Beware the appraisal.
I had fully intended to quickly bury yesterday’s “What day is it?” stream of consciousness post with something a little more relevant to real estate, but I got sidetracked. I had an unscheduled crisis on my hands. Consequently, I found myself spending the better part of the day appealing the appraisal of a seller client’s home, an appraisal which missed by not a few Benjamin’s but by a whole bunch and threatened to derail an otherwise fine escrow.
In the case of my low appraisal yesterday, there were so many things wrong, I didn’t know where to start. It marked only the second time in eleven years that I have had an appraisal come in low on one of our transactions, and the other not so coincidentally was just a couple of months ago. So, it seems like a good time to post a cautionary note to sellers. Just because you have a buyer who is willing to pay “X,” “X” being a palatable price to you, this doesn’t mean you are going to be cashing that check. And if you are unrealistic about pricing yet happen to hit pay dirt with that one buyer who is willing to pay more for your home than the market would suggest he should, you will still have a very large appraisal hurdle to overcome.
I often fret the appraisal these days for many reasons. A slower market and fewer sales means fewer “comps” on which the appraiser can base their estimate of market value. And, lenders who are paying for their blank check-writing practices of the past several years are skittish, with the result being that appraisers are under more pressure to make a defensible and even conservative determination of value.
I didn’t see this one coming. It was a no-brainer, as they say. In an area of few sales over the past six months, we were lucky enough to have a carbon copy, a model match, around the corner which sold just one month ago. Well, there was one difference — our model match enjoyed a location which, in technical appraisal speak, would be considered inferior. In this case, inferior means it backed to a very busy four-lane road. For all but the most devoted NASCAR enthusiasts, this would be considered a negative.
Our appraisal made no adjustment for location. Our appraisal was also fraught with errors in the areas of features, amenities and even views. More surprising though was that our appraisal factored in a time diminution of value. More recent sales were dinged at a rate of almost 1.5% a month to reflect a declining market. It was the whole declining market argument that had me scratching my head.
What a strange and different market we are dealing with. Five years ago, anyone could get a loan for any amount. Today, even the most qualified buyers are having to undergo a lengthy interrogation process to secure financing. When we were in the throes of a rapidly appreciating housing market, one where offers routinely exceeded asking price and always exceeded the price of the last comparable sale, we still had to sweat the appraisal, but we did so because appraisers were reluctant to give consideration to market trends. Today, the rules are apparently different.
Past performance may not be indicative of future results. Then why is it OK for an appraiser to assume as much? And if every appraisal used this declining market logic in determining value, how would our market or any market reverse course? I understand, from the lender’s perspective, the need for caution in this market. And I understand the need for appraisals to confirm that a contract price is reasonable, in the ball park. But, if a transaction is found to be legitimate, arms length, and absent fraud, shouldn’t appraisers be recognizing that the biggest determiner of value is what a buyer is willing to pay?
I suppose not. One last side note. Short-sales and bank-owned sales do matter. They are “comps” today and, at least in our case, no adjustment was made for the distress nature of these sales. Fortunately, we were successful in getting our appraisal overturned, but Seller beware. Your home is not sold until the Fat Lady closes escrow. And this requires that the property appraise at contract price, which is no small feat in our current market.
July 3rd, 2008 at 11:04 am
Join the club Kris, I’m afraid we’ll see this happening more and more over the next several months. I just had my first “appraisal fail” a month or so ago - prices falling among a particular product, as builders offered up to 10% in closing costs or price reductions, and suddenly what was a sure thing was missing the cut by $2500. 6 months ago, in my market, that was a “send it back to the appraiser with an extra comp and they’d fix that”. Now, Seller had to concede on another item and make up the difference.
“…shouldn’t appraisers be recognizing that the biggest determiner of value is what a buyer is willing to pay?” That’s what market value used to be, but Not No Mo.
July 3rd, 2008 at 3:40 pm
When Mrs Smithers and I bought our first condo in 1986 (in Highland Park, LA, straddling the 110 frwy), I believe we had agreed to pay $69K, with ten% down (credit union), and the appraisal came back at $67K or $67.5K - I forget. My recollection is that the seller dropped the price to match the appraisal, and that was that.
Anyone selling their house in this market who does not do the same thing is pretty clueless, IMHO.
July 3rd, 2008 at 3:51 pm
Kris — I gotta know. What was this appraiser’s excuse such a lame effort?
July 3rd, 2008 at 10:36 pm
“…shouldn’t appraisers be recognizing that the biggest determiner of value is what a buyer is willing to pay?”
That would be true if it was actually the buyers’ money. But, then there would be no appraisal. Where there is a loan involved, which I gather is usually the case, it is not in fact the buyer’s money at stake, and buyers, it turns out, cannot be trusted when it comes to spending other peoples’ money.
July 3rd, 2008 at 11:32 pm
We’re seeing similar issues. May of the low appraisals were “drive by” appraisals with *conditionally challenged* foreclosure sales used as comparables.
July 4th, 2008 at 8:00 am
Hi, Francy! Nice to meet Mrs. Phoenix Real Estate Guy! I am asked constantly whether or not shorts and REOs really are impacting the market. Unless you live in La Jolla or Bel Aire, the answer is most certainly yes and for this very reason, not the more obvious one.
You are right, Jeremy. I was blown away that we were actually able to get this one overturned.
>(buyers) cannot be trusted when it comes to spending other people’s money.
Smithers - I have to concede this point. It’s a good one.
July 4th, 2008 at 8:15 am
[…] Original post: Beware The Appraisal […]
July 4th, 2008 at 9:34 pm
As an appraiser, I’d like to address a few points on this topic.
An appraisal is not intended to be a “rubber stamp” of a purchase contract. Smithers makes a very accurate observation that when its someone else’s money, there is necessarily going to be a verification that the deal makes sense. If the buyer is purchasing solely with their own cash and resources, I don’t think you’re going to see an appraiser show up.
An appraiser is supposed to be the eyes and ears of the client - most of the time, the lender. We are hopefully going to provide some expertise in gauging value in the marketplace. Please note appraisers do not create values, rather, we are supposed to (as accurately as possible) figure out what is going on in a market, and then figure out a value within that market.
Aside from all the errors the appraiser made in regards to locational factors and upgrading, may I ask why you are surprised about time adjustments to account for a declining market? If the home you sold is in area that is declining 1.5% per month, and one of the comps sold three months before, then theoretically, that home would sell for 4.5% less at the present time. Of course this is not 100 percent accurate, but it makes general sense. In many of the appraisals I have performed over the last year, you can look back over the months and the rate of depreciation is fairly obvious.
Additionally, appraisals are not going to pass review with underwriters if the decline of the market is not factored in somehow. Since just about every area is declining these days, except Carlsbad 92011, Solana Beach, La Jolla, and Coronado, most appraisals have negative time adjustments. 1.5 percent per month is actually relatively mild…. have you been up in some areas of Oceanside 92057, Vista 92083, Escondido, 92027, Lemon Grove, Encanto? Some of these areas have declined 30 - 40 percent over the last year. in response to rampant short sales and REO’s.
“Past performance may not be indicative of future results. Then why is it OK for an appraiser to assume as much? And if every appraisal used this declining market logic in determining value, how would our market or any market reverse course?” An appraiser is not creating market trends, he or she is supposed to be accurately reporting on them. When the market was going up so rapidly in 2004 and 2005, we appraisers were having to do positive time adjustments to make the comps fall in line. Did this practice prevent the market from turning back down into one of declining values? Of course not.
And someday, the decline we are seeing in most neighborhoods will come to an end, and we’ll be back in an appreciating market again. When that happens, appraisers won’t have to do negative time adjustments any more. But until that happens, appraisers are going to have to report on declining values.
July 4th, 2008 at 10:28 pm
“And someday, the decline we are seeing in most neighborhoods will come to an end, and we’ll be back in an appreciating market again.”
With all due respect, Fred, the declining market extrapolation (and that’s what it is) assumes that Scripps Ranch real estate is in an 18% year over year free fall. It is mathematically ridiculous to consider such a thing. Each sudden drop makes us that much closer to the bottom.
I think appraisers are hamstrung with this declining market extrapolation. Usurping a buyer and seller set price in an arm’s length transaction is radical. I’m sure it’s being dictated to the appraisers but it really interferes with market pricing
July 4th, 2008 at 10:30 pm
“Some of these areas have declined 30 - 40 percent over the last year. in response to rampant short sales and REO’s.”
Which proves my point. To assume that a similar drop will happen for the next 12 months is radical. Fred, does this make sense to you?
Markets don’t respond in a linear fashion
July 4th, 2008 at 11:21 pm
Brian:
Time adjustments in appraisals are not attempting to predict the future. When we do an appraisal, it is (unless for a date of death estate assignment) effective on the date of inspection. No appraiser I know is making time adjustments to predict the next twelve months of market behavior. Rather, they are made to account for changes in value in a market that have already been occuring.
I agree that markets do not operate in a linear fashion. That’s why just about every appraisal I do in a particular neighborhood cannot rely on the same market condition numbers every month because everything changes. A good appraiser is going to always update the market analysis.
When I do an appraisal, I am not assuming a similar drop will happen in the next twelve months. I have no way to know what will happen……. All I am trying to arrive at is where we are in the present time.
Lets say a buyer and seller agree on selling price of $850K, and the market value (based upon comps and current trends is $800K. The bank is giving the buyer a mortgage for 80% of the selling price. The appraiser is interfering with market pricing by pointing out to the lender that the price is too high?
Incidentally, most of the purchase appraisals I have done over the last few years have verified the contract price. But everyonce in awhile, one comes along that just won’t work….
July 5th, 2008 at 12:52 am
I have had the same thing happen in the last 2 weeks- one on a new build and the other on a house with “few” comps. I am telling my sellers that are tending to market their homes on the high side, even if they get a “close” to list price offer, we still have to get past the appraisal. With the mortgage mess, appraisals are being examed with much scrutiny.
July 5th, 2008 at 9:36 am
Wow. Take a day off and look what happens.
I understand what you are saying, Fred, but here was my difficulty in this situation. We have one real, apples-to-apples comp in this neighborhood in the past 12 months. It just happens to be one month prior. So, the appraiser says, on average, all condos in all of Scripps have declined by X in the past six months. Therefore, we will divide by six, and voila! So what happens when we have actually reached a point of stability or, god forbid, a return to price increases? My appraiser’s divide-by-six, looking in the rear-view mirror rule will never recognize the end of this trend, and if the home can’t appraise, even though buyers may be ready to pay more, the prices are being driven (restricted) by the appraisal limitations. It seems like a catch 22.
July 5th, 2008 at 3:02 pm
Kris -
I understand your frustration with the appraisal in this instance - I don’t know the appraiser or the property so I cannot provide comments on his accuracy….. sometimes there are poor appraisals, and there are also poor appraisers out there.
What we’ve been trying to do (with some success) is provide an accurate assessment of the property and the market it is in at the time of appraisal. To do that, we take the last twelve months of sales activity for a market sector from the MLS and import the data to an Excel spreadsheet, which produces a regression analysis and trendline graph. The regression analysis shows the daily rate of change (positive or negative). If the number is positive, it looks like that market (sometimes an individual neighborhood) has stabilzed, and then we can typically decide there are no negative adjustments required. The trendline graph will also show whether the values are still headed downwards or have started to level out.
The current listings also need to be looked at. If all the listings are still heading south and prices have been declining over the last few months, that neighborhood is almost certainly continuing to head downwards.
Here’s another scenario for you…. I have performed quite a few short sale appraisals where the lender wants verification that the pending offer(s) received are truly all they can expect to get. If I just relied on the last few months of closed sales activity, most of the time I would arrive at an answer of, ” the sales price should be higher.” However, if I use regression and analyze the listings, I can arrrive at a much more accurate assessment. A lot of these deals made sense when the comps were time adjusted, and the listings were showing a continuing decline. …..But a few of them just didn’t pencil and there was just no way to hit that low a value.
I have to go back to writing some reports………….
July 5th, 2008 at 6:54 pm
Interesting topic. Yes, tougher lending standards and the recognition of a declining market may cause the market to decline even more. But I understand why the lenders are nervous. It seems like the middle to mid-upper priced homee sales are slowing down (year over year) and are ready for some more squish-down. When we purchased our home four years ago we put so much money down the lender (GMAC) did not require an appraisal. I kind of wish I would have gone ahead and bought an appraisal. I don’t know that it would have caught it, but the seller of my home mis-represented the square footage by about 400 s.f. It was a large custom spec home and I relied on the builder. My mistake to have not indepently verified the square footage.
July 6th, 2008 at 11:39 am
“Smithers makes a very accurate observation”
Go Smithers!
I will push my luck, with one more observation of the obvious:
Prices cannot trend down indefinitely without approaching zero, which is unrealistic. If I can choose between a 5 bd, 3 1/2 ba, fully updated ranch with a pool on a couple of flat, private acres in Rancho Sante Fe, or a tank of unleaded gas, I would buy the house.
However, we can look at historical data on home prices relative to income, and make a resonably decent (but still imperfect) assumption that house prices will trend to back to their historical relationship with income, especially since both of these numbers will reflect (in the long run) inflation. Price bubbles happen, and will happen again. This one got so out of control, the “correction” (that was for you, Steve) will seem crazy. But, eventually, we will probably hit the same price/income curve. Yes, individual houses and conditions will vary….
If I were a lender (and I’m not), I would require a downpayment to reflect, at least, the difference between current “market price” and the historical “market price” tied to incomes at which we are heading. Obviously, Americans cannot be trusted or judged based on their past “creditworthiness”. “I promise to pay you back” means absolutely nothing to too many people out there.
July 7th, 2008 at 1:13 pm
Smithers - I am trying to stay incognito, but since you mentioned my name, you force me out of my self-imposed moratorium. To your point, if more buyers over the past 3-4 years had any amount of money in the purchase (i.e., 10%) I don’t think we would be seeing the current magnitude of those walking away from homes. The fact that so many had little or nothing to lose (monetarily speaking) made the walk-away relatively easy.
Fred: Regarding the monthly 1.5% declining value, I still don’t agree with the appraisal approach. It’s overly simplistic to take a regional or even a community average as the defining parameter when the neighborhood comps for that particular product doesn’t match with it. When you have good supporting data, you can’t just ignore it in favor of a generalized declining %.
July 7th, 2008 at 1:57 pm
Fred,
You write ethically and intelligently about this topic. However, as with all theoretical applications to the real world, your declining value approach casts no doubt to the fact that the theory itself has reached a mathematical limit (Brian says it much simpler), and it seems that the concept of limits with regard to those mathematical interpretations is not understood by either yourself or your colleagues.
Look, I’m not making this up. Even Einstein cried “uncle” when he was unable to completely blend his Theory of Relativity into the Unifying Theory. That is, he didn’t continue to bang his head when the observable facts began to undermine his theories.
This is an exercise in frustration for real estate agents, and rightly so. The dogma associated with declining values just creates a failed theory, and even your articulation of the rationale is insufficient to make the “error” go away.
Come on, cry “uncle” just once, for the sake of all of us who still revere the observable over the theoritical. This valuation of this home was subjected to a dogmatic, theoretical approach, and the concept of a well reasoned “arms length” transaction is now being discounted by you as if we were all crying out that the earth was flat.
We’re saying that the variable you are using in the declining market evaluation must be applied logically, not dogmatically. There can hardly be an argument in support of dogma here. To do so, again as aptly put by some of my colleagues, is professional foolhardiness.
July 7th, 2008 at 2:54 pm
Don — Not gonna happen. I won’t explain why, ‘cuz this is a family blog. But it’s not gonna happen.
July 8th, 2008 at 12:16 am
I guess in the previous stuff I wrote I did a lousy job of communicating. I am not proposing that a rigid set of negative time adjustments needs to be applied no matter the scenario. Tools are only useful if they are applicable.
My comment about “we’ve been trying to do…” was probably construed as a defense of all appraisers… sorry about that one. I was referring to some of the analysis that some guys and myself do that is a little more flexible. Look, if the appraiser of Kris’s deal just applied a 1.5%/month negative time adjustment because that is what the overall rate is, and didn’t look beyond that, that’s taking a hard line.
Let’s say the overall rate of annual decline for attached housing in the Scripps Ranch area is 18%. There are lots of different ways to look at that. Let’s take attached homes that sold for $300K - $400K as a rung of pricing. If I run that through the regression analysis I mentioned, I come up with a declining rate of just over nine percent annually. If the closed sales and listings validate it, that’s what I would use as a rate of decline in time adjusting. Or maybe I would have to dig in farther into it………
I think we can all agree that most areas have some rate of decline going on at this time. And there are undoubtedly appraisers who don’t do enough analysis and just use some overall rate…… “ready, fire, aim!” afflicts every profession, right? If the appraiser applies the same level of decline to Encinitas Ranch that is going on in Village Park (both in 92024, but very different markets), that’s rigid.
What concerns me is the idea that seems to be circulating here that by observing the declining market, appraisers are contributing to the trend. “And if every appraisal used this declining market logic in determining value, how would our market or any market reverse course?” Appraisers just don’t have that kind of power. Did agents object when we used positive time adjustments to make purchase appraisal numbers work in 2004 and 2005? Did our use of them cause the market to keep going up farther than it should have? As soon as the market leveled off, appraisers generally quit applying positive adjustments…. and as different areas begin to stabilize out of this downturn, appraisals will reflect it (or should anyway)….. Uncle……
July 8th, 2008 at 6:31 pm
Your last comment captured me, Fred.
You are demonstrably head and shoulders above your peers.
July 8th, 2008 at 6:37 pm
Fred,
Hyperlink your name.
There are tons of SD originators who would appreciate an appraiser who openly discusses these topics. While we may not be able to choose you after Jan 1, It would be nice to get a cogent explanation when it doesn’t work out
July 8th, 2008 at 6:40 pm
Jeff,
>Fred surprised all of us.
Fred,
>Indeed, hyperlink. You are a flexible professional, apparently not given to much hyperbole, and thoughtful in every way.
July 8th, 2008 at 6:50 pm
You’re right, Don.
One in a row for appraisers.
July 9th, 2008 at 5:28 am
“Short-sales and bank-owned sales do matter. They are “comps” today and, at least in our case, no adjustment was made for the distress nature of these sales.”
We have been warning agents about this for months on end. They simply would not listen! Now they get a quick lesson on reality.
We interviewed Jonathan Miller yesterday and it was amazing what he said about the valuation of homes in this market.
A realtor need not be caught by surprised in this market. They should expect the obvious.
Here in South Florida closed sales mean virtually nothing. We have actives WAY below previous closed and the regression analysis paints an entirely different picture.
July 9th, 2008 at 5:57 pm
Here’s my e-mail address -
please feel free to contact me if I can help with anything.
fbrick2011@yahoo.com
Thanks,
Fred