Tuesday , 29 September 2020

Appraisal Creep – An Interview with John Wake

Appraisal values should not be influenced by the price of the listing, but could a bias exist that proves otherwise? “Does the typical appraisal protect you from overpaying for a house?” asks John Wake in his article, The Hidden Reason Why House Prices Are Too High (And Income Growth Is Too Low) — Appraisal Creep. We sat down for an interview regarding his article on the Fannie Mae study and further topics such as confirmation bias, the real estate bubble, and much more.

Buzz: Could we please have your professional background?

John: I have an M.S. in Agricultural Economics. I worked for USDA in Washington D.C. first as an expert on imports and exports statistics, then in trade policy, and finally, as an Agricultural Attaché at the American Embassy in Paris. This was before returning home and getting a job for several years at the Arizona Department of Agriculture.

In 2001, I taught myself Perl and HTML and created an email newsletter that published the official sale prices of houses sold in metro Phoenix by zip code. It was sort of a mini-Zillow created four years before the real Zillow. I had over 15,000 weekly subscribers, but no real estate agents wanted to buy ads in the new-fangled email newsletter. Readers thought I was a real estate agent, so I became one. That worked well because I had lots of online leads and I was on the Arizona Association of Realtors, Technology Committee, for a few years.

I also got a front-row seat to the Great Real Estate Bubble. I’ve had a lot of internet real estate related projects, including, ArizonaRealEstateNotebook.com and Best of Real Estate Video. Since 2015 my main focus has been on RealEstateDecoded.com and trying to figure out what the heck happened during the real estate bubble. I’m also active on Twitter at @JohnWake.

Buzz: Could you please elaborate on the Fannie Mae study?

John: I first learned about the Fannie Mae study watching a video from the 2017 AEI-CRN Housing Conference where one of the authors summarized the study very well.

The study looked at houses where two appraisals were done, one after they were foreclosed on and Fannie took ownership, and a second appraisal when they were under contract. Both appraisals were done within 6 months of each other and no repairs were made to the houses in the meantime. After adjusting for general house price appreciation between the first and second appraisals, the study found the second appraisals were 4.2% higher than the first appraisals.

In addition, the first appraisals had more of a normal bell-shaped distribution with about half of the appraisals being below the eventual contract price. However, the second appraisals were sharply skewed to the contract price or above with only 7% below the contract price.

Buzz: What is the final conclusion that was reached and what does it mean to future markets?

John: The conclusion was that “Appraisal Bias” (AKA “Confirmation Bias” or “Contract Bias”) exists and it’s large.

Buzz: How does this contribute to “Appraisal Creep?”

John: My worry was the macroeconomic impact of this creeping up in appraisal values. The higher second appraisals suggested that house sale prices increased faster than otherwise. Even if the economic fundamentals were flat, this “appraisal creep” would naturally cause house prices to creep up unnecessarily until a lot of buyers were priced out of the market.

Buzz: Are there ways in which this can be slowed or prevented? In what ways can we combat “Appraisal Creep” in the future?

The study made a few suggestions. The one I mentioned in the Forbes.com piece was not giving the appraiser the contract price. On one hand, the contract price holds a lot of information in it. On the other hand, releasing the contract price seems to skew the resulting appraisals a lot.

Remember, the appraised value in the first appraisals (done without knowing the future contract price), on average, ended up being very close to the ultimate contract prices. It was the second appraisals that were way off, on average.

If they didn’t release the contract price to appraisers, a lot more appraisals would come in below the contract price. That would help some homebuyers, but it would be a lot more work for everyone else and it would kill more deals late in the process after everyone has invested a lot of time into the deals.

Buzz: How can appraisers do their part to be conscientious?

John: I don’t think of this as being a problem with appraisers. I think it’s a problem with the current mortgage system.

Ideally, among a lot of other things, I’d like to see a system where buyers can get their own appraisals done during the inspection period – if they want – without having to pay their lender for the lender’s appraisal later on. If the buyer provides an appraisal to the loan originator, the originator shouldn’t be allowed to charge the buyer for another appraisal. If the lender wants or needs their own appraisal, fine, the lender can pay for it themselves.

A more basic problem is all of the hand-offs in the current mortgage system. When, say, five different entities are involved in (securitizing) mortgages, does that make the mortgages five times safer or 20% as safe? The game seems to be to ignore risk, hide risk, and push off risk onto the other players as much as possible.

I suspect that when lenders hold and service the mortgages they originate, appraisal bias is much smaller. I’d say, the problem isn’t appraisal bias, the problem is the design of the current mortgage system that creates appraisal bias. Appraisal bias leads to selling more and larger mortgages and appraisal price creep leads to selling larger mortgages with fewer foreclosures.  At least until house prices become so high that sales and prices weaken.

Buzz: Why should appraisers care? How can they influence others to care?

John: It seems the only thing the real estate industry can agree on besides, “Now is a good time to buy!” is that whenever there’s a problem, it’s the appraisers’ fault. I’m thinking of the origins of AMCs. Currently, homebuyers are paying for the lenders’ appraisals. Why can’t buyers pay for their own appraisals instead? Can we change the mortgage system from being bank-centric to being homebuyer-centric? Probably not. It’s a mortgage system, it’s not a homebuyer system.

I know that lenders are the main market for appraisers, so this idea is impractical. However, I think there would be advantages to the whole economy if we could somehow shift from using appraisals to protect lenders first and homebuyers second to using appraisals to protect homebuyers first and lenders second.

Thank you for answering our questions.

Have any comments or would you like to submit content of your own? Email comments@appraisalbuzz.com for more information!

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