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.
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.
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.