Appraisals cost money at a time when the Internet is driving the price of information toward zero
The real estate market has had a good run during the past few years, but for one group the story has been different. Appraisers are facing tough times. Their job numbers are in decline, business is being lost to high-tech competitors, management companies are cannibalizing fees, and HUD has questioned the accuracy appraisals provide. To make matters worse, federal regulators have proposed new rules to make residential appraisals unnecessary for huge numbers of transactions.
The oddity is that no one doubts or denies the importance of independent valuations. Instead, appraisers are losing out to new technologies, lower costs, and faster prep times. The need for valuations is there but that need is increasingly filled by big data and artificial intelligence (AI).
Theory vs. Reality
Appraisers are at the center of the lending process. Lenders and borrowers hire them to prevent two forms of financial tragedy: over-lending by mortgage lenders and overpaying by real estate buyers. Lenders don’t want to put up more cash than they should and thus increase their risk if a property must be foreclosed. At the same time, we don’t want buyers to pay inflated home prices as a result of innocence or exuberance.
Proper valuations surely benefit the lending system in general but when it comes to individual transactions the view is often different.
First, appraisals cost money at the very moment when borrower funds are likely to be tight. No doubt many residential borrowers would be perfectly happy to avoid $500 or so in appraisal expenses.
Second, while there’s a lot of talk about the need for accurate appraisals, the real goal in many transactions is simply to finish the deal and get people paid.
If the appraised value is less than a property’s sale price then contract terms will need to be “modified,” a polite term that means maybe the price goes down or the buyer finds more cash. Or both. If the parties cannot make adjustments then the deal can end, suddenly and unhappily, forcing everyone to start all over again. There will be no sale dollars for sellers who may have a contract to purchase a replacement property. There will be no dream house for buyers, no commission for brokers, and no fees for lenders. A whole bunch of people are likely to be very unhappy with a low appraisal, even one which is unquestionably on target.
“A real estate appraiser who submits an appraisal that is under the contract price knows the potential consequences,” explains Isaac Peck, writing for Working RE. “In addition to pressure and harassment from homeowners, agents, and Appraisal Management Companies (AMCs), appraisers also run the risk of being branded ‘deal killers’ and losing both lender and AMC clients; a high price for simply doing one’s job – performing accurate, unbiased appraisals.”
Comparative Market Analysis (CMA)
Like other professions, appraisers have marked off their territory. You need a license to be an appraiser. You can’t get a license without training and experience. You cannot sell an “appraisal” unless you’re a licensed appraiser.
Real estate brokers can offer a Competitive Market Analysis or a Comparative Market Analysis (known generally as CMAs in either case) estimating the listing or purchase price of a property but they can never call it an “appraisal.”
Real estate regulators routinely require plainly-written CMA disclosure statements so that no one misses the point. Maryland, for example, says real estate licensees “may prepare a competitive market analysis of a specific property for a client, prospective client, or customer. The analysis shall include the following statement printed conspicuously and without change on the first page:”
No matter how well done, lenders will not substitute a CMA prepared by a real estate licensee for an appraisal. That’s because the CMA is produced with the intent of helping someone buy or sell property, actions from which the broker hopes to gain a fee. Appraisers, in contrast, are paid for the act of appraising, regardless of the final number.
Broker Price Opinion (BPO)
Another potential appraisal substitute is the broker price opinion (BPO), a form of home value report provided by local real estate brokers. A drive-by BPO, one where the interior of the home is not checked, is frequently used to establish that a property in a foreclosure or short sale simply exists.
Drive-by valuations have their pros and cons. They’re certainly quick and cheap when compared with a full-blown appraisal. Property owners do not need to fix interior spaces. There’s no need for an appointment. Alternatively, the extra value created by a new kitchen or bath can’t be seen, hurting owners.
The rules for BPOs vary by state. In some jurisdictions real estate licensees are allowed to provide a BPO but cannot charge for it. In still others, brokers may both do BPOs and get a fee for the service.
At the federal level, the use of appraisal alternatives is restricted – but hardly banned.
Dodd-Frank says, “In conjunction with the purchase of a consumer’s principal dwelling, broker price opinions may not be used as the primary basis to determine the value of a piece of property for the purpose of a loan origination of a residential mortgage loan secured by such piece of property.”
The Dodd-Frank language includes an impressive number of BPO loopholes. The wording applies to the “purchase of a consumer’s principal dwelling.” Does this mean a BPO can be used for refinancing a principal residence or the purchase of a second home? What about commercial properties?
If BPOs seem poised to compete with appraisals in some areas under Dodd-Frank, that’s not the whole story. In 2010, federal regulators issued their Interagency Appraisal and Evaluation Guidelines which built on the Dodd-Frank standards. The guidelines state, “A valuation method that does not provide a property’s market value or sufficient information and analysis to support the value conclusion is not acceptable as an evaluation. For example, a valuation method that provides a sales or list price, such as a broker price opinion, cannot be used as an evaluation because, among other things, it does not provide a property’s market value.”
Automated Valuation Models (AVMs)
Dodd-Frank defines the term “automated valuation model” (AVM) to mean, “any computerized model used by mortgage originators and secondary market issuers to determine the collateral worth of a mortgage secured by a consumer’s principal dwelling.”
This language doesn’t prevent or limit the use of AVMs for principal residences while being silent on second homes and commercial property.
In case the point is missed, Dodd-Frank also creates a huge AVM loophole in its definition of a “broker price opinion.”
A BPO, says Dodd-Frank, is “an estimate prepared by a real estate broker, agent, or salesperson that details the probable selling price of a particular piece of real estate property and provides a varying level of detail about the property’s condition, market, and neighborhood, and information on comparable sales, but does not include an automated valuation model.”
Online Home Value Estimates
Zillow reports that in the third quarter, “more than 186 million average monthly unique users accessed Zillow Group brands’ mobile apps and websites, an increase of 7 percent year-over-year.”
What makes these huge and growing numbers remarkable is that in 2018, existing home sales declined, single-family housing starts were down, and mortgage rates were up. No less amazing, how do you get 186 million unique users to visit your sites when home sales for 2018 only totaled about 6.2 million new and used units?
The Zillow sites — which include both Zillow.com and Trulia.com — are just one part of the online real estate marketplace. There are other substantial sites, including Yahoo! Homes, Realtor.com, Redfin.com, and Homes.com.
Leading online property sites hold vast amounts of information. A visitor can find such things as a sale price, square footage, photos, price per square foot, past sale prices, past listing prices, the number of bedrooms, and tax costs. This material — market intelligence, really — is presented in a way that’s easy for site visitors to understand, the public side of complex automated valuation models (AVMs).
The catch is that online valuations — no matter how beautifully presented — can differ from each other.
Go to several property sites and check the value for your home. Each estimate will likely be different, and the gap between the highest and lowest valuations can be significant.
Why does this happen?
- The variables and weights used in one model may differ from another.
- The availability of recent property information can vary by jurisdiction.
- A new subdivision with three models and lots of sales is easier to price than a neighborhood built 100 years ago where every home is different and sales are infrequent.
- One system may allow owner inputs while another does not.
- Online valuations can differ significantly from appraised values and marketing advice provided by real estate brokers.
“AVMs are the new fraud frontier,” said Joan Trice, Founder and CEO of Allterra Group. Allterra Group is the parent company of such well-known industry brands as the Appraisal Buzz website, Appraisal Buzz Magazine, Valuation Expo, and the Collateral Risk Network. “It is just assumed the AVM is superior. Everyone is infatuated with technology. We have lost all respect for experts. How would an AVM know about the 35 cats you have in your basement?”
Property sites are careful to explain that an AVM is not a substitute for an appraisal. Zillow, for example, states that its Zestimate “is not an appraisal. It is a starting point in determining a home’s value.” It advises site visitors to also obtain a comparative market analysis (CMA) as well as an appraisal and to physically visit the property when possible.
If it is true that an AVM is not an appraisal, it’s also true that home value estimates are typically free, instantly available, and constantly being updated. Online AVMs are being checked and rechecked by the public, not because people are necessarily in the market to buy or sell but because home values impact our ego and sense of financial success. Who doesn’t like to see the estimated price of their home, especially when prices are rising? Barriers such as price (there are none) and time (online valuations are available day and night) simply don’t exist with online systems. And – not that anyone would ever do this – you can easily and anonymously check the pricing of your manager’s house or how much Uncle Wally paid for his home.
Conflict arises when homeowners see online AVMs as a benchmark which shows a higher value than an appraisal or CMA. It must then be explained by appraisers, brokers, and lenders that no, the property is not really worth as much as some sites might suggest, a conversation which is likely to be discomforting.
“Consumers,” says the National Association of Realtors (NAR), “who are seriously in the home-buying and home-selling market should be mindful of a variety of competing home price estimators. Solely relying on just one price estimate is likely to skew the views of what a particular property will actually transact for. When it comes to online home value estimates, however, the number one caveat for consumers is that these estimates are not a substitute for formal appraisals, comparative market analyses, and the in-depth expertise of real estate professionals.”
“AVMs are a misnomer,” explains Joan Trice, who is also the Founder and CEO of Clearbox, an appraiser credentials database used by lenders, regulators and AMCs. “They are not valuation models. They are sales price models. Who cares what the prices are? Fannie and Freddie should care about value, yet they have dismantled the appraisal process to a single approach to value, the Greater Fool Theory.”
What About Accuracy?
How accurate are valuations, whether human or electronic? HUD, for one, has caused a stir by claiming that appraisals for reverse mortgages – what HUD calls home equity conversion mortgages or HECMs – often do not offer sufficient accuracy.
“During FY 2018,” said HUD, in its latest annual report to Congress, “FHA became aware of concerns with the accuracy of appraisals used to originate HECMs. A comparison of over 80,000 HECMs endorsed between 2016 and 2018 strongly suggested that certain appraisals used in FHA’s HECM program were overvaluing the collateral and generating inflated property appraised values. Over this period, 21 percent of the population had an appraisal that was 10 percent or more above the automated valuation model (AVM) estimate. Over the same period, 9 percent of appraisals were inflated by 20 percent or more, and 4 percent of appraisals were inflated by more than 30 percent.”
HUD has now begun to require two appraisals for selected HECM applications as a result of its findings, but the government’s claims are not without question.
“It is worth noting that any losses the FHA is recording today are actually the result of transactions made years earlier, and in some cases many years earlier,” explains Larry M. Elkin, president of the Palisades Hudson Financial Group, an asset manager.
Elkin adds, “Blaming appraisers for losses on reverse mortgages is just another exercise in scapegoating. The appraisal industry’s collective role in any losses connected to these transactions is minimal compared to all the other risks involved. The FHA’s proclivity to blame the appraisers is an exercise in self-deception, or misdirection, or both.”
Between 2009 and 2017, existing home sales rose from 4.34 million units to 5.51 million units, a gain of 1,170,000 transactions, and yet the number of appraisers has declined. In 2009 there were 92,750 active real estate appraisers, according to the Appraisal Institute. By the end of 2017, the Institute estimates that the number of practitioners had fallen to 82,208, a loss of more than 10,000 professionals.
“The average annual rate of decrease for the past five years has been approximately negative two percent,” said the Appraisal Institute. “Broader analysis suggests that declines may continue for the next five-to-ten years due to retirements, fewer new people entering the appraisal profession, economic factors, government regulation, and greater use of data analysis technologies.”
With less to sell, finance, and close, there’s no doubt that the housing crash caused people in many shelter-related fields to leave. But, in turn, with less activity are so many appraisers actually needed?
Joan Trice explains, “We had a housing finance crisis that resulted in a dramatic decrease in transactions. It flushed out a lot of part-timers in all aspects of the housing economy. If you look at the number of appraisers who submit to UCDP (Uniform Collateral Data Portal) the number is around 45,000. If you look at the number of transactions, it comes to an average of two appraisals per week. That is an oversupply of appraisers.
“What makes the headlines,” she continued, “is the shortage in ‘bubblicious’ markets. Can we ever fulfill supply in bubbles? No, the supply isn’t that elastic. And the bigger question is should we?”
Fees & AMCs
Appraisals cost money at a time when the Internet is driving the price of information toward zero.
The cost of a big bank residential appraisal is $500 or so according to ValuePenguin. That’s a big number for a lot of borrowers and a glaring contrast with electronic valuations, but in looking at appraisal costs, several points are often lost.
First – and of huge importance – appraisers actually spend time at the property, go inside, and are local valuation experts. Borrowers are getting something for their money.
Second, the appraiser’s job is to establish a property value, a value which may prevent buyers from paying too much and lenders from accepting too much risk.
“In the typical real property transaction, the appraiser is the only party with nothing to gain by closing the transaction,” says Francois (Frank) K. Gregoire, an appraiser based in St. Petersburg, FL and a four-time chairman of the Florida Real Estate Appraisal Board. “Their role is to be competent, independent, impartial, and objective. Also, in a typical real property transaction, the appraiser provides the report of his opinions and conclusions to the lender to assist in the loan underwriting decision.
“If the lender opts to make that decision without an appraisal,” Gregoire continued, “the borrower is still on the hook to repay the loan, regardless of the market value of the property. In some circumstances, wouldn’t a prudent buyer seek the unbiased opinion of a well-credentialed, experienced professional before committing to 30 years of payments? It might be money well spent.”
Third, there can be a major difference between what borrowers pay for appraisal services and what appraisers actually collect, a point that doesn’t get much attention.
After the mortgage meltdown, federal and state governments wanted to make sure that appraisers could not be pressured by lenders to hit a certain number or curry favor with favorable valuations. One result was the Mortgage Disclosure Improvement Act (MDIA).
The MDIA led to the establishment of appraisal management companies (AMCs). Instead of hiring appraisers directly, lenders can hire AMCs and have the AMCs hire appraisers, thus separating appraisers from loan officers and other mortgage officials. And, of course, for this service there’s a fee to the AMCs.
Borrowers, for their part, often see an appraisal fee but not how the fee is divided. Without disclosure, consumers may believe the entire fee is going to the appraiser.
“AMCs often get more than 50 percent of the borrower’s application fee designated for the appraisal,” says Jonathan J. Miller, President and CEO of Miller Samuel, Inc., New York-based real estate appraisers and consultants.
“I’ve seen as much as 70 percent go to the AMC,” said Miller (no relation to the author). “I’ve had appraisers tell me their AMC clients don’t allow the appraiser to place the breakdown of the fee on the report. Their lobby has pushed hard to keep that issue unclear to the consumer. Imagine if the consumer was aware that a large portion of the ‘appraisal fee’ was designated for clerical work. This one issue has decimated appraisers and caused many to leave the profession.
“Think about that 50 percent to 70 percent share of the appraiser’s fee for a second,” Miller continued.
“AMC’s must be the most inefficient financial institution ever invented since all they actually do is order reports via software, verify our certifications, and claim they are a barrier between the appraiser and the bank. Trained appraisers are forced to work with 19-year-olds chewing gum who don’t really understand what we do.
“In my experience the AMC process adds at least a week onto the turnaround time. AMCs shop for the cheapest fee and that may take three to four days. Yet the industry is so concerned about turnaround time that they expect us to complete a credible report in 24 to 48 hours.”
“There has never been a shortage of appraisers,” added Miller. “There is only a shortage of appraisers willing and able to work for 50 percent of the market rate.”
“There is anecdotal evidence of some AMCs taking 50 percent or more of the fee charged to the borrower,” says Gregoire, who has also been a past chairman of the National Association of Realtors Appraisal Committee. “Rarely is the borrower aware of the arrangement between the lender and the AMC. Even more rare are situations where the borrower is informed of the percentage of the ‘appraisal fee’ retained by the Appraisal Management Company.”
The Commercial Model
So far it would seem that appraisers have done a good job protecting their territory. To quote the Cowardly Lion, “not nobody!” can provide an appraisal except an appraiser. “Not nohow!”
The rules protecting appraisers have helped defend their turf against encroachments by other professions. The emerging problem is not that another profession will offer “appraisals” but that the market will accept substitutes.
Last spring, federal regulators adopted a new appraisal threshold for commercial mortgages. “The final rule,” said the Federal Register notice, “increases the threshold level at or below which appraisals are not required for commercial real estate transactions from $250,000 to $500,000.
“For commercial real estate transactions exempted from the appraisal requirement as a result of the revised threshold,” said the notice, “regulated institutions must obtain an evaluation of the real property collateral that is consistent with safe and sound banking practices.”
Under the higher threshold, government regulators estimated that almost 32 percent of all commercial transactions will be impacted by the new rule. However, seen another way, less than two percent of all commercial transactions by dollar value will be exempted by the new appraisal requirement.
Of course, while the need for appraisals declines under the new commercial standard, the demand for “evaluations” can be expected to increase. This is the opportunity for AVMs.
The Push to $400,000
In late 2018, government regulators proposed raising the residential appraisal threshold to $400,000, up from $250,000, a figure established in 1994. If adopted, “an additional 214,000 residential real estate loans originated by FDIC-insured institutions or affiliated institutions” would no longer require appraisals. Of course, many residential mortgages are originated by organizations not insured by the FDIC. Also, these 214,000 properties are above the 750,000 already exempted from an appraisal requirement under the $250,000 minimum.
“The regulators have lost their collective minds,” Trice told the Housing News Report. “And they propose this under the guise of ‘safety and soundness.’ It feels so 2005-ish. I hope Michael Lewis has already started his next book. This next crisis is going to be a collateral crisis, not a credit crunch. Collateral matters.”
In the context of residential property, the proposed threshold would be significantly above the typical prices paid by consumers. For instance, in Q4 2018, the median existing home sale price was $245,000 according to ATTOM Data Solutions. For new homes, the government reported that the median price was $309,700 in October.
As with the new commercial threshold, fewer required residential appraisals would open the doors for alternatives. As the proposal states, “Evaluations would continue to be required for transactions exempt under the increased threshold.”
“This increase in the number of loans that would no longer require appraisals would provide meaningful burden reduction for regulated institutions,” explains the Office of the Comptroller of the Currency (OCC).
And yet, curiously, if there’s a $400,000 minimum threshold for residential appraisals it means that independent evaluations will be required for more expensive homes. This policy will protect upper-bracket borrowers with deeper pockets against overpaying while pushing entry-level and median-income borrowers away from such valuations.
Fewer burdens for banks sounds attractive, but how much relief do banks need? FDIC-insured institutions reported $62 billion in net income in third quarter, up 29.3 percent from a year earlier.
While it’s great that federal regulators are looking out for banks, who is looking out for borrowers? If a bank over-lends for one property out of a hundred it’s not a big deal, but for residential borrowers the situation is different. They’re only buying one property. If buyers overpay they can face a major loss. There are no other properties in the picture to offset their risk.
“Appraisers should be protected by the prudential regulators,” said Trice. “Instead they are under assault. It cannot end well when you remove the only independent third party who is unbiased.”
There’s an oddity with progress. The results we get are sometimes not the results we expect. We live in the computer era and yet we still use a lot of paper, about 10,000 pages per year for the typical office worker. In a similar sense, AVMs are here to stay. Their use will increase. This is a natural progression to expect in the Internet age.
But AVM growth does not mean appraisals will disappear. There’s a need for physical, on-site, independent valuations by trained appraisers. There’s a place today for both AVMs and appraisals.
And there will be tomorrow.