From the Trenches - Deadly Appraisals

Today I had three phone calls dealing with appraisal problems.

The first was from a broker who called me for help. His client was in contract to buy a home and the appraisal came in $150,000 under the contract price. Because I specialize in this area, he wanted to know if I could give him some comparables to justify the purchase price to the appraiser.

This same broker contacted me a few weeks earlier when his client first wanted to write an offer. Knowing I was familiar with the area, he asked if I thought the list price was appropriate. At that time I told him the property was overpriced. I pointed out that the listing agent did not price the property in line with other, similar, homes which had sold. I provided him with these addresses and sales prices. In essence, I "appraised" the property for him.

But his client wanted the home anyway and put in a high bid. When it came time for the bank appraisal, the appraiser used the same comparables I gave to the sales agent. Not surprisingly, the appraisal came in at a lower value, the one justified by the comparable sales.

The second call came from one of my clients. His lender had just informed him that the appraisal on the home he wants to buy came in $130,000 below the contract price. The third call was from another appraiser who had also been hired to appraise this same home. That appraisal came in $200,000 under the contract price!

When I looked at the comparables used in these last two appraisals, it became clear that these appraisers, neither of whom are local, were not familiar with the home they appraised. They used comparables that were located in different neighborhoods and did not have the same amenities as my client's property. And because they used inappropriate comparables, they wrote incorrect appraisals.

The saying "all real estate is local" is true, not just for Realtors, but for appraisers. The need for area specialists, people who are intimate with the details of a specific market segment, is more important now than ever. Unfortunately, the trend in the appraisal field has been to move away from local appraisers and towards large companies that cover big geographic areas. It's easier for the lender to schedule a series of appraisals- one phone call can cover a number of appraisal appointments. But it is worse for the client who sometimes gets an incorrect appraisal that can turn out to be a "deal killer".

Option ARMs a Headache for Lenders

Countrywide Financial Corp. said in a regulatory filing Monday that the average borrower with an option adjustable-rate loan now owes 95 percent of the value of his home, up from 76 percent when the loan was made.

Seventy-two percent are making less than full interest payments and 12.4 percent are at least 90 days delinquent. The average FICO credit score has dropped to 680 from an original 715. The U.S. median is 723.

Bank of America has said about 66 percent of the option ARMs went to California and Florida borrowers.

Bank of America is not the only big lender with option ARM headaches.

Wachovia Corp said borrowers in its $122 billion "Pick-a-Pay" option ARM portfolio owed 85 percent of what their homes were worth on June 30, up from an original 71 percent. In California's Central Valley, the average was 109 percent. The average overall FICO score was down to 661 from 675.

Source: Reuters News, Jonathan Stempel (08/12/2008)

Home-Value Web Sites Miss the Mark

This article comes from the Associate Press (06/23/2008)

Online home-value sites offer some useful tools, but their estimates are often wrong.

"The percentage of error on these estimates is still very large," says Delores Conway, director of the Casden Forecast at the University of Southern California Lusk Center for Real Estate. If there are not many comparable sales in one area, for example, she says, "the estimates will have huge errors in them."

Zillow.com and Cyberhomes.com rely on computer-generated automated models to estimate values. The models help compensate for the fact that many neighborhoods don’t have enough sales to generate accurate values based on experience.

But these computer models don’t reflect home condition, improvements and may not even accurately convey property descriptions.

Marty Frame, general manager of Cyberhomes.com, says the data on the site is best used as a way to form an overall impression of a neighborhood."

Our goal is to provide you all this information and let you cherry-pick the things that are most interesting to you," Frame says. "You're going to look at an estimate and say, "that makes sense' or 'that doesn't make any sense."

Ask the Expert - The Effect of Short Sales on Home Appraisals

Question: I’ve recently noticed some places for sale listed as a “short sale”. My understanding is that they are trying to get an offer to present to the lender in hopes they will accept the offer instead of the seller defaulting on the loan and forcing the lender to foreclose. My question is this. If a lender accepts a very low offer because it is more than they would get in a foreclosure sale, does that sale price negatively impact the property value of the surrounding homes? Or is there something that distinguishes a short sale price from a regular sale price when looking at comps? Thanks

Answer: The simple answer to your question is yes - the sale price does negatively impact the value of surrounding homes, and no - there is nothing to distinguish a short sale from any other sale. Now for the details....

You are correct in your understanding of the mechanics of a short sale. Typically, the homeowner lists the property with a Realtor. On the multiple listing service, the agent is required to show that this is a short sale and that the sale is contingent on being accepted by the lender.

However, it is not always the case that a short sale will yield a higher price than a foreclosure. The lender will weigh the costs involved in a foreclosure: months that the borrower lives in the home without paying the mortgage; attorneys fees; repairs and upkeep; etc. In comparison, short sales can be less of a drain on the lender. The borrower remains in the property until it sells, which usually means the home stays in good condition. Because the borrower initiates the short sale, they are much more likely to cooperate with the lender, and this can greatly reduce any legal fees. Therefore, in many instances, the lender will agree to a short sale price that is significantly lower than what the home would sell for had it gone into foreclosure. So this addresses the first part of your question - short sales absolutely will negatively impact the value of surrounding homes, often more so than foreclosures.

Now to your second question. When a home sells, it is recorded into the public records. There is nothing in these records that differentiates a "regular" sale from a short sale or a foreclosure. If an appraiser is looking for comparables, they may be able to find this information on the multiple listing service, or by talking to the local Realtor.

If the appraiser learns that the sale of record is a short sale, they will try not to include it as a comparable. Why? The definition of "fair market value" is the price a willing buyer will pay and a willing seller will accept. This definition assumes that there are no mitigating forces pushing either party. Such forces include divorce, death, and job layoff. Certainly, the inability to pay the mortgage fits this category. So, from an appraiser's point of view, a short sale price does not reflect fair market value. However, if you live in an area where the majority of sales are from foreclosures or short sales, the appraiser may not have an option. In that case, these sales will be used.

Appraising the Appraisal - New Guidelines for Home Appraisals

There is plenty of blame to go around when it comes to the housing crisis - lenders, Realtors, mortgage brokers, and borrowers. Even the appraiser has been derided for overstating values. But appraisers have been placed in a very difficult position.

Many banks and savings and loans have their own "in-house" appraisal departments. The appraiser, a bank employee, is told that the loan department wants to make a loan on a particular home. In order to do so, the appraisal needs to come in at or above a certain home value. The appraiser knows that if he does not come in at that amount, the loan will not go through and he'll have the loan department breathing down his neck. Enough of these complaints and he might lose his job. So he manipulates the numbers to make sure his appraisal comes in at the required value.

This problem exists even for independant appraisers (those who do not work directly for a lending institution). Most appraisal companies are on a lenders "approved appraiser" list. This means that, with each new loan, the lender will turn to this list to hire an appraiser. For many appraisal companies, this is how they get the majority of their business. And if they are thrown off the list, the appraisal company may go under.

Either way, the in-house appraiser or the approved appraiser has every reason to manipulate the appraisal to meet the lender's required loan amount. But this is about to end.

Starting in 2009, Fannie Mae and Freddie Mac, two of the biggest players in the secondary mortgage market, have announced that they will no longer buy loans from lenders who do not use independent appraisers. Lenders who want to sell loans to Fannie Mae or Freddie Mac will not be allowed to use in-house appraisers, or appraisals done by a subsidiary or an affiliated company. Also, mortgage brokers and real estate agents may no longer choose the appraiser. And finally, Fannie Mae and Freddie Mac will create the Independent Valuation Protection Institute, a group that will accept complaints from consumers who feel their appraisals are unfair, and appraisers who feel that they are being pressured to provide inacurate appraisals.

Will this make it harder to get a loan? Yes, but at least you will know that your homes appraised is a realistic estimate of it's true worth.

How to Value a Property - Whose Fault is it if I Paid Too Much?

There is an article in today's New York Times about a woman who is suing her Realtor because she believes she paid too much for her house. She claims her Realtor withheld important information about the value of the home, and that the lender and appraiser aided in this fraud. As a real estate professional, I am intrigued by the specifics of the suit. But it brings up a broader question. Excluding cases where there has been fraud or misrepresentation, what influences a buyer's opinion when deciding what a home is worth?

Buyers look to a number of resources for help when deciding on an offer price. Typically, the primary source for pricing information is their Realtor. Hopefully the Realtor and client have looked at other homes in the neighborhood for comparison. In addition, the Realtor should be able to show the client sales prices for similar homes. But no two homes are identical. Even homes with the same floor plan can have vastly different values depending on condition, upgrades, lot, views, etc.

A second source of information is the appraisal. At it's most basic, an appraisal is designed to assure the lender of the home's value. This is why many purchase agreements have a contingency that states the appraisal must equal or exceed the offer price. Usually the appraiser finds recent sales of similar homes. He then lists the differences between these "comparables" and the subject property and assigns a value to each difference. By adjusting the value of the subject property based on the value of these differences (adding value for assets the subject has that the others don't, subtracting value for assets the comparables have that the subject does not), he comes up with the appraised value of the home.

But buyers also turn to another source for help in establishing a home's worth and, in my experience, this group has more influence then either the Realtor or the appraiser. It consists of friends and family. They may or may not have actually knowledge of similar property values, but they will certainly have an opinion. Most of us like to have our decisions confirmed by those we know and trust. If a friend looks at the home, hears the offer price and starts to gush about what a great a "deal" it is, odds are that the buyer will go ahead and make the offer. If, however, this same friend frowns and suggests the price is too high, no amount of comparables proving otherwise will make most buyers comfortable with the offer price.

But the final judge of a property's worth comes down to the buyer herself. We all see property through our own set of preferences and prejudices. Sometimes we know what we want, describe it to the Realtor, and he finds something that comes close. But every Realtor who has been in the business for more than a few years has a story about a buyer making a list of "must-haves", then buying something different.

When a buyer walks into a home and her eyes light up, nothing and no one will dissuade her from doing whatever she can to get the home. Her Realtor can show her "better" homes; the appraiser can provide lower-priced comparables; friends can point out the home's defects. But even with all this data, sometimes a buyer simply must have that house. It's as if she has fallen in love. And, as with love, a buyer can be blind to the house's true value. It's only after the honeymoon period is over that the buyer may realize she has paid too much. And, like a marriage, it can be very costly to "divorce" your house.

Ask the Expert - Appraisal Question

Question: I am in the process of refinancing my home loan. The lender called the other day and said they would be sending an appraiser out to my home. What effect, if any, will the appraisal have on my interest rate?

Answer: The appraised value of your home certainly can alter your interest rate. Basically, the more equity you have in your home, the better your loan rate and terms. Why? Because the lender thinks you will be less likely to default on a loan if you have a lot of equity in the house. What's a lot of equity? For an owner occupied home, the lender would like to see 20% or more equity. So if the home is valued at $100,000, the lender will loan you up to $80,000 and still give you the best rate and terms. That is not to say the lender will not loan you more, but, in most circumstances, the rate and terms will be the most advantageous at this 80% number. So back to your question - the appraisal certainly can affect your interest rate. If you want to refinance $80,000 of debt, you hope the property appraises for at least $100,000. If not, you may need to accept a less advantageous rate or term, or you may need to borrow less money.