as the seller is not under any stress. Upon closer scrutiny the appraiser would detect micro markets within a subdivision. Window sizes should be adjusted for micro markets. Given planned urban communities and communities undergoing revitalization, a subdivision is too dissimilar to subject all properties in that subdivision to blanket rules.
Correcting the Measurement Technique: An appraisal is a prediction. It looks at recent events and predicts what a buyer may pay for a given property in the immediate future. However, the appraisal process does not include any technique correction steps that is crucial to any predictive measurement technique. For example, if you predict a position of a moving object and the object appears outside the window of that prediction, the window is corrected with the measured position of the object and the prediction process is fine tuned. See how a flight is tracked based on plots: Kalman Filtering. No such technique is utilized by appraisal rules to ensure that the method is correct for the market or sub-market measured.
I would challenge appraisers to tune their measurement techniques by first applying their method to already sold properties at at least three definite points in the recent past, say a year or so. Rewind the clock and appraise the three sold properties using other sold comps historic to each subject and verify if you have the correct prediction for each subject. If not, using the actual sold value, tune your method and your rules. Once you know that your method is correctly predicting sold values in that market, use that to appraise your real subject.
Prophesying Measurement: Appraisals are not only intrusive in nature that it has the ability to alter the value of the property per se but are also quite prophesying. If deals are adjusted to reflect appraised values, it converts an estimate, an opinion of value to real price. That real price will then feed into subsequent appraisals.
Given the magnitude of the real estate crisis, it is excruciatingly important for appraisers to act like dispassionate members of a jury who are often required to be blissfully unaware of any news that could impede their judgment and possibly de-focus them from facts. One way to achieve this objectivity might be to require multiple independent appraisals on a subject to see if there is consensus. Most likely they will find that there is a wide variance in just the measured size of the property, let alone computed values based on measured size. Alternatively, banks could use other recent appraisals of comparable properties to at least correct outlandish appraisals. Given the size of our banks, especially among the survivors of the collapse of 2008, this can be quite effectively done. Assuming of course, there is motivation to get to real value.
All said and done, for an investor, a low ball appraisal is not the end of the world. In these blogs we talk about being conservative with the property estimate when we even go to buy it, so we should be well prepared for a low ball. It keeps the strong in the play and makes room for investors who work with seasoned mentors who have handled more than a curve ball or two. It keeps the loan amount down and generates increased cash flows. Read the post on why single family rental investment is a self hedged investment. Last but not the least, a low ball appraisal at least helps you protest your property taxes!
However, given that most working class Americans have their hard earned and gradually accumulated wealth in their modest homes, to them a low-ball appraisal is tantamount to “statutory vandalism”, for what difference does it make if someone defaces, deforms, and destroys your house, or merely equates it in value to one that has been? For you, the devastation is real.