As far as the appraiser’s role in the market, our hands are tied to some degree. We are limited in what we can and can’t say about a property and its fair market value. We have to base our conclusions on appropriate research and documentation and analysis. We are directed to use the most recent comparable sales (comps) to form the basis of our analysis. Thus, even if I have a personal suspicion that prices are going up too fast, if I cannot back that up with reliable data, I cannot report that.
An appraiser is asked to report to a lender, “the most probable price which a property should bring in a competitive and open market all conditions requisite to a fair sale, the buyer and seller, each acting prudently, knowledgeably and assuming the price is not affected by undue stimulus.”
For example, let’s say I have been asked to appraise a property that is currently pending sale. The purchase price is $475,000. All the comparable sales in the last 6 months, within one mile of my subject, have sold between $450,000 and $495,000. That is the amount of money a typically motivated buyer, in a particular neighborhood, has been willing and qualified to spend on a single family residence (SFR).
Based on research, data collection and analysis of the comparable sales, I conclude that the purchase price of $475,000 is consistent with the range of adjusted values in my report and current market values in the neighborhood.
Even if comparable properties in the same neighborhood sold for $375,000 to $450,000, only 14 months year ago. Because they are so dated, I would typically exclude them from my analysis. Though they indicate prices are rising too quickly, they would not be a good indication of current market value.
Approaching the appraisal
When valuing SFR properties, appraisers most often give greatest weight to the sales comparison approach. Typically, the cost approach is only a supporting value indication and not the primary value indication.
In fact, the Fannie Mae form 1004 (Residential Appraisal Report – Detached Single Family Unit or PUD) for appraising SFRs is designed specifically and primarily for the sales comparison approach, with built-in pages for grid adjustments of comparable sales and listings. The cost approach is only developed in one small section at the bottom of the 1004 form report.
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Further, the cost approach is only reliable if there are adequate recent land sales to establish a reasonable estimate of the site value. In the Los Angeles area of Southern California, finding recent land sales can be challenging. You will be lucky to find one or two comparable land sales in the last year or two. Sometimes there are none.
Then an appraiser has to estimate replacement cost of the dwelling and estimate the amount of depreciation.
Cost estimating services are helpful with replacement cost, but estimating depreciation of improvements is more difficult. Only in rare cases, where there are simply no comparable sales from which to develop an opinion of value, only then would an appraiser use the cost approach as their primary basis of valuation.
Rapid escalation of home prices in 2013
In regards to the rapid escalation of home prices in 2013: speculator activity has been driving the market up to quickly to unsustainable levels. Speculators have been snapping up properties, quickly renovating them, then selling them for a quick profit. And often these properties are at the leading edge of the upward trend in neighborhoods, and moreover, are a significant driving force in the market.
With low interest rates, and a significant increase in qualified buyers, speculator properties are desirable to the typical buyer because they are already remodeled and the workmanship and materials is generally very good. Buyers don’t have to fix or update anything right after they move in, or deal with permits or contractors.
Often these properties generate multiple offers and the sale price can get pushed over the list price. Even if an appraiser reports the fair market value is less than the contract price, many buyers will simply put more money down and ignore what the appraiser reported.
Then the listing agent typically jumps in and disparages an appraiser’s report. Since the real estate agent has a duty to serve their client (and to sell their property for the most money possible) the seller’s agent submits an appraisal challenge to the lender or appraisal management company.
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Real estate licensees and appraisal management companies may not improperly influence appraisers
The challenge includes properties they think are more comparable to the subject than the ones used in the report. The appraiser then has to defend their selection of comparables and their analysis.
In the end, the property sells, and what’s reported on the MLS is the recorded sale price, not the appraised value.
Thus, even if appraisers are reporting values under sale prices, real estate agents and the general public will never see this. Appraisals are only for the client who ordered them. The borrower gets a copy and that’s it. No one else can see that report. So even if buyers are “over paying” for real estate in a neighborhood, how are they supposed to know this based on the public record of sales activity?
The answer is they won’t, simply based on recent sales activity. This, in my opinion, puts a lot of responsibility on a buyer’s agent. They need to know their market area and be able to advise their buyers of the most they should pay for a particular property. If they think values are going up too fast to unsustainable levels, buyer’s agents should be willing to advise their buyers to wait — or at least be more conservative when making a purchase.
They might lose a potential sale in the short run, but they could be preventing a future short sale or real estate owned property (REO).
The buyer’s role in the market
Then there is the typical buyer. They simply cannot spend more than they are qualified to spend. Buyers of real estate have to take their share of responsibility, and so do lenders. Instead of buying the most house they are qualified to buy, perhaps buyers should be more conservative. Be willing to walk away from a property with multiple offers. Don’t get caught up in the heat of the moment, the excitement of competition and out bidding everyone else.
Appraisers are only one component of the real estate market as a whole. Appraisers report value. We do not create value. We report the activity of buyers and sellers interacting in the market.
You know the old saying: Buyer beware. Congress can pass all the legislation they want, but that will never relieve buyers from their personal responsibility. Yes, they can consult a real estate agent, or two or three. Buyers can get a consensus of what the market is doing before making a purchase. If there is a mortgage involved, an appraisal will be ordered so a neutral third-party will give the buyer their professional opinion of market value.
But buyers should still do their own research, asking themselves:
- What is the health of the economy?
- What are the chances of getting laid off from their job?
- What is the historical trend of sales in a neighborhood or market area over the last five years?
Do not simply look at the last 12 months, and think prices are just going to keep going up, so I’d better jump in now...
That thinking led to the last mortgage crisis.
What really concerns me, in many market areas where I appraise, is that properties are already selling at price levels seen in 2006-2007. If a house sold for $590,000 in 2007, and is currently pending sale at $625,000, why are agents not concerned? Why are listing agents and buyers agents consistently ignore the warning signs?
They seem to be most concerned with closing their deal and getting a fee, rather than the bigger picture and the health and stability of the real estate market as a whole.
It’s possible the rise and fall of real estate is just part of capitalism, and there is nothing to “fix,” so to speak. However, there is room for refinement and ways to further safeguard the public and the market from wild swings up or down. No single person, profession or industry is solely responsible for the economy, for better or worse.
As an appraiser, all I can do is use the best possible data, along with sound appraisal techniques and good judgment to value property for banks and mortgage companies to hopefully make sound lending decisions. That’s all an appraiser can do.
I think Marissa was too busy looking for grammatical errors and missed the entire point.
Your article was timely and very thorough in explaining the role of an appraiser using sound appraisal techniques and good judgements. That is how I understood it. That is commendable and easier to do when working in areas with tract housing and conforming neighborhoods. The “one size fits all” guideline will not necessarily work when appraisers are assigned with “arms length” intent to correct the errors in the most recent recession, even if they are from out of area. Couple that with an appraiser’s mindset of that past distressed market, oblivious to current market trends indicating a housing recovery, however slow, and evidently unfamiliar with a particular community’s neighborhoods, thereby having to rely strictly on computer data, and “good judgement” didn’t enter the equation in a recent appraisal I experienced. If appraisers management companies are going to be corralled by Dodd/Frank regulations due to the recent fiasco in the housing market, then in all fairness, in addition to the present costly appeal process, perhaps a mediation board may become necessary so commonsense has a voice.
Well, this article and commentary exemplify why there are so many ongoing problems in RE! And the number one problem is lack of education on every level. Buyers are ignorant, sellers are ignorant, and the people involved in the profession profess to do their best, but even the grammatical oversights in the article and commentary are enlightening and alarming!
If the information and knowledge that is needed for any particular transaction cannot be accessed and interpreted, and if no one wants to look for it or read it, well, what do you think is going to happen?
A response to Mr. Pfeifer from the author Mr. Mitchell:
In no way am I moralizing and asserting that I am an advocate for anyone when completing an appraisal assignment! As an appraiser, I am not allowed to be an advocate or an activist. And to characterize me an an “activist” appraiser is slanderous and unfounded. My article was to provide another perspective on valuing real property that might be beneficial for realtors because I too am a realtor. I am in a unique position to see the activities and roles of each profession. Some of my observations and opinions are from the perspective of a real estate professional. The two perspectives should not be confused.
When completing and appraisal assignment, I am giving a lender/client an unbiased opinion of a properties current market value. If I discover after thorough research and analysis using approved appraisal techniques, that a buyer’s current purchase offer is significantly over market value….then that is what I report to my client, i.e. the lender. That’s my job.
The lender will surely give a copy of the report to the buyer. The buyer is free to reveiw my work, read my conclusions, and decide that I’m an idiot and ignore my professional opinion as a State licensed real estate appaiser. But I am not an advocate for the buyer or an adviser to them. Reporting that a buyer is offering to pay significantly more for a property than its current market value is not moralizing or being an activist appraiser. That is me doing my job as an appraiser.
Is Mr. Pfeifer suggesting that the appraisal profession, and legislators, and Fannie Mae regulators should step aside and let a completely free market determine its own course and fate?
Who would Mr Pfeifer suggest determine what a property is worth? Should a homeowner tell the banks what their property is worth? Hey Mr. Lender, I have this guy who is willing and qualified to buy my 1200 SF house for $500,000. So that must be what it’s worth right? Never mind that all the other comparable properties in the neighborhood currently sell for $300,000.
Or should realtors be allowed to tell the banks and lenders what a property is worth to secure a mortgage? Just think about that for a minute. It might sound great. No regulation. Free market.
In reality, that would have disastrous consequences!
Does Mr. Pfeifer forget that the appraisal profession was born because of the 1930’s Great Depression, when there was no standardized way of valuing real property in the United States? The real estate market was at the mercy of unscrupulous business men and many a con-man selling real estate to uniformed buyers who had no idea how much they should pay for property relative to another similar property.
Finally, Mr. Pfeifer stated the reason for the mortgage crisis and the recent great recession was a “politically induced ‘Crash’ based on the philosophy that all citizens were entitled to ‘purchase’ a home”….which is most certainly referring to FHA loans. Does he forget about the Wall Street creation of Mortgage backed securities that compounded the crisis and made it far worse.
Yes, it is true, many of the market areas with a high percentage of REOs were also market areas where FHA financing was prevalent. However, REO’s and Short Sales, were also seen in high numbers (between 2008 and 2011) in market areas where conventional financing was prevalent, where borrowers had qualified for home loans between 2005 to 2007, with 700+ credit scores, a sizable down payment, and had sufficient income “stable” long-term jobs.
Then many of those borrowers lost their jobs, or were laid off, and eventually lost their homes to foreclosure. Some simply decided to walk away from their homes even though they could still afford to make the payments. They decided taking a hit on their credit for a few years would take far less time than waiting for their negative-equity property to be positive again.
Given that homes values in many of the Los Angeles market areas are approaching 2005 and 2006 levels, and we are certainly not fully recovered from the great recession, and won’t be for some years to come, I am concerned that real estate values could be approaching unsustainable levels again due to the still-recovering job market. That is merely an observation based on studying historical data from the real estate market, and job growth, and inflation, and interest rates, etc.
When I develop and report an appraisal on a property, my opinions are focused on valuing that property relative to the market in the subject’s neighborhood. I am required by Fannie Mae regulations and USPAP to also report on value trends in the local market, and any positive or negative influences on value outside the property known as externalities.
In my article “The Appraiser’s Role in the Market”, I am simply making an observation that historically, real estate values in many market areas are approaching levels seen in Los Angeles just prior to the beginning of the great recession that began in 2008.
Again, that is not being an advocate or an activist. It’s part of my job as an appraiser to be aware of historical value trends in the market areas where I work. It is also my job to report my opinion to lenders and clients who are paying for my unbiased, professional opinion before making a loan to a borrower.
David H Mitchell
Residential Real Estate Appraiser
The author seems to be moralizing how the appraiser’s assessment of the “value” of a home is designed to protect the unwary Buyers from unscrupulous Real Estate Agents. If a Buyer believes in the “value” of the purchase they are making who better to decide “value”. There is no basis for this Author or the Appraisal Industry to have a social agenda…specifically, it is not their purpose to find reasons to hold down values if, in the opinion of the Appraiser, values are too high. So long as the principle of a Willing Buyer negotiating with a Willing Seller exists, there is no basis for concern that home values have reached or will soon reach or may reach even higher values than those reached prior to the Politically encouraged Lender induced Real Estate depression…That thinking would destroy the upward march of home values which increase generally because the Buyer believes the home is worth the investment. It is not, or should not be, the role of the Appraisal Industry to protect us from ourselves. Finally, I am concerned that the author of this article mis-states the reason for the recent Real Estate depression, it occurred when Congress urged Lenders to establish lending policies that allowed unqualified buyers to be approved for loans with disregard for their financial ability to repay the loan. This was a politically induced “Crash” based on the political philosophy that all citizens were entitled to “purchase” a home. Banks and Wall Street were only too happy to accomodate this reckless approach to social engineering. I do agree with the Author that legislation is NOT needed. Allow the free market to set price and each Buyer’s financial ability to secure financing prevail. Appraise please… there is no place for an activist Appraiser who believes he/she knows when values are “too high” or needs to use their industry to protect the Buyer from purchasing the home of their dreams.