Real Estate Appraisers, Get With the Program!

Driving home from the grocery store last week, I noticed a car slowly driving around my neighborhood, with a sign on the door that clearly read "real estate appraiser." I knew these people existed, and one had certainly signed off on the price of my house when I bought it, but I'd never actually seen one in person. I felt like I had spotted a unicorn.

I think I can say that housing is a mess without sparking any arguments. However, when it comes to what caused the problem, or how to fix it, there seems little that people can agree on. Some homeowners may have recently hit the lottery -- even though I didn't agree with it -- but I don't think anyone is deluded enough to think that measure will squelch the housing market's ongoing inferno.

Given all that, I had to chase down this appraiser and get some answers.

People just don't do it that way!
After introducing myself to the nattily dressed, Cadillac-driving appraiser, I began my asking what method he used when determining the value of residential real estate. Not at all surprisingly, he replied that it was based on comparable home sales in the area -- "comps," in appraiser and realtor speak.

Why don't appraisers use some sort of approach such as multiples of local rents, or even a discounted cash flow of assumed rental income, which would put a more solid value on the home? "Because people just don't buy houses that way."

A light bulb flashed on above my head: That's exactly the problem! I tried to argue the point with him, suggesting that the current massive slump in housing prices suggested that maybe there was something wrong with the way things had been done. No use. All I got was a few more repetitions of "people just don't buy houses that way."

The value of a house
To talk to my appraiser friend, you'd think that the primary value of a home was something ephemeral, something you could measure based on how much people paid elsewhere, but not something you could touch, feel, or stomp your foot on. It makes a home seem like a work of art. Somebody paid $2 million for a Picasso last week? Well, we'll price this Picasso, which is very similar in size and but slightly higher-quality, at $2.1 million.

But take it from somebody who has toured quite a number of KB Home (NYSE: KBH  ) and Toll Brothers (NYSE: TOL  ) homes -- there's nothing artistic about most homes built today. They have four walls, a front door, and a roof up top. Depending on where you live, some new communities offer little more than that. Don't get me wrong; personal preference certainly comes into the picture when choosing a home. But if people had a better sense of what the asset value of the home was when they bought it, I think it might temper their enthusiasm for paying $100,000 or more beyond that asset value.

The role of the appraiser
Appraisers get paid for assessing the value of houses. They need to be the sober third party who comes in to provide a realistic picture of the situation. If an appraiser says that the value of a house is $200,000, even though the seller is asking $215,000, it's up to buyers to decide whether they're willing to pay that extra $15,000. Even so, at least those buyers have a solid value to start from.

We've seen all too many times what can happen when the supposedly sober third party in a financial transaction gets drunk along with the rest of the partygoers. In fact, we had a perfect example just a few years before the real estate bubble -- the Internet bubble. Financial advisors who should have been giving their clients an accurate assessment of the nuttiness in the stock market instead got caught up in the hype. Stocks like Cisco (Nasdaq: CSCO  ) and Amazon.com (Nasdaq: AMZN  ) got bid up to truly insane multiples. When Mr. Market's massive dose of happy pills wore off, the Nasdaq collapsed by some 75%.

And hey, if the appraisers are primarily worried about how people buy houses when they're doing their valuations, why do we need appraisers at all? If they're trying so hard to put themselves in the shoes of buyers, why not just let the buyers sign off?

Why it's better for everyone
Comps seem to be a way of life in residential real estate, so why change things now? Well, for one thing, a huge national slump in housing prices just might suggest that this particular method isn't working.

I'm guessing that homebuilders won't like this argument. DR Horton (NYSE: DHI  ) , for example, saw profit margins far exceeding its historical norms from 2003 to 2006. Rather than some miraculous leap in efficiency, I suspect that increase owed to sky-high sale prices for their homes. Take a hammer and nails to the valuation process, instead of a paintbrush, and you're likely to keep those margins from ever inflating so dramatically again.

A realistic valuation of homes would be a great benefit to banks, though. Whether we're talking about big ol' Wells Fargo (NYSE: WFC  ) or the somewhat smaller Regions Financial (NYSE: RF  ) , banks are suffering major losses a people foreclose on their homes, and bank discover that they can only resell those homes at a heady discount to what they lent out. When a mortgage loan is made, it's made against a house -- an asset -- not an emotionally valued home. Realistic valuations from appraisers would provide a lot of downside protection to banks when they make their loans.

And of course, it would help consumers, too. We'd be less likely to run into an out-of-control housing market in the future -- at least, not one as bad as we have now. At the same time, it wouldn't hinder buyers from paying up for a house that truly was unique or in a great location. They'd just have to face up to the difference between the asset and intangible values of their purchase.

This change could also help put a floor under today's falling housing market. If all you know is comps-based valuations, housing prices can spiral downward just as dramatically as they rose. Realistic valuations will give both investors and homebuyers confidence that they're paying a fair price for a house.

The comps stop here
Just like valuing a stock, looking at comparable homes can be a good place to start when valuing a house -- but that shouldn't be where the process stops. While arresting the pain of the current economic disaster is of primary importance, we also need to seek ways to prevent a similar situation in the future. Tightening the screws on how real estate is valued seems like a great step in that direction.

Further financial Foolishness:

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Fool contributor Matt Koppenheffer does not own shares of any of the companies mentioned. The Fool's disclosure policy has never once been caught with its pants down. Of course, it doesn't actually wear pants...


Read/Post Comments (52) | Recommend This Article (54)

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  • Report this Comment On February 26, 2009, at 4:57 PM, lution wrote:

    Mind if we do the same thing to the tax assessments? Funny how assessed values have continued to go up with everything else going on in the housing market.

  • Report this Comment On February 26, 2009, at 5:04 PM, ScottConroy wrote:

    Commercial real estate appraisal *is* done as you suggest. Typically uses three approaches to valuation: comparable sales, income, and replacement cost. Sometimes they get out of whack, but the income approach is given priority.

  • Report this Comment On February 26, 2009, at 5:20 PM, TMFKaren wrote:

    I don't think we should use rental rates for valuation of real estate in a owner occupied area. They're 2 different animals. Replacement building cost comes to mind (but land value would still be the variable). That too will be affected in various types of market conditions.

    Interestingly, the foreclosure market doesn't impact comps. From what I understand at least in my local real estate market, the appraiser cannot use the distressed sale of a property as a comp. I guess that can create a scenario you described in your article. The appraiser has to determine value using other methods even though the houses may have the same square footage and attributes and be near to each other.

    Karen

  • Report this Comment On February 26, 2009, at 5:57 PM, adamb1234 wrote:

    Actually I think comparison to sale prices of nearby comparable homes is the only accurate measure of home value. This isn't some sort of speculative subjective pricing it is the actual demand for the particular area. The rental market and real estate market, though related, aren't really the same market and forcing both to some sort of correlation introduces a new dependency that is not based on market valuation.

    Remember, correlation equations are part of what got us in this whole mortgage-backed securities nightmare.

  • Report this Comment On February 26, 2009, at 6:01 PM, DanLobb wrote:

    Hi Matt:

    One thing that has really frustrated agents about appraisals made for mortgage lenders is that they are informed of the amount of the sales contract. The practice has been to find houses that justify the price rather than the true value of the house based on the best comps.

    An example based on a real transaction: Subject House located in a subdivison of like age and size properties on the East side of the town.

    Contract price $80K - list price $95K - appraised value $81K.

    Appraiser used a comp located behind a motel on the interstate on the west side of town and a brick house located in a run down neighborhood of 1940s clapboard houses. Appraiser ignored house 2 doors down and a house across the street form the subject house. These were built by the same builder, same build year, similar design - within 30 sqft. The problem - these indicated a price of $91-98K. Appraiser selection is made by the lender and they are provided with the contract price before they go out. This was a loan made by a bank mentioned in your article.

    The argument against the income approach has less to do with "how people buy houses" than the availability of rental data in most residential markets. Unlike sales, in many areas, rental contracts are not listed through the MLS systems. There is some data there, but not enough to make the income approach feasible. In looking at rental investments, I enlist the aid of a property management agent for information that is not publicly available. They compile their own data and they have a better feel for a market than the appraiser.

  • Report this Comment On February 26, 2009, at 6:07 PM, Netteligent09 wrote:

    Housing market is contagious with toxic assests, frauds, design for failure from top to bottom. We will paying the price. No Bail Out.

  • Report this Comment On February 26, 2009, at 6:26 PM, DanLobb wrote:

    I would add one more factor in your argument against appraisals based on sales comps. Its not as apparent when prices are declining or remain steady, but in a growth market its a clincher. Sales comp method gives a range based on the location, size, age, and condition of the house and will give a range of prices. If house prices are going up the appraisal would always be lower than true FMV based solely on the data present. The appraiser has to make subjective adjustments to justify a price higher than any previous sales indicate.

    Lenders practice is to require the use of an appraiser on their approved list. This can be a big problem when they have no appraisers that know the local market. An appraiser from Dallas will not know the market in a Fort Worth neighborhood well enough. That subjective adjustment and the corresponding appraisal value are not reliable source of FMV.

    It would be better to forbid the lender from revealing the contract price to the appraiser and idealy, if it weren't cost prohibitive, to have more than one opinion.

  • Report this Comment On February 26, 2009, at 7:02 PM, Whatsupjack wrote:

    The use of comparable sales is actually only a part of the process. Appraisers are also required to consider current competitive listings. Another words if your appraising a 1500 ft home then you need to consider how many other 1500 ft homes are currently listed for sale in that immediate area and for how much? It's called the principle of substitution. Why would a knowledgable buyer pay more for a home if there are several other similar homes available for less. This idea is applied to to both comparable sales and current listings.

    The main problem is that "list of approved appraisers".

    The question should be why do banks need to approve the use of any specfic appraiser. Appraisers are licensed through state agencies and are subject to oversight via those same agencies. If an appraiser does a "bad" job the Bank can report that directly to the State agency and get immediate results.

    Maybe that's not the results some Banks have been looking for???????

  • Report this Comment On February 26, 2009, at 8:30 PM, KeitaiOtaku wrote:

    After having gone through many appraisals, and having interrogated many appraisers, I think I've come to a simple realization: In the end, the value of anything is what people are willing to pay for it. When house hunting (I remember house hunting in the prices-going-up market) the value of the home was determine by the neighborhood it was in, and the comparable homes... that were recently actually purchased in the neighborhood.

    The estimated value of the home starts with similar homes, plus or minus for some feature of the house. The real value of the home is determined at closing when you actually submit the cash to pay for the home. This is why the better picasso is worth 2.1 million, after the sale of one for 2.0 million.

    This is how everyone prices everything... it's all we can do as consumers. I don't want to know the price of an Ansel Adams picture, when I'm buying a Picasso!!! That doesn't help! And if we're talking about the price of some canvas and paint, that would make a Picasso worth $15! Which of course, is insane.

    The appraisers don't lie to us... they tell us exactly what buildings, and exactly where they're located. Zillow.Com does the same. Confusing people by introducing some other metric, is slightly in the face of capitalism.

  • Report this Comment On February 26, 2009, at 9:34 PM, TMFKopp wrote:

    Here's a quick question to anyone that thinks I'm off base in my assertion: if a (savvy) investor came into a neighborhood and wanted to buy a home to rent out, how would she value the home? Is she going to buy a home to rent out if the costs (mortgage and other) will leave her in the red every month?

    Just because somebody is buying a house to live in (rather than rent out) doesn't mean that they need to abandon reason and pay whatever for a house -- particularly when a similar residence can be rented at a lower cost.

    Also, keep in mind that rents do take into account aspects such as location -- a house near schools will typically rent out for more than a similar house that's out in the middle of nowhere.

    Matt

  • Report this Comment On February 27, 2009, at 3:18 AM, Simon333 wrote:

    KeitaiOtaku makes a great point. One of the strongest indicators of value _is_ what someone is willing to pay ...which is why we want the sales contract when we appraise a house that's selling on the open market.

    Also, there's nothing wrong with the comparable sales approach when the appraiser isn't under duress to hit a number by the bank that hired him/her.

    Why would a bank want to push an appraiser to hit a higher value when it would mean higher risk on their investment? Because they knew they were going to package the loans into securities and sell them on the international market. The ratings agencies gave those securities "AAA" ratings based on the insurers coverage which was the fundamental "fly in the ointment" (ehem, AIG).

    The insurers funds to "cover" potential loses were based on a complex "betting" system which was illegal for decades until just a few years ago. This means they didn't really have the money to cover potential losses. When the pyramid scheme ran out of suckers, the whole thing folded.

    Value is a tricky thing. Imagine if I'd come to refinance your house in 2006 and came in at a value much lower than what your neighbor just sold or refinanced his house for. Would you have railed the opposite side saying comparable data is the strongest? ...I wonder.

    What we need is a system where banks don't have direct access to the appraisers they hire. This would free us from the pressure to "hit a number".

  • Report this Comment On February 27, 2009, at 10:26 AM, HalMann wrote:

    The proposal demonstrates colossal ignorance. Most single family residential neighborhoods do not have any rental market. So, under this ridiculous proposal, those properties would have values of zero, as they have zero rental income potential. Where do they come up with this nonsense?

  • Report this Comment On February 27, 2009, at 11:10 AM, KWT8011 wrote:

    I've always thought that the appraisal process was one of the problems of the housing boom. My mom bought a small house in 2003 for 125 and refi'd a few years later at 180 with no changes made, and I thought to myself, huh, I wonder which appraiser was way off. Then I find out they're told what the terms of the deal are prior to appraisal and 'the tail wags the dog' so to say...

    In the end, Otaku is right. An appraisal doesn't really mater if you have a stingy buyer going up against a stubborn seller. Example: Maybe a house is listed at $250k and a buyer comes in looks and says, "ehh 250 is out of my range but I'd offer 240." Maybe that's a fair price, and you could find comparable houses in the ZIP code at 240, but if the seller's response is a counter at $249k, well the appraisal just doesn't matter to the deal. In fact it really only matters to the bank assessing risk as a lender, whether or not they'll allow a mortgage.

  • Report this Comment On February 27, 2009, at 11:14 AM, Elliottz wrote:

    Matt,

    I drive a Jeep Grand Cherokee, is that the 'right' kind of car an appraiser should drive?

    I think your shooting from the hip about real estate valuation. I like to think appraisers act in a manner similar to a 'specialist' at a stock exchange. We gather lots of information about "stocks" (house sales) and try to create an efficient, fair market. We have a duty to protect the lender and buyer from not paying too much for the property, and we have a duty to the owner to estimate a supportable current value estimate based on what other's are 'trading' properties for that are similar to the subject.

    Check out www.appraisersforum.com and you can find out how we dress, what cars we drive, and even the tape measurers we use.

  • Report this Comment On February 27, 2009, at 12:03 PM, LERRET wrote:

    duh>>>Has to be one of the stupidest comments a writer could make about appraising.

    Appraisers are required to appraise to market..you know, like "mark to market"...

    And if you use MARKET data, then the INCOME approach will not be far off the SALES APPROACH. AND, gross rent multipliers have plunged. Many real estate markets are seeing surplus rentals and rents are dropping as fast as sale prices not to mention vacancy is rising.

    I agree that using REO (Bank owned) distressed sales should not be the basis for valuation, even though bankers are demanding it, but foreclosures are and will put downward pressure on true 'arms length' transactions. And until you stop the hemmorage of foreclosures, there is no 'fix'.

    Further, the run up between 2000 - 2006 [our peak was Aug of 2006] was inflated by bad appraising because few appraisers discounted those stupid "incentives" and concessions that builders were throwing in. Usually that happened because bankers and builders were reluctant to even disclose them in order to push values higher. And, of course, once an inflated sale was closed, it was used by legitimate appraisals to support higher valuation.

    The 'old head' appraisers were fenced out as Mortgage brokers blacklisted appraisers who did not kowtow to their demands. The newbies and wannabes appraised them too high in humble submission to the Loan officers....Today I can count 5 appraisers in my county that the state has sanctioned. 4 had licenses revoked and all over issues of inflated valuations. I promise you. Any appraiser who did not use the sales approach on a residential property would be subject to sanction. And should be. In fact, Freddy and Fannie require it. They will not fund a loan on any appraisal not based upon the Sales Approach.

    As for myself, I fired the mortgage brokers in 2000 and haven't looked back since. My estate appraisal business is still steady. My farm appraisals are steady.

    Truth is, these house prices need to fall to their intrinsic value. The base line value is established by the cost approach. We quite possibly are near or, briefly, will fall below it. But that is a liquidity issue, not a valuation issue. With millions of vacant lots languishing on the market, that means the LAND VALUE is near zero -at best in many markets 20% of 2006 prices, and the cost to build has dropped significantly since 2007. I just watched an entire subdivision (7 acres, 2 streets) sell for $20,000. THAT'S NOT THE APPRAISERS FAULT. It is a total lack of buyers and MARKET VALUE assumes MARKET PARTICIPANTS DOESN'T IT?

    This problem isn't due to bad appraising. If we are going to let the lender or the homeowner set prices, then forget the appraisal altogether. It certainly hasn't helped that banks were bypassing the process with Automated Valuation Models (AVMs) like Zillow which has as much to do with "market value" as Spanish bullfighting has to do with the Dept. of Agriculture. Trying to create some non-existent value by tinkering with the numbers is what banks did when they created CDOs...your story is BS.

  • Report this Comment On February 27, 2009, at 1:50 PM, madflipper wrote:

    There is one thing this article fails to take into account. If you were to base home values on average rental income then what value do you add for the inherent benefits of home ownership? People pay less for rent then they may for a owned home of similar size and condition. The reason is that the owner gets tax breaks and write-offs. They also get to take advantage of any appreciation the home gains over the life of ownership. How can you predict what those benefits will be worth?

  • Report this Comment On February 27, 2009, at 3:08 PM, elduderino38 wrote:

    Wow, what an absolute knucklehead article.

    3 approaches to value ARE considered in every residential appraisal report (sales comparison, cost, income). Not all apply though. Determining an opinion of market value for rental properties is quite different from a typical owner occupied - investors think and buy differently, and the appraisal is approached that way.

    Here is the definition of market value for you as well Mr. Foolhardy

    "Market Value is the estimated amount for which a property should exchange on the date of valuation between a willing buyer and a willing seller in an arms-length transaction after proper marketing wherein the parties had each acted knowledgably, prudently, and without compulsion."

    Whats your next suggestion, 9 innings in a football game?

  • Report this Comment On February 27, 2009, at 3:50 PM, DreamersRock wrote:

    Have pity the lenders say.

    Yet, they forclose on homeowners who have been

    paying a mortgage for many years. Often exceeding the purchase price several times. Then turn around and forclose. On top of this they whine and cry when having to sell this property at greatly reduced prices after making huge gains at the expense of the now homeless. What a racket.

    Creative asset manipulation is what they call it.

    I call it creating something from nothing. It is all a shell game. Only the lender wins. Any body wonder why the Government is getting into banking? Just maybe it is a better source of income over and above taxes. Our Boys and Girls in washington are like a girlfriend with daddys credit card...

    Will somebody please take the T-Bird away.

  • Report this Comment On February 27, 2009, at 6:18 PM, TMFKopp wrote:

    "KeitaiOtaku makes a great point. One of the strongest indicators of value _is_ what someone is willing to pay"

    I'm sorry, but that's just not true. If we go by that logic, then the folks paying 100x earnings for Cisco in 2000 were correct because somebody was willing to pay it. One of the strongest indicators of price is what somebody is willing to pay. If we learned anything from Graham and Buffett, the market's price for something and its true value don't always align.

    An appraisal is supposed to determine value, so having somebody come along and confirm current market price is of little use to anyone. Now on the flip side, what if an appraiser comes along and values a house at $200k and the seller won't sell it for less than $250k? Well, if you buy it you've just paid a market price for that house, but you've paid more than its underlying value as an asset.

    And there is a very real asset value to a house -- it is the current and future value of what you would have to pay to rent. As I pointed out in the article, there is also an intangible value of a house -- the warm and fuzzy feeling of owning a home, not having to answer to a landlord, being able to see the mountains out of the window of one particular house. The intangible value is very real to the homeowner, but banks should not be lending against that value, nor should a homebuyer be convinced that the intangible value is anything more than intangible.

    I can't say that I'm surprised at the amount of disagreement here -- the current system is very well entrenched and to change it would cause quite a shake-up. But just because everybody already does something a certain way hardly makes it right. Maybe along the way we can also break the American imperative of owning homes -- if what you're paying to buy a home far exceeds the comparative cost of renting, in most cases you just shouldn't be buying.

    Matt

  • Report this Comment On February 27, 2009, at 9:04 PM, nin4086 wrote:

    @TMFKopp

    Can't agree more...a house is a house is a house where people live. Its economic value *does not* depend on whether it is owned or rented! Using the rent as a measure of cash flow potential is a good idea. Although, as one reader pointed out: this information is not available. Moreover, most areas are either "mostly rentals" or "mostly owned", so even if you had rental information available there wouldn't be enough of it in an area where you are likely looking to buy a home.

    Of course, as you pointed out, a house is not a "unique" item like a Picasso painting; it is a commodity, so extrapolating from similar school/demographic/geographic areas(and there are good algorithms to quantify these parameters) can solve this problem of rental-heavy or owner-heavy regions.

    This will not be perfect, but much better than what we have now. The fact that commercial real estate uses this approach is quite comforting: there is intelligence out there!

  • Report this Comment On February 28, 2009, at 7:14 AM, Constructor103 wrote:

    Matt,

    This is going to be a bit of a novel but you need to understand that for most people and situations you cannot value homes the way equities are valued. It is similar to me saying you need to "comp" stocks because that is the way homes are done..there is one instance where it does happen (which I will address at the end) but you can't generalize.

    As an aside - I use IRR for my DCF modeling on commercial real estate which also includes some larger multi-family buildings so that is the use of DCF I use as my frame of reference. I am assuming you are talking about NPV or IRR as your DCF analysis.

    First - real etate via your home is extremely "local". I am talking about local as in 6 block radius. That needs to be applied to your logic first. To that end when you analyize an income property you have to first look at the competition or comparable (your comp) so DCF models cannot operate in a vacuum. You need comps no matter how many times you like to say they are not necessary. If you model without one you will get your a#$ handed to you very quickly. Building in unrealistic rents is a recipe for disaster and the largest downfall of commercial developers - so, how do you get realistic rents - you comp the area. Again - we are in the commercial realm but I'll bring it back to residential here -

    Now, lets assume I'm comping my house so I can come up with a DCF model...hmmm...where do I find a 2800 sq ft rental on a premium, mature street - granite countertops, 2 stall garage, 80 year old architecture done by a regionally famous architect next door to doctors, lawyers and bank presidents (who blew the world up)....well..there is none. Not only is there none within a 6 block radius because it is not a rental area - there is none in the entire city because you dont rent out 2800 sq foot homes of that type (see description above)...I could keep writing here and would be more than happy to go into how to make money in income properites but then I would be like one of those late night commercials.

    Point is - if you cant get a comp to model you DCF you cant even get traction on your first and most important assumption. Every discussion or lesson I give after that doesn't matter (like the basis in a rental property versus a home - via materials used - or cost of land because land bought in large parcels are cheaper than a 3/4 acre lot on a residential street) because we cannot even get to the first assumption in the DCF model.

    As promised there is one part of it that you are correct on - buying a house in a neighborhood with rentals close by - or buying a house that has duplexes or something similar in size and quality to rentals in your area. At that point do a discounted cash flow analysis - but - you do have to do it considering all the "income streams" including tax savings, appreciation (if any..) and throw in a little for having a place to call your own and not have to get landlord approval to paint your walls...if you really want to get into this there is a great book written called "the income stream" it was my real estate bible and it has served me well.

    Here is some advice on real estate for your home..

    Buy the worst house on the best street so you can customize it up the way you want without pushing you to the most expensive house on your street.

    Dont buy McMansions in the subarbs- live in an area close to your downtown (sorry - not a hard and fast rule but I have to plug my distaste for subarban living),

    Dont obsess about how much your house appreciates in value becasue it shouldnt be an investment

    Buy what you can afford...

    Keep it to those rules and who cares if the market moves around...hell, I don't know or care how much my house can sell for; my mortgage is 60% of the kinda my guess value, it seems to have held that value and that is all I care about within a few percent...

    Now..give me some advice on equities because although I'm having fun throwing darts at stocks, I know when I start making money in the stock market (which I have to thank this site for) that is the sign showing we are all doomed...lol

  • Report this Comment On February 28, 2009, at 5:00 PM, hnerbovig wrote:

    As they say, one man's junk is another man's treasure. Value is and always will be subjective. Anyone who sells houses for a living knows this. People always pay significantly more for a home when it is staged, when it has been "freshened up" with a new coat of paint and carpets, when a home has an attractive garden that's taken years to grow, when it is close to something they consider important to their life - like a school, park, shopping, when it is exceptionally quiet and the sun sparkles through the windows at a certain angle, when the floor plan exactly matches some personal need, like a hobby or homeschooling space, when the garage is big enough for their car collection, etc, etc, etc. These are all self-expression and quality of life sentiments of higher civilizations and which cannot be reduced to a specific number. This goes well above our base human needs of food and shelter. People use both sides of their brain for decison-making and especially when selecting a home - the analytical/separation-oriented left side and the creative/holistic right side. Our left side keeps us safe and is critical and our right side allows us to dream and grow. A system by definition is mostly a left-oriented process; it breaks things down into pieces that can be studied. A house may be just four walls and a door, but a home is much more than that. That's why comps are used by appraisers - they attempt to combine both left and right brain approaches that the buyer naturally uses. There is no perfect system to capture that - at least not yet!

  • Report this Comment On March 01, 2009, at 12:22 AM, Johncarringer wrote:

    Hey Matt, If you think about it, you will realize that people don't buy common stocks that way either!

  • Report this Comment On March 01, 2009, at 10:33 AM, IIcx wrote:

    I completely agree with you.

    Buyer Beware is the real estate motto which is why a buyer needs to get a real estate agent that represents their interests and not the interest of the seller.

    Assessed value and demand drive the price.

    You've touched on one of the true causes of the mess we're in. The appraisers didn't value the homes based on their comp in a given neighborhood. They valued the homes based on a broader geographic area which inflated the price.

    But, no one forced the buyer to pay the price.

  • Report this Comment On March 01, 2009, at 11:39 AM, none0such wrote:

    @elduderino38

    "Determining an opinion of market value for rental properties is quite different from a typical owner occupied - investors think and buy differently, and the appraisal is approached that way."

    Talk about the pot calling the kettle black ...

    Your statement is valid only if people who buy houses to live in them don't think of them as investments: I would be so bold as to say that all home owners, to some extent, think of their single largest purchase ever as an investment - so now you see the problem. (I don't own a home so my single largest purchase ever was a federal income tax bill - I don't consider that an investment but perhaps I just need someone to appraise the value of living in the US for me). Once more, the comparison of home valuation to art valuation is valid - art is not an investment but it is treated as one (witness the many corporate art collections around - they don't rent their paintings so how do they make any money? ... could it be the future sale of the items?), however I don't think overpricing Post Modern Art would push the world into a recession - so now you see why the sarcasm.

    Home buyers (as Constructor103 points out) should not treat their home as an investment. Appraisers should not think they are bystanders to the business cycle.

  • Report this Comment On March 01, 2009, at 2:22 PM, WhyTheHeckNot wrote:

    Finally someone besides Professor Shiller recognizes this problem. The best thing you can say about residential appraising during the past decade is that it accomplished nothing. It did not protect the public and it did not as a whole act as the objective third party as was necessary. Let’s start with broker select. This practice of the commission earning sales person choosing the appraiser to place a value on collateral for loans ultimately backed by the US Taxpayer in one form or another resulted in exactly what you would expect – disaster. Thankfully new policies by Fannie and Freddie will end this soon but it is amazing to hear the unmitigated whining coming from the appraisal and mortgage broker communities that their collusive and insidious relationships that are up to the eyeballs in conflicts of interest are finally and mercifully going to be severed.

    And lets please clarify something – when appraisers make the long standing argument about how someone signed a contract and was willing to pay $750K for that 2 room shack, how hard is it to see that this someone was not using their own money – that is why we supposedly need appraisers, because someone else’s money is usually involved. So thanks to all of the appraisers who somehow found a way to send comparable after comparable 3,4, 5% higher than the last sale of a similar home in the area because their broker client needed to make the deal happen and “someone” was willing to “pay” for it so it must be worth that much. Think about this happening again and again over the course of 9 years and it is no wonder this bubble happened.

    And drop the B.S. about how you consider cost and income approaches. Without a market for vacant land the cost approach has limited utility and when you throw in the subjective measures of depreciation it becomes a complete joke. As for the way you guys do the income approach with a GRM that is determined via market sales it is difficult to contemplate an analysis that is more useless.

    Market value should of course be determined and presented, hopefully by an unbiased, uninfluenced real estate appraiser. The addition of other realistic measures tied to rents or median incomes in the area would have been helpful to all parties. If real estate appraisers don’t want to contribute an analysis of this type then fine - f'em, but some other group should certainly pick up this ball and run with it.

  • Report this Comment On March 03, 2009, at 6:54 PM, EdMcswindle wrote:

    Matt, I asked around the 'unicorn' watercooler. Constructor103 explains this (what's wrong with your 'logic') best, if you can understand him. I would add to his post, you began trying compare how real property behaves with the (much more tangible) stock market (with its clear and linear logic and its unquestionable 'asset values)', you never completed the analogy. Probably because it didn't make your point, which was 'bad unicorns'? The asset value will always be the point at which someone believes it is underpriced and can capitalize, but you can capitalize on a house in ways stocks never directly yield. However, since most home buyers have no effective purchasing power, because apparently the banks don't have any money to lend them...Complete the analogy to the stock market now, please. Shame you went out of your way to take an unfairly broad swipe at a valuation profession you do not clearly understand. Feeling quite foolish, caps excluded. Bet you're just tops with stuff you know about- which is why I signed up- please focus.

  • Report this Comment On March 03, 2009, at 10:42 PM, dfreeman9902 wrote:

    Sir,

    I have read all of the previous comments, from the silly, the astute, and the down right foolish. However in most of these comments most of the people have forgotten that ALL of the information is market derived. It can also change over time and depending upon economic conditions, go up or down. Similar to the stock markets.

    Valuing a house based on a multiplier of rents is doable. However you have the mistaken notion that this would be a immovable value. I assure you sir, the multiliers can, and do go up and down, and the GRM or gross rent multipliers go up or down over time and during a economic cycle.

    The use of DCF and IRR also changes based on the underlying assumptions as to inflation, interest rates, and what is termed cash on cash yield. Garbage in, garbage out similar to various security pros, when they thought Washington Mutual was a safe investment. DCF and IRR analysis is the most abused forms of financial modeling available. If you don't believe it ask Kolberg Kravis & Roberts about their RJR Nabisco investment when these same financial models went kablooie.

    The capitalization rate &/or income approach will change for a particular commercial property based on these same above mentioned conditions, and many more. This approach is also derived from comps and the marketplace.

    I understand you are not a real estate professional, but a little bit of knowledge is dangerous, and unfortunately you have very little regarding this subject. I suggest that you write about something you know, or do a complete research job before you publish what I consider inaccurate toxic waste.

  • Report this Comment On March 04, 2009, at 12:42 AM, WhyTheHeckNot wrote:

    ALL of the information is market derived - hmmm, ya think?!! - and so their would have been no value in exploring what was happening in the rental markets as compared to what was happening in the market price of the homes? - Are you indicating that there was not a major divergence here that was completely ignored by the residential appraisal profession? Or that it does not matter because both are market derived albeit from what were obviously different markets, one that maintained some sanity and was dependent upon local incomes and the other that was a complete and total fraud brought on by financial gamesmanship/greed and enabled by the residential real estate appraisal profession.

    We need a Red Herring Alert Button for some of these posts -

    Red Herring #1 - the author indicated that homes should be valued like stocks - nice try guys but suggesting that maybe some other "approach" would be helpful and using the example of the NASDAQ bubble when a bunch of other irresponsible boobs under the thumb of those paying their bills ignored the fundamentals did not put anyone in the "houses are just like stocks" straight jacket as you suggest.

    Red Herring #2 - the author has the notion that applying a method not attached at the hip to market value would result in an "immovable value" - Where in the essay was there the suggestion that an alternative analysis would result in an immovable value or that an immovable value would be desired.

    I love this - gee Sir, so sorry but you're just not smart enough to understand what we do - determining market value on a home requires more intelligence and finesse than you realize and there is really no reason for you to bother yourself with this complicated stuff - go back to analyzing stocks.

    You want some toxic waste - put on your radiation suit and go take a look at the portfolios of MBS's where the assetts were given their value by guess who.

  • Report this Comment On March 04, 2009, at 5:55 PM, Gadzmo wrote:

    I think this is where the industry should head:

    http://www.zaio.com/

  • Report this Comment On March 04, 2009, at 6:55 PM, AppraiserDave wrote:

    What a joke of an article. Where to begin? I'm a General Certified Appraiser with 20 years experience. I primarily appraise commercial property, but have quite a bit of residential experience as well. I can't speak for the residential appraiser you talked to, but I can tell you guys have no clue about the appraisal profession. An income approach to value? Wow, pat yourself on the back for coming up with that one! You are the smartest guys in the room!

    Seriously, if your talking about income properties (purchased for investment) then the income approach (analysis of market rent, operating expenses, capitalization rates or discounted cash flow analysis) is the way to go. I'm talking about apartment complexes, office, strip retail centers, etc. But for single family homes the best approach to value is the sales comparison (what other houses with similar characteristics recentlly sold for in the area). The problem with appraising over the past 10 years has been the blackballing of good appraisers by mortgage lenders because they won't play ball and "hit" the number needed for a loan. That is one of the main reasons I quit doing residential work and stick to commercial. I was sick of being punished for being a good appraiser.

  • Report this Comment On March 04, 2009, at 7:27 PM, AppraiserBob wrote:

    An appraisal is not there to dictate what the market should pay but what the market is doing. As with stocks rates and ratios change. The majority of homes are owner occupied thus you are basing market value on the minority of purchasers and not what the majority are doing.

    Lets look at the real cause of the problem. It has to do with lose lending. By giving everyone too much money we flooded the market with both money and buyers. Whats happens to any market when there is to much money chasing supply - it creates a buble.

    Then there is the control that the lenders have over the appraiser. There has not been a firewall to allow appraisers to do their work in an unbiased manner. The lenders stop using the appraiser who does things the right way. How do i know - I was driven out of the business by crooked lenders. If my value came in below what they needed to make a loan then they find another appraiser that will. If I reported that the property needs a new roof or structural inspection the lender called me and demaned I take that out of the appraisal-either way I lost that client.

    If you look at Wells Fargo, Country Wide, etc.. They created an appraisal management company to act as a go between. In reality they were another profit center for the bank. They would charge the borrower from $400-600 for an appraisal. Then they would drive the appraisal fee paid to the appraisal firm down. Many appraisers were paid less than $240. If it was a driveby appraisal the appraiser got $150 or less. There might not have been an appraisal done but rather an AVM at a cost of $25. Whatever was done the borrower paid a lot more than the appaiser recieved.

    Then there were appraisal management companies that broke the encryption on the submitted appraisal and change the appraisal. Some apprasial management companies broke the encryption and mined the data in violation of copyright laws. The mined data was then used in computor programs to do computer appraisals called AVM's - a $25 appraisal that the borrower may have paid $400 or more.

    The lenders are not allowed to mark up costs to things like appraisal, credit reports, etc. But the use of appraisal managment companies was thought to be a way around it.

    What did the appraisal management companies expect from an appraiser. Turn around times that did not give appraisers the necessary time to do a creddible appraisal. They demanded low fees, after considering the cost of being in business the appraiserl was not being paid a wage that matched his education. The appraisers were put under pressure to do it how the management company demanded, when they didnt the "fired" the appraiser. These appraisers learned that in order to feed thier families they had to inflate vales when necessary and to ignore any determental condition that should have been addressed.

    The banks and those funding the loans did not follow tried and true under writing. They ignored guidelines and good judgement because they were chasing the dollar. The lenders created the liars loan (you told the bank what you earnet and they didnt check) and 125% loans.

    Then there is the loan officer. There are many cases of the loan officer taking the borrowers information and changing the income so that they could qauify. A loan officer needed no real training, he could have been a bar tender or burger flipper a week before. The loan officer is not required to act in the best interest of the borrower. If the borrower could qualify for a better loan rate the lender isnt required to tell him that. Instead their is something called the Yield Spread Premium. By getting you into a higher interest rate the loan officer made more money. Then there are countless stories of lenders who changed terms or addd junk fees that would be discovered at closing. The hope was that the borrower would be under pressure to accept them.

    Then there is Wall Street creating mortgage back securities in which the investor could not gauge the quality of loans. They mixed in prime loans with subprime.

    Franklin Raines, now an advisior to Obama, was the head of FannieMae. If you thought the boys at Enron cooked the books, Raines did it one better. His creative accounting was in the billions. Of course he made tens of millions of dollars and set up the policies that lead to the collapse of FannieMae.

    I will finish with the appraiser can do a good job if the client allows him too. In order for this to happen there has to be some honesty on the lenders part and a firewall between the lending department and the appraiser. The appraiser can not be punished for being the barrer of bad news. When the appraiser is punished he is being used to cover up the bad deeds of someone else.

  • Report this Comment On March 04, 2009, at 8:56 PM, Briantheaprsr wrote:

    "Why don't appraisers use some sort of approach such as multiples of local rents, or even a discounted cash flow of assumed rental income,"

    We do sometimes. It depends on who the typical buyer and seller are in the market. If the property is in a resort town and most buyers and sellers are investors, then an income approach would be used. If the typical buyer and seller are owner occupants the income approach would not be used. You have to look at what motivates the typical buyer and seller.

    "If they're trying so hard to put themselves in the shoes of buyers, why not just let the buyers sign off?"

    Because they are buying it with soembody elses money. If they were paying cash the certainly could and do sign off.

    The process of valuing real estate is solid and does not need to be changed. It just needs to be done correctly.

    It's easier said than done though when you have a DR Horton or Beezer threatening to fire a commissioned real estate agent, who is threatening to fire a commissioned loan officer, who is threatening to fire the appraiser.

  • Report this Comment On March 04, 2009, at 9:15 PM, AppraiserJeremy wrote:

    @WhyTheHeckNot?

    "And drop the B.S. about how you consider cost and income approaches. Without a market for vacant land the cost approach has limited utility and when you throw in the subjective measures of depreciation it becomes a complete joke. As for the way you guys do the income approach with a GRM that is determined via market sales it is difficult to contemplate an analysis that is more useless."

    I can tell you that I, personally, complete the cost approach on every single appraisal I do. Pesky USPAP and all. Do I neccessarily give it weight in the final reconciliation? Not always, very dependent on age of the dwelling. As the home gets older, yes depreciation is figured and yes it is highly subjective.

    The one approach to value I find myself rarely ever considering is *gasp* the income approach. The bulk of single family homes are not looked at in that way by typical market participants. As appraisers that's what we do, measure market participants reaction. The typical purchaser when looking to buy a home, that they themselves intend to occupy, thinks "I wonder how much I could rent this for?". Come on now.

    I always get a good chuckle out of lenders asking me to complete a comparable rent schedule and operating income statement on a SFR of median or higher value for the locale. Even better are the higher priced homes, say that a child might by for their parent. Where I live rentals valued over $100,000 are non-existent. Why would you rent @ $1,200 a month when you can buy the house for $650 a month? Right, you wouldn't. Anyone who can afford to spend $1,200 a month ain't renting a house. Absurd notion, hence, there is no "market" for such a scenario and why the income approach is not fully developed. Considered, and developed are two totally different principles.

    REO/foreclosure type sales can absolutely be used as valid indicators of value. This might blow your mind, but you know how I can say with 100% certainty they can be used? IF, the neighborhood is currently driven by foreclosure sales, that IS the market in place. Say there's 15 houses on the street. 7 of which have sold in the last 6 months. Each and every one of them was "bank owned". You seriously expect me to go out of that neighborhood to look for "comps"? Ain't happenin' captain. Doing such would create an inflated value. Talk about a slam dunk for an attorney. Which brings me to my next point...

    An appraisal has an effective date, and for good reason. The market changes. Tis the same reason when you refinance the lender makes a new appraisal request. They want to know what the market is doing, NOW. Not what you think it's going to do, or what it was doing 18 months ago.

    Throw in the BS from good ol slick Willy, handed down from another just stellar gentleman, Mr. Jimmy Carter and you had next to no regulation and the "everyone deserves a home" bill. You know daggoned well what happened after this. Silly ARM's, stated income loans(seriously who the hell thought this was a good idea?) ad nauseum, etc. Oh now here's all of these folks flooding the market, approval letters in hand. Of course the cost of housing is going to skyrocket, you just created insane demand. You're telling me as appraisers we should have said "no this will not last, in 5 years I'm guessing this house will be worth 20% less so I'm going to appraise it for 20% under what every other purchaser in the market is paying for the same house"

    Our job is to appraise the subject, as of a specific date, in the current market conditions. If we know, for certain, that some type of change is undoubtedly coming(new employment, loss of employment, zoning change, etc.) then yes we invoke the principle of forecasting.

    Zillow and other AVM's are laughable for the majority of the country. One quick one for you that think the garbage in garbage out models work, universally. Loan originator approached me to appraise a local home. He had a clear to close, through an AVM, at a value of $150,000. I just appraised the home 3 months ago @ $105,000 as new construction first sale. Absolutely nothing to justify a nearly 50% increase in value. He told me to forget he called. They did close it too, I tracked the deed of trust. Heh, who's the fool now?

    Good looking out by the fellow appraisers who have posted. Well done.

    fool.com...aptly named apparently

  • Report this Comment On March 04, 2009, at 9:17 PM, Briantheaprsr wrote:

    If you don't think that there is ever a time and place to use REO sales as comparables, then you need to take a ride around the 30310.

  • Report this Comment On March 04, 2009, at 9:31 PM, btlamb wrote:

    First off - I'm a residential appraiser. The appraisal process is not broken. However, what is broken is the monitoring of appraisers. One big part of this problem is lender pressure.

    As Briantheaprsr states: "It's easier said than done though when you have a DR Horton or Beezer threatening to fire a commissioned real estate agent, who is threatening to fire a commissioned loan officer, who is threatening to fire the appraiser." This is the chain of lender pressure.

    Some appraiser have worked according to the rules/guidelines/laws. However, the lack of enforcement by state and federal have essentially allowed appraisal to be like the wild wild west. It's not appraisal that is broken, its a lack appraisers getting punished for these wrong doings. We don't need the HVCC as much as we need to crack down on bad appraisers.

    However, this was only one piece of the puzzle.

    Don't forget

    Lenders were also allowing poorly underwritten loans to be funded.

    Think about this - How many home lender commercials say they'll fix your credit. So, the credit score goes up after the fix and they qualify for a bigger loan. After the credit score was fixed, no one cared or took precautions, despite the borrower having a history of not making payments.

    Let's not forget that underwriters were also getting threatened with their jobs for not approving a loan. I'm specifically talking about Countrywide. How come Anthony Monzilla isn't in jail by now????

  • Report this Comment On March 04, 2009, at 10:26 PM, PolyNail wrote:

    Hello Matt! What that appraiser apparently didn't have time to explain to you because he was on somebody else's clock, was that the Uniform Standards of Professional Appraisal Practice (federal guidelines ALL appraisers have to abide by) DO require the use of gross rent multiples and discounted cash flows for ALL income producing properties - residential as well as commercial. The problem is that most houses are not income producing and cash flow information on ones that are is private. Unless you're appraising a home in a neighborhood with a high percentage of rentals, or a unit in a condominium, the data necessary to perform an income approach can be difficult if not impossible to obtain.

    Even if rental data was easy to obtain, those multiples will rise and fall with the market which is based on supply and demand. When demand is high prices go up - period.

    The appraiser is the only party to a mortgage transaction that is NOT paid based on the price of the home. It is not the appraiser that decides how much to loan to whom. The problem with the current housing situation is that too many lenders were throwing too much money at buyers who had little or no money to put down. This created a market frenzy that drove prices up - it is certainly not the appraisers fault that property owners are now having to dump properties on the market because the supply of loans has dried up.

  • Report this Comment On March 04, 2009, at 10:48 PM, gmh180 wrote:

    Obviously an article written by someone who knows very little about the subject: the appraisal profession. There are standards enforced by state and federal boards that have been developed and enhanced for decades. An income approach is one of the three approaches typically used in an appraisal. For residential appraisals, typically an income approach is not considered applicable. In most residential real estate markets, single family residences are not constructed nor purchased for their income producing capabilities; as the purchaser will be occupying the home. In areas and/or for certain homes where the primary purpose would be for leasing of the property, then an income approach would be applicable and necessary to provide credible results. In commercial property, the same applies. In the case of a single tenant facility, such as an office/warehouse facility, that has not been purchased nor constructed for income producing capabilities, the income approach would not be applicable; however, if the facility is for a multi-tenant use, then an income approach would be required to provide credible results. It would not make sense for someone to buy a house based on income they do not plan on generating from the property and in most cases; these properties (large single family residences) would have a limited market for tenants. Learn more about the subject of your article before writing.

  • Report this Comment On March 05, 2009, at 1:17 AM, imjustme wrote:

    Please read a newspaper. You have no clue what you're talking about.

    PS. The housing mess was caused by banks extending credit to people who didn't have the income, assets or credit scores to warrant it, then selling off the loans to unsuspecting investors. When investors started losing money, they stopped investing and viola-lending crisis.

  • Report this Comment On March 05, 2009, at 1:55 AM, FUBO wrote:

    Gadzmo said...

    I think this is where the industry should head:

    http://www.zaio.com/....

    Yeah that worked well...liquidated and went belly up sticking all their appraisers with unpaid invoices.

    An owner occupied house IS NOT AN ASSET. If it doesn't put money in your pocket it is a liability. In most cases you'll pay more for upkeep and expenses than will ever be returned.

  • Report this Comment On March 05, 2009, at 9:03 AM, BBrown2851 wrote:

    Matt, The definition of market value is codified in FIRREA. It stipulates that the value is based on the most probable price paid in a competitive market by willing buyer & seller, both acting prudently, knowledgeably, blah blah..., as of a specific date. Short term demand and supply issues have significant effects on that value. Maybe a better fix would be to develop a "lending value" definition that tied value to long term appreciation/depreciation rates, mitigating the wide fluctuations. Or better yet, lets call residential mortgages what they really are.....consumer loans. The appraisal is simply a hurdle to accommodate the regulators. It doesn't matter what the home's value is at the time of mtg origination, it will only be worth a fraction of that amount the moment foreclosure procedings begin, in any market.

  • Report this Comment On March 05, 2009, at 9:53 AM, none0such wrote:

    Me thinks the appraisers protest too much.

    The engineers in California responsible for shutting down power plants for "routine maintenance", creating rolling brown-outs and, in effect, enabled Enron to manipulate the newly deregulated energy market there KNEW THEY MADE A MISTAKE in judgment by underwriting this abuse. As a direct result of that action, today there is a code of ethics for engineers in the hope that it won't happen again.

    There have been several posts by (alleged) appraisers who identify pressure and unethical tactics from sources KNOWN TO BE RESPONSIBLE for making bad business decisions - their solution was to not participate in residential appraisals either by choice or by design. Where are the reform minded appraisers? Only PolyNail with something constructive to say?

    Instead of beginning your post with "The author doesn't know anything ..." (and I agree that Mr Koppenheffer' s articles are a bit obtuse - but that is stating the obvious) why not start by offering your insight on how residential appraisals might be made better - that is the nature of the article, not to encourage finger pointing.

    I may not agree with everything the author writes but at least he has the courage of his convictions.

  • Report this Comment On March 05, 2009, at 11:51 AM, dago19 wrote:

    "KeitaiOtaku makes a great point. One of the strongest indicators of value _is_ what someone is willing to pay"

    I'm sorry, but that's just not true. If we go by that logic, then the folks paying 100x earnings for Cisco in 2000 were correct because somebody was willing to pay it. One of the strongest indicators of price is what somebody is willing to pay. If we learned anything from Graham and Buffett, the market's price for something and its true value don't always align.

    An appraisal is supposed to determine value, so having somebody come along and confirm current market price is of little use to anyone. Now on the flip side, what if an appraiser comes along and values a house at $200k and the seller won't sell it for less than $250k? Well, if you buy it you've just paid a market price for that house, but you've paid more than its underlying value as an asset.

    And there is a very real asset value to a house -- it is the current and future value of what you would have to pay to rent. As I pointed out in the article, there is also an intangible value of a house -- the warm and fuzzy feeling of owning a home, not having to answer to a landlord, being able to see the mountains out of the window of one particular house. The intangible value is very real to the homeowner, but banks should not be lending against that value, nor should a homebuyer be convinced that the intangible value is anything more than intangible.

    I can't say that I'm surprised at the amount of disagreement here -- the current system is very well entrenched and to change it would cause quite a shake-up. But just because everybody already does something a certain way hardly makes it right. Maybe along the way we can also break the American imperative of owning homes -- if what you're paying to buy a home far exceeds the comparative cost of renting, in most cases you just shouldn't be buying.

    Matt

    Matt, what you are missing here is that the appraiser's job is to determine"market value", not some intrinsic, ethereal,or any other kind of value you think should be used. It is the value that the market indicates. And how else, like your appraiser friend suggested, do people buy houses? Houses are unlike other investments in that they are really not viewed as such. Why else would we be having this talk? When we are dealing in the residential housing market, decisions to buy are based on location, amenities and just plain ol' preference! One Picasso as oposed to onother if you will.To apply invester standards to a non invester market is apples to oranges. The trouble is not how houses are appraised, the trouble is turning the mortgages, and mathematical portions of them, into investment instruments. Take your Picasso example further. There is no international trade in the financing of art for obvious reasons. There should never have been for homes either!

  • Report this Comment On March 05, 2009, at 12:11 PM, FargoAppraiser wrote:

    Matt wrote - "... If we go by that logic, then the folks paying 100x earnings for Cisco in 2000 were correct because somebody was willing to pay it. One of the strongest indicators of price is what somebody is willing to pay. If we learned anything from Graham and Buffett, the market's price for something and its true value don't always align."

    You are correct that true value and market value don't always align. The thing you are forgetting is that appraisers are hired to determine the "MARKET VALUE" not some sort of 'true value' or underlying asset value. That is why each appraisal has an effective date on it. The market will change, but the value as of the effective date is always the same. That is the value that a property would sell for on the open market at that moment in time.

    Now if you want something other than market value, and you want an appraiser to gather data on past market trends and future projections, the appraiser can do that for you as well. And the appraiser will be able to give you a much better idea as to what the underlying value may be. However, that is not a determination of 'CURRENT market value', as requested by the lender.

    Also keep in mind there is a reason that lenders didn't ask for the true value of the property. They quite frankly didn't care. They simply wanted to make loans. And besides, it wasn't even their money they were lending. They would make the loan and sell it to Fannie Mae or Freddie Mac as quickly as they could. So it mattered little to them what happened to the loan after they made it.

    Of course Fannie and Freddie didn't care much either. They were a government sponsored entity. They knew that if anything happened to them the gov would bail them out. Just as it did.

    I have commented for years that the best thing we could do for the mortgage industry is to dissolve Fannie and Freddie. Only when the lending institution is lending its own money will they care what the real value of the property is. As long as they are lending someone elses money, they have little interest in knowing the real value of a property.

    Please read the post above from AppraiserBob again. He does a much better job of describing the situation than I just have. Pay particular attention as to the role of Franklin Raines in all of this. Now ask yourself who has a bigger stake in this game and who is more likely to be dishonest and cover up the cause of this problem. The appraiser who is making $300 per appraisal or someone like Raines who made millions if not billions of dollars for his role in all of this. And now that Raines has a prominent position in the Obama administration, don't be surprise if you can't find any accurate information regarding the true status of Fannie Mae while it was under his control.

  • Report this Comment On March 05, 2009, at 1:52 PM, norenore wrote:

    Your first mistake was talking to an appraiser that drives a Cadillac.

    I logged 15,000 miles last year working as an appraiser...next time talk to an appraiser that drives a Prius.

  • Report this Comment On March 05, 2009, at 3:14 PM, jross7301 wrote:

    Appraisers do have to report market conditions... but prices paid should also be considered in the context of cost and rental income. Markets can become over-heated pretty quickly and a comparison to cost and rental income would be helpful. Appraisers would be in a more defensible and credible position today if they’d included a statement like the following:

    “Current sales support a price of $X. However, the underwriter should be aware that current market prices are high relative to cost estimates (e.g., $Y/sq. foot vs. a normal range of $y to $z/sq. ft.), as well as to rental rates (ratio of current prices to rent vs. normal range). This suggests an overheated market.”

    And, of course, now the opposite may be true in some markets, i.e., sales prices (where sales have occurred) appear to be on the low side relative to cost and rent.

    Someone pointed out that sometimes data is hard to find (few or no rentals), but appraisers should be able to use the next best source of information (perhaps an index of rental rates in the community, city or region -- the comparison is to historical trends, and will offer insight into the state of the market).

    And, that brings up a final point: data on real estate is inconsistent, under-reported and sometimes not available. Part of the bailout should focus on improving the quality, consistency and availability of market data for real estate.

  • Report this Comment On March 05, 2009, at 3:29 PM, coynegroup wrote:

    What a fool you are! License the loan officer, underwriter, loan processor and keep track of the loans that the deal with and rate their performance. The appraised value had nothing to do with the homeowner not making thier payment as promised. Maybe, the $5.00 cup of coffe they buy everyday, maybe it's the job they lost, maybe it's because they didn't report all their expenses or misreported the income. Bottom line, it doesn't matter what the home appraised for, it's the consumer who borrowed money and quit paying the mortgage payment. People act like it's a car or something, so what let them have it back.

  • Report this Comment On March 05, 2009, at 4:54 PM, ejclason2 wrote:

    I may appear to be going off on a tangent, but stay with me.

    Today if I buy a house for the appraised value, I can avoid mortgage insurance (PMI) if I pay 20% down. If I buy a house for more than it's apraisal I would have to pay more the 20% to avoid PMI (I know people who have done this).

    Matt, if we used your method of appraisal, people who buy houses in a over prices (hot) market would have to pay a larger down payment to avoid PMI. I'm not saying that's wrong. But you need to be clear, that would be one of the side effects of changing the appraised value of a house from it market value to it's "true" value.

  • Report this Comment On March 05, 2009, at 7:26 PM, TMFKopp wrote:

    Thanks everyone for all the comments. Though a lot of you don't agree with my take I certainly appreciate that so many have taken the time to share their thoughts.

    I will say, however, that a lot of the argument against what I've said seems to be that I'm wrong because... it's just not done that way. There were more than a few people that emphasized that an appraiser's job is to appraise to market. Ok, well maybe we've found that signing off on what current market value is isn't terribly valuable in the process, so maybe it's time to rethink the appraisal process and consider that trying to place a true value on a property is a worthier mark to be aiming for.

    Matt

  • Report this Comment On March 05, 2009, at 9:22 PM, FargoAppraiser wrote:

    Matt wrote

    ... There were more than a few people that emphasized that an appraiser's job is to appraise to market. Ok, well maybe we've found that signing off on what current market value is isn't terribly valuable in the process, so maybe it's time to rethink the appraisal process and consider that trying to place a true value on a property is a worthier mark to be aiming for.

    Matt

    I agree completely. I would love to have a bank come to me and ask me to appraise a house for what I think its underlying value is worth. The problem is that banks are in the business to make loans. So they want the appraisal to be as high as possible so they can loan as much as possible. It doesn't matter if the borrow can ever pay it back or not. The loan officer (who is not licensed or sanctioned in any way) is payed on commission. The bigger the loan the bigger the commission. The problem starts and ends with the bank. The appraiser is simply providing an estimate of market value as the bank requested.

    Now if you want to look for a solution consider the following.

    1) Look at regulating the banks and licensing the loan officers. If loan officers had even half of the licensing and continuing education requirements the appraisers have, it would go a long way to avoiding this problem

    2) Let Fannie and Freddie go bankrupt and get rid of them, along with FHA and VA. Banks wont be responsible for what they lend until they start lending their own money. Of course this creates the problems we had in the 30's. Many banks did not have enough money to lend. So only the very rich could afford to purchase homes. So realistically it may not be the best solution.

    3) Require lending institutions to hold a loan for 6 months to a year before selling it on the secondary market. Then have Fannie Mae or Freddie Mac require a 2nd appraisal on the property before they purchase the loan. If a lending institution knows that they have to sit on the loan for a year before they can sell it and even then the loan may not be purchased if it was over appraised the first time, the banks will be sure to get an accurate appraisal on the property. They won't want to be stuck with a bad loan. But as it is now, they know that they can pass that bad loan on to Fannie Mae and Freddie Mac who will not require another appraisal on it. If Fannie and Freddie want solid estimates of value, they will need to hire the appraiser themselves, not rely on the appraisal that was done for the bank that was pressuring the appraiser to make value or loose their business and not get paid for past work performed.

  • Report this Comment On March 05, 2009, at 10:03 PM, homeValence wrote:

    Fascinating discussion...not unlike the one that pops up now and then. Last time on the Freakonomics Web site. I challenge the author to try and use this bright idea to buy a home and report back.

    I find the HPI data based on Fannie Mae & Freddy Mac's purchase and refi appraisals to be a reasonable estimate of values. Especially since the ultimate source is the data-rich MLS.

    In fact, this is the reason behind the launch of homeValence.com; a simple site that allows people to privately track their home's appreciation. Not perfect but getting there and as accurate as AVMs like Zillow.

    Mr. homeValence

  • Report this Comment On March 06, 2009, at 10:27 PM, belletaine wrote:

    I have to agree with one of the earlier comments, that when it comes to appraisers, the "tail wags the dog". I sold a home that was a rental near a University in 2003. The buyer negotiated with me by bringing in his appraiser/friend, who valued it about $25,000 below what I knew would be market value. At this time investors were all ga-ga about getting into real estate and I easily found another buyer who would offer me what I wanted. When I dangled this in front of my buyers eyes, his appraiser suddenly "reappraised" his figure to agree with me. He admitted to the ephemeral nature of the job-- the tail wags the dog. I got my price.

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