One of the first things we are taught when learning real estate appraisal is the age-old adage, Location, Location, Location.
What should also immediately follow that statement is that real estate markets are dynamic, seldom static and almost always in transition, with property values either increasing or decreasing.
Numerous lenders are reporting that appraisers are identifying increasing prices and supply shortages in the Neighborhood – One Unit Housing Trends section of appraisal reports but not adjusting dated sales for differences in market levels from the contract date of the sales to the market levels as of the effective date of the appraisal. This is problematic. It impacts everyone involved in the transaction and in some instances, actually resulting in complaints being filed against appraisers.
The reason I say this is because failing to adequately analyze and report market trends is one of the most frequent deficiencies noted by several state appraisal boards and the GSEs. It is also a USPAP violation.
USPAP, Standards Rule 1-3 states:
“When necessary for credible assignment results in developing a market value opinion, an appraiser must: (a) identify and analyze the effect on use and value of existing land use regulations, reasonably probable modifications of such land use regulations, economic supply and demand, the physical adaptability of the real estate, and market area trends…”
The intent of this article is to remind everyone the significant importance to ensure your Scope of Work includes an in-depth analysis of your local supply/demand and market trends, especially in markets experiencing rapid increases in sales prices, reductions in available inventory, reductions in days on market (DOM) and sales prices at or above the initial list prices (%SP/LP).
The Appraisal Practices Board (APB) of The Appraisal Foundation published APB Advisory #3 in 2012, Residential Appraising in Declining Markets, providing guidance on how to appraise a property in a declining market. The analysis process utilized in a declining market are also applicable in an increasing market so I thought it appropriate to highlight some of the key elements of that Advisory.
A Market vs. A Neighborhood
We start with the distinction between a Market and a Neighborhood.
A neighborhood is a grouping of complementary land uses. This is a geographically defined term and therefore could include residential, commercial and even industrial uses within the neighborhood.
A market study is focused on competing properties. Therefore, a market analysis need not have the same geographic limits as the neighborhood. When defining a market, it is important to use parameters that include competing properties and exclude noncompetitive properties. The market area may be more important than the neighborhood. This might result in utilization of comparable data located outside your defined neighborhood, and yes, it will require justification and commentary in the Sales Comparison Approach comments but is acceptable within appraisal practice when an insufficient population of competitive market data is not available within the defined neighborhood.
Our analysis of competitive market data should be more focused on identifying the subject market which might be encompassed within the identified neighborhood, but not necessarily.
Recognizing the characteristics of an appreciating market.
Most appraisers can identify the indicators of an appreciating market. However, many have trouble interpreting the indicators and then deciding when the indicators lead to a conclusive identification of an appreciating market. Some characteristics of an increasing market are as follows:
- Undersupply of competing properties (i.e., supply and demand are out of balance).
- Reduced marketing times for active, pending and closed sales.
- Prior listings of the subject that reflect list prices lower than the current contract, sale price or value.
- Prior sales of the subject and/or comparable sales that reflect lower prices than current prices.
- Increase in sale prices as a percent of list prices.
- Decrease in REO and Short-Sale listings in neighborhood.
The presence of only one or two of the indicators from this list would not necessarily be enough evidence to confirm an appreciating market, however, the presence of several or all of the indicators would be a strong indication that the market is appreciating and appropriate analysis and adjustments for date of sale/time to comparable sales becomes necessary to produce credible assignment results.
Quantifying Market Adjustments in Appreciating Markets.
When a market has been identified as appreciating, appraisers are tasked with identifying and supporting appropriate adjustments to any dated sales used in the appraisal. Analytics include:
- Tracking over time the median sale prices in a defined market segment (e.g., 1004 MC form).
- Researching and calculation of rates of change from sales and resales of the same properties.
- Tracking over time the Days on Market (DOM) of comparable listings or comparable sales.
- Tracking over time the sale price to list price ratios (SP/LP). The assumption is that diminishing discounts from list price to sales price are a reflection of motivated buyers willing to pay prices higher than previous sales.
- Tracking over time the number of REO/Short Sale properties. The assumption is that REO/Short Sale properties adversely impact property values within their respective markets. As the number of REO / Short Sale properties diminish, that negative impact diminishes, thus improving the market appeal of the other properties in the market.
Sales Concessions and Property Condition
In addition to the traditional market trend indicators noted in the list above, other indicators that help to distinguish whether the market being analyzed is a Buyer’s Market or a Seller’s Market include the existence or absence of seller concessions and whether property condition impacts marketability.
In a seller’s market where a high level of competition exists, seller concessions will either be non-existent or very minimal. This is in contrast to a buyer’s market where an abundance of competing properties exist and sellers are motivated to offer concessions to stimulate contracts.
Also in a seller’s market where a high level of competition exists, buyers are less likely to write contracts that include repair of deferred maintenance or replacement of older appliances/fixtures for fear a competing buyer will not require the repairs and gain a competitive advantage in the bidding process.
This is significant for appraisers to appropriately analyze and recognize such trends to prevent making condition adjustments the market is not recognizing as of the transaction dates.
When appraising a sale, appraisers are reminded the subject is also a market transaction / agreement that occurred between a willing buyer and a willing seller and has also just become a pending sale comparable within that market. This is especially significant when it is the most recent sale in an escalating market and as a result is the highest sale of directly competing properties in that market.
The tendency might be to appraise a sale at a value that is no higher than the highest previous comparable sale. However, that might result in a deficient analysis and reconciliation and even be misleading if the sale price is consistent with the market trend,.
- Subject was listed for $305,000, is in contract for $300,000 after 12 Days on the market.
- Sale 1 was listed for $300,000 and sold for $295,000 three months ago after 15 DOM;
- Sale 2 was listed for $289,000, sold for $285,000 five months ago after 20 DOM;
- Sale 3 was listed for $280,000, sold for $270,000 seven months ago after 25 DOM.
- There is a pending sale that listed for $300,000 and sold for an undisclosed price after 5 DOM.
The highest previous sales price is $295,000. However, based upon the sales price trend, reduction in DOM and increase in SP as a % of LP, the $300,000 appears to be consistent with the upward market trend and could be supported in an appraisal (all other things being equal). The point of the demonstration is to remind everyone to not get “boxed in” and let the data tell you where the market is at and reconcile accordingly.
Taking Advantage of Technology
Most multiple listing services have programs that an appraiser can use to conduct a market search then transfer the results to an Excel file to develop the analysis of market trends on a monthly or quarterly basis.
Within the past few years several software programs have been developed to assist appraisers by electronically analyzing several months of historic sales data, producing the results in significantly less time than using Excel spread sheets or other manual processes. The acceptability and use of such programs has increased as their ease of use and user-friendly functionality continues to improve.
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