There have been a lot of anecdotal stories lately about how appraisals and appraisers contributed to the real estate meltdown and are currently preventing the market from recovering. Your friends at www.condosaletrends.com (A certified general/certified residential appraiser in Colorado and Florida with 25 years of experience) would like to clear up some misconceptions.
There are many implicit rules involved in the real estate investment arena. Two of my favorite are, “If you want to be successful, you have to play by the rules of the ball park in which you choose to play” (according to Harvey Mackay, a management guru) and “If you get all of your information from someone whose compensation and career success are contingent on a particular event happening, you can be assured that their information will be skewed toward that event actually happening”.
Appraisers are required to follow a strict set of rules required by various professional appraiser organizations, mortgage companies, banks, and the state and federal government. If an appraiser does not follow the rules, he could lose his license, be fined, or even go to jail. The appraiser is supposed to be independent of the various parties who stand to benefit from the real estate transaction.
One of the major rules is the definition of current market value, which is lengthy. For civilian use, the definition is basically the highest price that would attract a buyer during a given marketing period. The market (buyers and sellers) always sets the current market value of a property. There is always a buyer at current market value. The market is a heartless and unruly beast.
The appraiser’s job is to estimate a reasonable sale price as of a particular date, assuming the property had been marketed and available for purchase during a specified marketing time previous to the date of value. For example, an appraisal of a condo with an effective date of value of July 1, 2009 would assume that the property had been listed for sale in the local MLS for a reasonable marketing time.
Let’s say an appraiser was asked to appraise a 1BR/1.5Ba condo over at The Summit building as of July 20, 2004 that had a contract for $280,000. The graph below shows actual sale prices of this type of unit from 1/1/2004 to 7/1/2004. The graph shows an increase in sale prices of 35% over the six month period or around five per cents per month. The $280,000 sale price is around 3.7 percent above the last sale of $270,000 on July 1, which is within the relevant price appreciation range. Suppose the appraiser had included in the report that this rate of sale price appreciation was unsustainable and a price correction was inevitable and concluded a value of $270,000. There would have been howls of protest from the real estate agents, the buyer and seller, and the mortgage company. The appraiser would have never received another assignment and would have had to look for a new line of work. According to the rules, the appraiser is supposed to estimate a realistic sale price as of the date of the inspection based on closed sales. In this case, the estimated value based on the historical evidence of the past six months would have been $280,000. It is the responsibility of the lending agency to evaluate the risk associated with excessive price appreciation, not the appraiser.
There are many culprits in the current housing predicament. Certainly there were appraisers that came in at the contract price no matter what. Real estate agents whose primary motivation was getting a sale to obtain a commission. Loan officers whose primary motivation was closing a loan in order to obtain a commission. Bankers who needed loans to sell as mortgage backed securities. And not the least, elected federal officials who needed to buy votes. The guilty parties will be explored in a future post.
Let’s fast forward to today. Suppose an appraiser was asked to appraise a 1BR/1.5Ba condo over at The Summit building as of 1/1/2010 that had a contract for $150,000 with a 95% loan of $142,500. The graph below shows actual sale prices of this type of unit from 9/1/2009 to 1/1/2010. Only two of the sales were bank related. The non-bank related sales had an average sale price of less than one percent above the bank related sale prices. The highest priced unit since 9/15/2009 was $140,000. Based on the closed sales over the past four months, the appraisal should reflect a value of around of $140,000, $10,000 below the contract price. Again, howls of protest from the real estate agents, buyer and seller, and loan officer. The appraiser is accused of killing the sale and impeding the housing recovery.
A closer look at the contract reveals the seller is paying six points (6% of the loan value) or $8,550 toward the buyer’s closing costs. Based on letters to the editor in the Florida Association of Realtors newsletter, the real estate sales community considers six seller paid points as a legitimate concession and should not affect the contract sale price. One to two seller paid points are not unusual, but excessive seller concessions artificially increase the sale price and borders on fraud. In this case the buyer is giving the seller an extra $8,550 in sale price and the seller gives the buyer the $8,550 back at closing. The real sale price is $150,000 minus the $8,550 or $141,450. If an appraiser is found that makes everyone happy and comes in at the contract price of $150,000, the buyer gets his loan of $142,500. The mortgage company thinks it has a buyer with five percent skin in the game when in fact the buyer gets a 100% loan, plus $1,000 in his pocket. The MLS reports a market-rate sale at $150,000 and the market has just been artificially inflated by six percent. As a side bar, the Panama City MLS does not require realtors to report seller concessions. The reason for the excessive seller concessions in this case is the buyer did not have the five percent required down payment. The sale price was artificially inflated in order to scam the mortgage company into financing the buyer’s closing costs so the sale could close, and commissions could be spread around. Fortunately, the appraiser reported the transaction in a factual manner according to the rules and the sale did not close. Of course the appraiser was soundly beaten about the head by the real estate agents, the loan officer, and the seller for low-balling the appraisal, killing the deal and single handedly preventing the recovery of the housing market. However, the taxpayers and the mortgage company were appreciative.
Excessive seller concessions are not always as apparent as seller paid points. I have come across numerous examples of sellers paying one year of Home Owner Association fees. For a condo with $400 to $500 per month HOA fees this amounts to around $5,000. And then there is the value of the furnishings which is usually included in the sale price of condos. Mortgage companies generally prohibit the value of the furnishings to be included in the sale price. That’s another $15,000 hit. You can see where this can get ugly fast.
In a declining market such as ours or even in a stable market, it is almost impossible for an appraiser to conclude a value much above the highest sale price of a similar property over the past three or four months. If we ever reach the bottom, buyers will have to assume the cost of the risk associated with being the first to purchase at higher prices. The cost of that risk will be higher down payments and appraised values that are less than the contract price. You can’t expect appraisers to make adjustments for appreciation until there is some evidence that prices are really increasing.
I hope my Realtor friends are not offended. This is just a little payback from all of us ***$$@@!!%$%% appraisers who are accused of killing deals and keeping the market down. There is always another side to the story.
As always, check more details at our blog at www.condosaletrends.com/blog.
By Sam Portman, Recovering Appraiser