Making Appraisers the Scapegoat

Dennis Norman St LouisIt seems we always need to find someone to blame for our problems…

When it comes to the meltdown in the housing market that has taken place over the past three years there has been no lack of finger pointing by many inside and outside the industry as to factors that either caused or contributed to the collapse of the housing market. Sub-prime lending, Wall Street, mortgage fraud, the mortgage industry, banks, community reinvestment act, real estate brokers and agents, fannie mae, freddie mac, federal government over-regulation, federal government under-regulation, appraisers, unemployment, the economy in general, “flipping”, sellers, buyers and more have been blamed in one way or another for the collapse. In my humble opinion and, based upon my 30+ years of experience in the industry, I would say all the aforementioned played a part in the collapse and certainly no one thing could have caused this mess on its own, it was a combination of several things that led up to the “perfect storm”.So why then is the media so quick to point their fingers at appraisers and basically blame them for not owning being responsible for the collapse but holding back the recovery as well? I’ve noticed in many articles as well as news stories on television that appraisers are frequently blamed for over-valuing homes during the boom times and being coerced or pressured by sellers, real estate brokers and lenders to put artificially high values on homes during the boom, leading to a collapse in the market once the reality finally hit that homes were not really worth what the prices had been run up to. Recently, in the Fox News video shown below, in addition to the aforementioned, appraisers are being accused of now low-balling sellers on value and thereby stalling the recovery of the housing market. Wow, talk about how you can’t win for losing…

If only it were that simple…..

During the boom years that lasted through October 2006 according to what I saw in the market, I had much concern about home prices that were rising faster than inflation and wondered how this could ever be sustained long-term. What I saw wasn’t being driven by appraisers however, what I saw was, in my opinion, being driven by primarily an abundance of “easy financing” for homes, readily available to just about anyone that wanted it.

“Everyone was drunk on real estate”…

An abundance of “new” types of mortgages became available making it easier and easier for existing homeowners to borrower more of the “equity” out of their existing homes, move up to a bigger, more expensive home as well as for first-time buyers to buy a home. Things that used to be important, such as good credit, steady income and having cash for a down-payment became less and less important. I remember the day I heard that there were “no doc” loans available to people with under a 600 credit score I laughed and wondered what had happened to the lending industry.

There was also an abundance of easy financing available for investors to buy property to resell it at a profit and for builders to develop new subdivisions and build new homes (I’m speaking from experience here). I saw new banks pop up that were begun with the idea of growing the bank almost exclusively through making real estate loans.

I had spent my entire adult life as a real estate “speculator” and investor so I was used to taking risks and took risks that most of my friends and acquaintances wanted nothing to do with. That is, until the “boom”….suddenly it seemed everyone was an investor or speculator and “flipping” real estate became part of the daily conversation for many people that before the boom didn’t invest in anything riskier than a CD. The allure of fast, easy profits from the quickly rising market and the easy access to the loans to enable one to jump into the market caused many to be blinded from reality by greed.

I remember two events that happened in 2006 that caused me concern about what was pumping up the real estate market. The first was when a restaurateur friend of mine in St. Louis (a very successful and conservative one) told me about the building lots he and a partner were buying in Florida to “flip” at a profit. I remember sitting there thinking “has this guy lost his mind?” I told him if he was looking to invest in real estate I could certainly help him do that in his own market but I thought investing in building lots he had not seen in Florida was risky. He then trumped me by telling me that they had already flipped one of the lots at a big profit and was close to selling the remaining one. The second event was when I was at a meeting and a lady I know that is a manager of a successful real estate office told me that she had just signed contracts to buy two condos in Florida sight unseen in a building that was going to be built soon. When I asked what she was going to do with the condos she said her friend in the business in Florida told her she wouldn’t have to close on the purchase that, before the building would be completed, she would be able to “sell” her contract at a tidy profit as the values would increase before the building was done. In both instances I remember thinking how silly it was to be buying property at full value expecting the value to rise so quickly that you could profit from it by the time you had to close on the purchase….basically sound like the “greater fool theory” to me…scary thing is it was working.

So how do appraisers fit in to all this? And why are they not to blame?

I think what I have illustrated here shows that greed and readily available, easy to get financing, were major factors in the meltdown. Now, I could write a book about all the factors that led to readily available financing, but I’ll just stick to discussing the role appraisers played in all of this. So what was their role? If the appraisers job is to put a value on a home and ultimately that value is too high, shouldn’t we blame them? Lets look at how appraisers were told to establish values to answer this question.

There are three basic methods appraisers use to establish the value of real estate: market value, cost approach or income approach. For homes and condos, which is what I’m really focusing on, the market value is the method typically used. So what is the “market-value” and how is it established? If I were an appraiser I could go into much depth and detail to explain market value but the short definition is it is basically what a buyer is willing to pay, and a seller is willing to sell, a property for in a normal, arms-length transaction.

The way this works is that when a property is sold, the lender requires that a copy of the sale contract be given to the appraiser before the appraisal is done. If the appraiser is supposed to be determining the value, then why do they need the contract? Ah, good question, but it goes back to the definition I gave….they need it to know what price the market will bear… other words, what price did the buyer and seller agree to? Wait, if the value is simply the price it sold for, what do we need appraisers for anyway? Because basically “one sale does not a market make”. In other words, an appraiser is not to base his opinion on just the one sale but also look at other recent comparable sales in the market to make sure the current sale price is supported. For the standard appraisal form, three “comps” are used.

“Domino Effect”

With the appraisal process in mind it isn’t hard to see how values in a rapidly moving market can get out of whack even if appraisers are doing their job correctly. The reason I say this is, because of the nature of the “market-value” process, all it takes are a couple of higher priced sales in a neighborhood to then bring the prices to a new level, then a couple of more sales at higher prices and new comps are born supporting yet higher prices. Since these new, higher prices, wouldn’t occur without ready willing and able buyers, they are basically market driven, not appraiser driven. Now this takes me back to where I started….the word “able” is significant….the buyers wouldn’t have been “able” to buy in many cases without the easy financing. Should appraisers have realized that the abundance of easy to get mortgage money was driving prices up and refused to accept all the current sales as indications of market value? Sounds good on paper, but I think that is not realistic…

Now let’s blame em for being conservative…

Simple question…you’re an appraiser. You’ve been bashed and blamed for causing the housing meltdown…for being sloppy, careless and caving in to pressure from sellers, real estate agents, etc. The federal government has stepped in and passed legislation that protects you, but also puts you under additional scrutiny. Oh yeah, not to mention you are working in a market that has seen decreasing home prices for the past couple of years and no one is quite sure if prices have hit bottom yet….not to mention one-third or more of the sales are foreclosures and short sales Are you going to perhaps be a little conservative when putting a value on a home? I hope so…this is no market for anyone to be aggressive in. I tell sellers that and buyers that. However, now appraisers are being bashed for being too conservative…go figure.

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