Saturday , 15 December 2018

Solving the Appraisal Pressure Problem

Appraisal Bias and Appraiser Pressure – Why All Appraisals are Always Wrong

Real estate markets cooled down in the fourth quarter of 2014, and despite historically low interest rates, refinance volumes dropped as well[1]. The increasing pressure on lenders and real estate agents to maintain loan and sales volumes has brought about renewed interest in appraisal accuracy and increasing concern that residential real estate appraisals are inflated.

A recent Wall Street Journal article asserts that “home appraisers are inflating the values of some properties they assess (appraise), often at the behest of loan officers and real estate agents, in what industry executives say is a return to practices seen before the financial crisis.”

This is a legitimate concern. It is widely believed that faulty appraisals played a role in both the duration and magnitude of the financial crisis of the 2000’s. However, faulty appraisals were more enablers of the crisis than creators of it.

The majority of residential appraisers do a great job, but there are some appraisers who lack education, ethics or both, and who are often the target of unscrupulous lenders and agents.

One key reason some appraisers give in to pressure is that they believe that if they do not give in, before long they will have very little work and pressure from real estate agents for the appraiser to simply endorse the contract price is ever-present.

The Appraisal Process

There are three traditional approaches to establishing real estate value: the Sales Comparison Approach, the Cost Approach and the Income Approach; the Sales Comparison Approach is the most commonly used and most widely known. In this approach the appraiser compares the property being appraised to similar, nearby properties that have recently sold using the selling prices of those “comparable” homes as a basis for the value of the home being appraised.

In the Cost Approach to value the appraiser calculates the replacement cost of the structure(s), less any depreciation, then adds the value of the underlying land to develop an estimate of the replacement cost.

The Income Approach estimates the value of the property based on the amount of rent the property might produce. This approach is more commonly used in non-residential properties, and although it has application in residential valuation, historically, there has not been much readily available rental data; therefore most residential appraisals do not include this approach.

Typically, when an appraisal does not support either the contract price in a purchase transaction or the threshold value required to complete a refinance, the blame goes to the appraiser. The predominant complaint is that the appraiser did not use the best comparable sales (known as “comps” in the industry) to support the value.

Responding to Appraiser Pressure

Appraisers are poorly armed to fight back in part, because the appraisal process itself is fundamentally flawed. Since the Sales Comparison Approach is the only approach developed, whoever can more persuasively demonstrate that their comps are the better comps often wins the battle. Some appraisers become battle worn and concede to use the supplied comps in order to conclude the assignment without rendering themselves ineligible for future work by being “uncooperative”.

Part of the problem is that nearly a decade ago the GSEs announced that, with rare exception, residential appraisals no longer required completion of the Cost Approach to value. Since the Income Approach had long ago gone out of use in residential lending appraisals, this left only a single approach – the Sales Comparison Approach. It isn’t so much that the Cost Approach itself was critical, rather, with the Income Approach already gone, what was lost was the only information against which to cross-check the outcome of the Sales Comparison Approach to value.

A primary reason for developing more than one approach to value is to test the reasonableness of any one approach against the outcome of another approach. When multiple approaches produce tight agreement, there is greater confidence that the outcome is sound.  When there is a lack of agreement, one or another of the approaches is most probably flawed.

A single approach to value is risky enough by itself, but when the only approach is Sales Comparison, the conclusion rendered is not a value opinion; it is simply a price opinion. When collateral risk policy is built around GSE form appraisals, every loan is a potentially risky loan simply because the basis for assessing value risk is a price-focused process. Since the entire residential mortgage lending system is built around these forms, the entire system is at risk. Instead of mitigating risk, the current appraisal process actually increases risk.

An appraiser is really a researcher. Fundamental tenets of research require that all aspects of the problem are addressed, and that the researcher’s conclusions are based on sound evidence and logic. Final research results should anticipate and refute counter-arguments before they are raised by others. Results from various methods of research are correlated to a conclusion. In a single approach appraisal research is confined to a very narrow subset of the relevant data; only one answer is returned and there is nothing to correlate.

The price isn’t always right

The concern about appraisal error is currently focused on inflated values. In reality, errors in valuation whether overstated or understated create problems that impact the entire financial system. The problem with identifying appraisal error is that the measure of error is almost always made against home sale prices, which presupposes that the sale price is always an accurate representation of true value. In the Wall Street Journal article cited above, Michael Fratantoni, chief economist at the Mortgage Bankers Association “cited the agreed-upon purchase price among the best measures of a home’s value.” Since other efforts to quantify appraisal error use automated value models (AVMs), I would agree with Mr. Fratantoni that an agreed upon purchase price may be a better measure than an AVM, but only marginally so, and only when markets are very stable.

But what if there is error in purchase prices themselves? My research (The Adverse Effects of Single Approach Appraisals and Single Point Valuations) demonstrates volatility in market prices for residential real estate, even in very stable markets with nearly identical homes. Where homogeneity is lacking, volatility and lack of precision is greater. What if the agreed upon purchase price is a result of multiple offers where the highest bidder’s offer is the agreed upon purchase price? That price is the highest probable price, not the most probable price and does not represent market value as defined in banking regulations. Yet, upon closing, that price is now a benchmark for measuring appraisal error.

Ultimately, there is a clear lack of precision in house prices themselves which makes it impossible to claim that an appraisal is fundamentally wrong simply because it disagrees with a selling price. To the same extent that there is a lack of precision in selling prices, we must accept that there is no such thing as absolute precision in appraised values as well.

How do we solve the problem?

The essential starting point is recognizing and accepting that the marketplace itself is imprecise. Once we accept that premise, we are eligible to address the appraisal process. As long as we impose the idea of a single, accurate value on each property we will be confronted with an unsolvable problem of so-called inaccurate appraisals.

There are several steps that need to be taken to restore confidence in the residential valuation process. The good news is that we now have the data and the technology to take these steps quickly and effectively.

First, the single approach appraisal must be eliminated. The Sales Comparison Approach remains vital, but it simply cannot stand alone. The depth and breadth of building cost data today is remarkable. Coupled with robust analytics available right at the appraiser’s desktop, developing a credible Cost Approach to value is a practical and essential step in the valuation process.

Further, recent interest in single family homes as rental investments, evidenced in part by the creation of the first Real Estate Investment Trusts (REITs) made up of single family homes means that there is a growing pool of data from which reliable income data can be drawn for development of the Income Approach to value for residential homes. A credible Income Approach to value can and should be developed for most owner-occupied homes in the country today.

Not only can we develop the three traditional approaches to value – sales comparison, cost and income – we can also develop new, additional valuation measures because of advancements in technology and the development of new ways to analyze data. Additional, statistically based approaches to value have been developed and can be quickly and responsibly deployed to add considerable credibility to the process. Development of multiple approaches to value allows for testing the reasonableness of each individual approach and reconciling a conclusion that is truly based on evidence and logic.

By expanding the scope of research and analysis beyond just recent sales, the conclusions developed become real values instead of merely a reflection of recent prices. Speculative price inflections can be identified for what they are and value related decisions can be made more responsibly.

Second, the requirement for pinpoint valuations is itself a big contributor to inflated values. Appraisers know that a pinpoint number just a single dollar below the contract price or refinance threshold means that there will be a lot of questions and either direct or implied pressure to bring the number up to one that supports the deal. Non-complicit appraisers are labeled as “deal-killers” regardless of how much evidence they may have to support their opinion.

Allowing appraised values to be communicated as a range (e.g. the value is between $195,000 and $205,000) would remove a lot of the pressure from appraisers and shift final responsibility for the lending decision back to the lender where it has always belonged. The lender can decide where within the value range the loan amount should be pegged based on the additional information only the lender has about the income, assets, credit and character of the applicant. Using a range would clearly illustrate the degree of agreement among the various approaches to value. Simply put, the tighter the agreement, the greater the confidence.

Requiring appraisers to be responsible for a degree of precision in value conclusions that is not achievable in the very marketplace they are measuring puts appraisers in an impossible position. The market silently acknowledges the lack of precision and accepts it now – as long as the error is upward and not truly random, that is, as long as it is not equally spread above and below the agreed upon contract price or refinance threshold amount.

The standard for determining an appraiser’s performance is the Uniform Standards of Professional Appraisal Practice (USPAP). This set of performance standards does not require accuracy or precision of the value opinion; it requires credibility of the value opinion. A range of values based on multiple approaches with support through relevant evidence and logic seems far more credible than a single number that implies all other numbers – no matter how close – are not correct.

For decades now we have known that there is a problem with appraisals. The discussion has always focused on the appraiser, the loan officer, the real estate agent or the appraisal management company. The elephant in the living room is the appraisal process itself.

[1] Cash-out refinances spiked in December 2014 due to unusually low interest rates along with rebounding home prices in many parts of the country.

Have any comments or would you like to submit content of your own. Email comments@appraisalbuzz.com.

Comments

About Bill King

Bill King
William (Bill) King is President and Chief Valuation Officer at Real Info, Inc. Based in Buffalo, NY, Real Info has been providing Automated Valuation Models (AVMs) and automated real estate analytics to national clients since 1995. Real Info provides access to one of the most comprehensive parcel databases containing assessment, ownership and sales data on over 110 million properties. The database serves as the foundation for the company’s real estate reporting, home price indices, neighborhood & sales analytics, and proprietary Automated Valuation Models. Mr. King is a licensed real estate broker and certified residential real estate appraiser in Washington State, and nationally recognized instructor of real estate and appraisal courses and seminars. Mr. King has over 35 years of experience in real estate and valuation; he has served as a forensic expert on valuation and housing issues in local, regional and national cases. In addition, he has taught dozens of appraisal courses and contributed to the country’s most widely used appraisal textbook, The Appraisal Institute’s The Appraisal of Real Estate. He was a key member of the Appraisal Institute for several project teams, and has published dozens of industry-related articles and papers. Mr. King has extensive experience in real estate and valuation technology. He has been a valuation representative to the Mortgage Industry Standards Maintenance Organization (MISMO), consulted with the GSEs on USPAP issues for UCDP, and participated in the creation of the Uniform Appraisal Dataset (UAD). He was a Co-Founder and Board Member of the Appraiser’s Coalition of Washington, Founder, President and Chief Appraiser of ValueOne Appraisal, and Regional Sales Manager for FNC. Prior to joining Real Info, Inc., King served as SVP, Valuation Solutions for Platinum Data Solutions in Aliso Viejo, CA.

Check Also

Industry Involvement Can Lead to Change

For many appraisers, they want to be a part of something bigger. They see the …

36 comments

  1. This guy is out of touch. Must be self promotion week.

  2. One step in the right direction would be to start calling it what it is … LENDER PRESSURE ON APPRAISERS. “Appraiser pressure” is incorrect English and implies a lie that appraisers just make it up out of thin air and there’s no reason for it. Put the responsibility where it lies, ON LENDERS! There is utterly no reason for an appraiser to ever inflate an appraisal except for pressure from lenders.

    • It really is lender pressure and it is lenders who want to peddle the loan to Fannie.

      At this point in our history appraisers should be well aware of who is pressuring them to do what and why. Apparently the pressure hasn’t diminished so the better question is why so many appraisers still enable it.

      Just say no and if you can’t, then refuse to work for the perps. It doesn’t take a rocket scientist to figure that out.

    • Tell it like it is. 🙂

  3. The solution is stopping pressure. The AMC model has created an environment of increased tension. Prior to the AMC, one loan agent out of 15 or 20 clients would try to pressure an appraiser and it was easy to tell that one (5%) goodbye. Now, the appraiser might be lucky to have 2 or 3 AMCs and it is not as easy to say goodbye to 50% of your work. The system is rigged!!!
    Behind the AMC are all the same loan agents ready to dump the AMC for another that will hire the “YES Man” appraiser.

    • …..and many of the AMCs are OWNED by the biggest lenders. All AMCs have done is funnel more control to the lender and pay for it all out of appraisers pockets.

  4. I do like the idea of a range of value. As for Cost Approach, I always run it in my reports however even conservatively that approach has been OVER sales approach for some time now. Not sure how builders make money, I know they get the Land Dirt Cheap, but land prices are rising. Cost approach at least in my area is still a good bit higher than Market or Sales Approach to value.

  5. If the appraisal is suppose to replicate the market participants how is the cost approach a valid indicator of value? Buyers and sellers do not develop a cost approach when buying or selling a house. Therefore, the approach is not valid. I do agree with a value range. Even drug trials allow for a degree of uncertainty.

    • It is on a new construction. Worthless otherwise.

    • The principle of substitution. The buyer would not pay more than the cost of building the house new minus deprecation (of the house being appraised).

      • The market participants are not performing a cost approach when buying or selling a house. Therefore, the approach is not valid. Survey 100 buyers with the question; did you perform a cost approach to determine the purchase price of the house? If they all so no, the approach is not valid.

  6. One key reason some appraisers give in to pressure is that they believe that if they do not give in, before long they will have very little work and pressure from real estate agents for the appraiser to simply endorse the contract price is ever-present—-Those appraisers would be right. Miraculously I have lost 3 AMCs clients to this very reason. Refi, ok, not matching the purchase price, bye bye.

  7. It use to be if you worked for ABC, 123 and XYZ mortgage companies they became your bread and butter. You ran into a property that there is no support for “what they needed to make a loan.” The appraiser advises ABC, 123 and were told: If you cant get that value, we’ll find someone who can. That’s your bread, butter and the market was going up….So? Then the bubble burst. Prices fell, values fell too. NOW thanks to “Frank-Dodd” instead of ABC, 123 “mortgage companies.” IT HAS NOW BECOME ABC, 123, & XYZ – AMC’S doing the banks leveraging. The AMC charge the banks a fee for their services. Offer the appraiser the work and take a cut off the top of the appraisal fee. $595 charged to the owner/borrower/buyer. Then offer $325 to the appraiser cutting themselves in for 46% of your work. Smiling all the time. Then the AMC has the audacity to tell you your fees are too high. If you’re thinking of becoming an appraiser: DONT. FLEE. Find something else, anything else.

    • We need to come together and unionize. Imagine the industry if every appraiser stopped working for 1 month. AMC would be kicked out of the equation or maybe we might. But I can’t stand the thought of splitting my fee with some administrative worker. Like yousaid, who has the audacity to tell me that 425 to 500 is a high base fee. Sorry jackals I get that from my direct lenders so in essence your fees are grossly underorice. (Referring to AMC)

      • We are our own worst enemies. The banks and the AMC’s laugh at us. The banks get together and set interest rates, so why not us? You and I agree to set our fees higher. There will be Andy and Alice Appraiser who will say: go ahead increase your fees. I’ll get your business. Mass collusion is needed. But there are laws against us from doing just that. Why is that?

        • Colluded has such a negative connotation. I would say unionize but that’s also become negative as well. I think it’s because if the industry as a whole decided to team up, we could ruin the mortgage industry. I’m not.going to assume anything, but are you sure it’s illegal? You’re right, we are the butt end joke of the industry. What are your ideas to bring forth change stigma wise and professionally?

          • In Hawaii and Maine the appraisers did get together and stopped accepting work from the AMC. They screamed, cried, whined but PAID the higher fees. Know where they are applying pressure to make up their losses? The other 48 states. The problem is “Alice and Andy Appraiser” Who won’t go along with standing up and demanding higher fees. Lets forget scope creep and more demands, more rules, more regulations, higher taxes, continued education, research costs and on and on costs go. Until you join an appraisal group (SRA, MIA, IFA etc.) and stand up collectively. We are as I said: Our own worst enemies. They are still paying (AMCS); what they were when I started back in 1996!!! If I knew then what I know now. I would have stayed in communications.

        • There are NO laws against a mass boycott however.

          • Your attention is invited to the problem that wont be resolved: Alice and Andy Appraisers. Under cutting appraisal whores.

  8. Imprecise and heterogeneous markets…. inherent pressure on appraisers to inflate values…. reliance on single approach to value …. a “range of values” would give more reliable indications …. sounds a lot like someone who favors replacing an appraiser’s rationale and judgement with something like a cascading array of valuation modeling scenarios based on user-defined risk parameters.

  9. So as I was reading this, I felt like I had been time-warped back to 2008. It’s the same talking points, just another year. The problem is that no policy or protocol can ever end “pressure” on appraisers. It is intrinsic to what we do. As long as someone has a stated goal or outcome, then an appraisal will play the role of spoiler or deal maker. In 24 years of appraising, I can tell you the solution was, is, and always be our liability. We can talk all day about knowledge, expertise and ethics (and they are all important) but the liability we have is the only guaranteed thing that will keep any professional on the straight and narrow. Weighing our risks of lawsuits, fraud charges, State sanctions, lender approval, license revocation, a maligned reputation, and countless others are what really determines the path we take. Liability is the appraisers best friend and most valuable asset. It’s what distinguishes us from every other valuation product.

    • I agree to some degree. I appraise every file like it’s got a chance of going to my state board. It’s frenetic ally paranoid but it keeps me from getting lazy. But I think the real answer is not liability. I think it’s true competency. I still don’t think many appraisers know the nature of buyers in the markets they are appraising. What do you think.

      • I would certainly agree that we can never cease in our pursuit of increasing competency. I’m just not convinced that is the core of our problem. The checks and balances that I referred to as our liability have weeded out many bad apples over the years even though there will always be some who survive in an imperfect world. The business model that was forced on us by regulation is driving some of the best appraisers out of the profession. That could contribute to some reduction in competency but probably not enough to cause these boom and bust cycles we always seem to be blamed for.

        • How much of the boom and bust is directly related to financial regulations. Lower interest rates, raise interest rates. The banks have the ultimate say on how the real estate market goes because they are responsible for buyers financing capabilities. I know this will never happen but the true market can happen if we eliminate financing. Imagine if every home purchase was a cash deal. How much more would a buyer and seller really have to engage in negotiations and do their respective diligence. Mortgage financing is a contribution to boom and bust. Would there be financial crisis’ if everyone who bought a home was a cash buyer. Also, how much more stable would home prices be. Farfetched idea but a true solution to the problem.

        • And one more thing. This would allow the appraiser to take on a legitimate role in the market being a consultant to a buyer or seller. Rather than filling out arbitrary information that any person who has the internet has access to.

  10. Isn’t this the moron who wrote a stupid article months ago regarding why his 15 year old home with no updates rated a C2 condition? The criticism of his article was astounding.

  11. I’m not exactly sure what markets this guy is specifically talking about. Talk about speaking in generalities. I’m a Los Angeles County appraiser, more specifically, the San Gabriel valley. I’ll tell you that we’re not inflating appraisals, we’re reporting what the market is doing. It’s not our fault that the market was flooded with increased capital capacity from all the foreign investors flooding our local markets. They came in and jacked up the prices by negotiating 10, 15, 20% above listing prices consistently for over 18 months consecutively. A majority of the increases came from top tier markets with mid and lower markets stabilizing earlier than the superior markets. I don’t understand this guy’s perspective note the wall street journal article he’s referencing. Any appraiser worth his grain of salt should understand the improved number of tools out there to support value. The correction comes when the foreign buying contingent drops off considerably and the typical 30 70 financed buyer becomes the norm again. If an appraiser is specifically inflating values for any reason, they shouldn’t be in the business to begin with by producing faulty CMA type appraisals. Why would an appraiser ever feel pressured by an agent? If they give me comps, I’ll look them over and sometimes they have access to information we don’t have but more times than not, I’ll have access to the same data. The fact is, our industry is full of incompetence and appraisers that say they have competence county wide. Are you kidding me? How can you have full comprehension of buying patterns of over 100 markets? I know my market because I am centralized and maybe my work volume isn’t high, but I get great fees working with direct lenders. There needs to be a legitimate hedging of our industry and incompetent far-stretched appraisers need to be expelled from our industry aND we need to make sure there are incentives for training new people into the business. It’s been a good Ole boys system for too long. There shouldn’t be finger pointing for high appraisal values when the market supports it. And conversely, there shouldn’t be finger pointing when prices correct.

  12. It appears that the only way Bill King can promote himself is to attack the honesty of every appraiser in the country. This guy has some nerve glorifying himself at the expense of the appraisal industry’s credibility. Certified or not, he is not a true appraiser. He’s an AVM geek at best. And whatever you do, don’t take his classes or buy his books.

    • The honesty of every appraiser is on the line every time a report is delivered. Just read USPAP and you’ll understand why.
      Unfortunately the race to lower fees and quicker turn times is one that many appraisers willing join and it has become the basis of competition for appraisal work. Few appraisers compete on the basis of quality, and even fewer insist on contributing to the terms of engagement. That has resulted in legitimate doubts of whether the profession has credibility.

  13. Appraiser pressure, like Collateral Underwriter violates an Appraiser’s independence,
    which is an outright contradiction of USPAP. The Ethics Rule of USPAP (see pg. U-7)
    mandates that an appraiser must perform assignments with impartiality, objectivity and independence. How can someone ask you to revise a rating, an adjustment or comp selection without violating your independence? Why am I taking USPAP every two years?Why aren’t the USPAP fanatics screaming at the top of their lungs about this?

    • Dodd-Frank has no carve out for lenders or AMC’s to place guidelines on appraisal orders. The fact that many require you to comment as to why you could not meet their guideline is a direct violation of the Appraisal Independence section of Dodd Frank. If your board regulates AMC’s you should file a complaint with them against the AMC.

Leave a Reply

Your email address will not be published. Required fields are marked *