Appraisal Question

[davelj]

I’ve got a friend who recently sold her condo for $345K. She originally listed it at $405K (the price for two comparable sales from a year ago). She got an offer for $400K, she accepted the offer, the condo was appraised at $400K but then it fell out of escrow (they argued over closing costs) and six months later after multiple reductions it finally sold at $345K (surprise – it appraised out at $345K).

I thought that that the appraisal is supposed to reflect the price at which the property would currently sell (i.e., the current market price). If it took her 8 months (total) to sell her place, and ultimately for $345K, then wasn’t the first appraisal (at $400K) simply wrong?

I think there are a lot of homes on the market today that could get appraised at their listing price if a buyer came along and offered the listing price. But, at the same time, if they end up lowering their listing price by 20% and end up finding a buyer at that level, then the appraisal will come in at that lower level. Which begs the questions: (1) Which appraisal is correct? and (2) What’s the point of the appraisal if it just reflects what any individual (perhaps irrational) buyer is willing to pay for the property?

I realize that the RE appraisal process is not an exact science, but right now it seems particularly flawed and unreliable.

[VanMorrisonFan]

Appraisal is partly art, partly science. The tricky part is appraising in a very slow market, where there are few (or maybe no) good “current” comps.

Your friend’s appraiser who first assigned a value of $405k relied on some old comps – but maybe there weren’t any current ones. The fact that a buyer was willing to offer that much suggests that this value was within reason. That it did not sell is due to bickering over closing costs – not necessarily a function of value. Perhaps the buyer wasn’t really wanting to buy at $405k and wanted some way to either get a lower price or get out of the purchase.

The fact that eight months passed between the failed sale at $405k and the sale at $345k indicates a strong decline. Not knowing where the condo is it’s impossible to say what happened. Did other people put their condos on the market too, with a glut forcing down prices, or did your friend price her condo below market just to get a quick sale?

On the second go-around the appraiser probably used the sales price as market value because there were few good sales.

Appraisers are under enormous pressure to “make” the number needed so a sale can close. It’s illegal, but there are many cases where lenders pressure appraisers – especially in “up” markets, but sometimes in “down” markets as well (where there are few sales and appraisers are competing for the few appraisal assignments). Lenders will hint or suggest that they want “cooperative” or “helpful” appraisers, and everyone knows what that means. I’ve been pressure on many occasions. Where a lender/client can point to sales that I may not have known about I am more than willing to reconsider my conclusions. However, at times a lender or client will simply yell, “You’re stupid…you don’t know what you’re doing.” I will always politely ask if there are any truly comparable sales that I have overlooked, and I usually get silence followed by a hang-up.

[Bugs]

It kind of sounds like the first deal fell through because the buyer couldn’t find a lender that would accept that appraisal.

When the market is running toward increases the “most probable price” will usually be at the upper end of the range indicated by the closed sales because of the lagtime between listing and closing. When the market transitions and then goes into decline, the leading edge of that trend would generally be toward the lower end of the range.

It’s unfortunate, but over 60% of the current residential appraisers have come into the business in the last 5 years and have never seen a declining market. Many of these folks are not prepared for what happens, and a lot of them have been listening to their mortgage broker clients and the NAR PR blitz that it’s almost over.

I was teaching an appraisal class (continuing education) a couple weeks ago where one appraiser told me that if there were buyers in the market that meant the market was stable and there is no further decline. I was about speechless.

There are a lot of appraisers who were trained to automatically appraise to the highest value the comps will support. Mortgage broker clients tend to look at appraisals as a ratification of their loan rather than a tool to underwrite it. That leads to appraisers being trained to look at comp selection in terms of what the lenders will accept as opposed to which comps are actually the most similar.

That kind of conduct is wrong, but it largely goes unnoticed when times are good. This example came to your attention primarily because the market is in decline right now. Otherwise it would probably wouldn’t have come up.

[sdcellar]

Actually, what seems funny is the fact that both times it appraised for exactly what the sales price was. Probably just the practice, but such accuracy is dubious to the layman (like me).

If I were auditing appraisals, I’d look at the ones that came in right at sales price first. Of course, if that really meant anything, the practice would just change to come within some percentage of sales price and *not* hit the exact number.

[Bugs]

The data for most SFR appraisals will result in a range of indicated values and – except for condos – it would be exceedingly rare for 3 or 5 comps to legitimately adjust out to the same pinpoint value. If a pending saleprice is within that adjusted range most appraisers will generally pin that tail on that number. We sometimes refer to that as a “tie goes to the runner” situation wherein a contract between a willing buyer and seller is considered just as valid an indication of market value as any other piece of market data. We don’t ignore it but we also don’t let it override everything else.

You may or may not be familiar with how loans are underwritten, but if an appraisal “misses” a sale price by even $1,000 it can mess up the loan application even though the variance on a $500k loan is literally within the margin of error. Although they should, these lenders don’t use a whole lot of discretion in calling reasonable equivalencies for loan purposes. For their purposes the appraisal either comes in at the sale price or else they may decline the loan application. As a result, appraisers almost never come in short if it’s within that margin of error because we can never be so certain that our outside data will override the indication from the contract at such a small amount. An appraisal will usually either come in at the contract price or if it does come in low it’ll be clearly outside that margin of error.

You’re are right about it looking suspicious though – and it’s definitely something that always bears some scrutiny.

[sdcellar]

Thanks Bugs, very interesting. I’m not familiar at all with underwriting, but it definitely sounds like the process encourages one to fit the numbers. Are there issues with coming in with an appraisal that’s significantly over the sales price?

[VanMorrisonFan]

Yes, this does happen, especially on foreclosed properties.

Typical scenario is that a lender forecloses on a property and wants to dump the property ASAP. They don’t like being in the real estate ownership/management business. They want to sell. A smart buyer makes a low-ball offer, but the lender needs an appraisal in order to do the sale. The appraiser comes up with “market” value, which may be higher than the low-ball offer. Here the lender pressures the appraiser to come in with a LOWER value so the sale can go through with no questions asked.

I once appraised a mobile home park that had some big problems, but was in a good area with very few housing options. There were successful mobile home parks in the area that were fully occupied. There was a lot of value in this troubled mobile home park, and my valuation reflected it. The lender wanted me to drop my value so he could do a quick sale. I said “No.”

[Bugs]

One of the things being debated in our profession right now is the appropriateness of expressing market value for a mortgage appraisal as a single number. The argument goes that if among typical buyers there would be a reasonable range of possible sale prices for a given property, wouldn’t it be more honest for appraisers to express it that way in their appraisal reports? Better that than to try and say the one number is the only right number, which obviously is not what happens out in the real world.

Then the lenders could directly exercise their own discretion instead of leaving the discretion to the appraiser and trying to influence it indirectly. If the sale price is within the range they can decide to do the loan, and if it isn’t they can increase or decrease that loan as suits their purposes. A borrower with great credit might be worth extending a slightly larger loan of 91% instead of the 90% (or whatever) normally offered. A borrower with crappy credit might only be worth an 85% loan.

Of course, none of this addresses the real reason why the two appraisals in question were so different, even when considering the 8 month interval and the declining market conditions. I’ll bet you a buck there’s something wrong with at least one of those reports, possibly both.

[Author]

Posts