The tiresome issue of the misunderstood appraisal
Raise your hand if you’re tired of hearing about low appraisals in the news. Raise your other hand if you have no clue what the definition of a “faulty appraisal” even is. If both of your hands are in the air, that’s awesome, mine were.
Let’s go back to class here for a second. An appraisal is an opinion of value, it determines how much a home is worth on a given day and time, based on age, size, condition, and several other factors. There are three methods on how this can be done – the income approach, for commercial or (duh) income producing properties, like multi-family homes, the cost approach, often used for manufactured homes, and occasionally for new construction – how much it literally costs to build or rebuild a home, and finally the most common, is the comparison approach, using active and sold comps in the neighborhood.
When done for a home purchase, an appraisal is done to protect the bank from lending more money on a home than it’s worth. It isn’t completed to meet the agreed upon price in the contract. It’s not there for the buyer’s peace of mind. It sure as heck isn’t there for the seller or Realtors involved. The lender is the client, they are the ones who are insuring their investment in the transaction by getting an appraisal ordered.
NAR and NAHB members claim lost deals
For nearly a year, between 10 and 18 percent of NAR members surveyed have reported at least one deal which has been delayed or killed due to appraisal issues. Usually the issue is that the appraisal is not meeting the contract price, and either the transaction falls apart completely, or the sales price needs to be renegotiated. Recently a report was released by the NAHB, wherein they are also reporting issues with appraisals. Within the last six months, of their surveyed members, roughly 60 percent said the appraisal was less than the contract price, and about half said the appraisal was less than the cost of building the home.
Both groups are trying to correct the problem of problem appraisals. In a NAHB statement on December 8th, they note they have been holding appraisal summits in Washington for several years with banking regulators in order to urge change of appraisal practices. One of their major concerns at this time is the use of distressed comps in new construction sales. NAR will be hosting a webinar in January with suggestions to make sure appraisers are qualified. Questions Realtors can ask when meeting an appraiser at a home, ensuring they know about upgrades, and providing neighborhood comps.
Not all appraisals are bad, but when they are…
This is all well and good. It never hurt anyone to be more informed about a property. However, to me, a crappy appraisal is one that isn’t up to standards, that is completed sloppily, inaccurately, one that doesn’t take all information into account, one in which data is falsified. Most appraisals are of quality, but when they are bad, they are really bad.
Not meeting contract price, for whatever reason; the home was overpriced to begin with, it was over-improved, the market is rapidly declining- possibly due to job loss or other economic issues, the market is driven by distressed properties, or even the condition of the home itself, this simply is not a reason to get into a huff. And I kind of have to say tuff tiddlywinks. The contract price, and sometimes even upgrades, don’t mean a whole lot, when the rest of the immediate area can’t support the value.
Ben Goheen
December 16, 2011 at 1:39 am
Since every area is different, so having a nationwide regulation against using a distressed property to new construction is bogus. A new construction appraisal I did a couple months ago came in low because there were TONS of 1-5 year old (bank owned) homes in the area selling for $20k less. You can't justify a higher price just because the builder won't break even – not my problem.
What's worse, a 'faulty' appraisal or completely inaccurate information listed in the MLS? Unfortunately the latter is way more common.
Kathleen Cosner
December 16, 2011 at 7:25 am
Agreed Ben. My fav example is this: A person can *ask* whatever they want when they sell their home, there's no law against it. There's nothing stopping Buddy the Dog from throwing a For Sale out front and a list price of $500k. Just like there's nothing stopping Xena the Kitty from agreeing to pay that cool $500k. However, if the house is only worth $100k, that's all *any* bank will ever lend on it. Ever.
John
December 27, 2011 at 2:24 am
I must disagree with your view on the appraisal world of today. I am a former real estate agent, and current part time builder, in that I own a company with a partner that builds entry level spec houses. (Although we have not built one in over 3 years) The last house we built had an offer put in on it, contingent on an acceptable appraisal which the buyers were to have done. The appraisal came in under their offer, although not drastically, but they did show me the appraisal. One of the "Comparables" was a 5 year old foreclosed house, that I had been through when it was for sale. The home was a true distressed property, as there was a lot of damage done before it was foreclosed, and it was build with cheap material and with some pretty shabby workmanship.
I also refinanced my own home 1 1/2 years ago, and there were only 3 comparables used, due to the lack of them. My home is a 19 yr old 1940 sq ft, full brick, full basement ranch, constructed not the best material, but above average. One of the comparables was a 2457 sq ft 2 story, vinyl siding without a basement that sold for $210,000. Sorry, this is not a comparable! The most recent sale of the comparables was a 6 yr old, 2064 sq ft, full brick ranch with basement. Of the 3, this was the most like mine, and sold for the highest amount at $284,000. The 3rd was sold almost 12 months earlier and was a 34 yr old 1750 sq ft brick ranch with basement, that sold in less than a month for $170,000, to settle an estate.
There ARE many issues with appraisals today that need to be corrected. The biggest is using foreclosures as comparables for new construction.
Rosemary Gleason Reed
December 16, 2011 at 9:23 am
Specializing in Short Sales appraisals are critical to successful marketing when shorting an FHA loan. Last year I received an appraisal well above what the comps showed and upon review found it was based on a ranch, a bungalow and a colonial. (This home was a 90 year old colonial in a neighborhood made up of almost identical homes. ) Here's the kicker…the colonial used was actually an ACTIVE listing. Armed with all this to show it was sloppy and inaccurate, I still fought that appraisal through HUD for months and never got anywhere.
Roger Perez
December 20, 2011 at 9:17 pm
I have been a real state broker, appraiser and builder for 25 years and have seen a lot of both sides of this argument. To Realtors and builders a bad appraisal is one that they dont agree with. Your article is good for the most part, unfortunately some Realtors and builders dont have a clue of what they are doing, they are priamrily salesmen, thats all. Some houses are appraising at less than construction cost because "cost does not equal market value". There are scores of beautiful , brand new houses sitting empty. They are only worth what somebody is willing to pay, which right now is nothing. You said it well with the cat and dog story , anyone can ask or pay whatever they want for an item, if the buyer pays cash there is no appraisal and he can overpay all he wants. The appraisal is only there to help the bank decide how much they are willing to lend (risk) on a deal, its not there to help an uninformed buyer to buy an overpriced house that some real estate agent told them what a great deal it is.
Ben Goheen
December 21, 2011 at 5:10 pm
I need a *like* button for this response ?
Kathleen Cosner
December 23, 2011 at 7:00 pm
You nailed it Roger.
Bill Ding
April 25, 2012 at 11:56 pm
Ben said; “. A new construction appraisal I did a couple months ago came in low because there were TONS of 1-5 year old (bank owned) homes in the area selling for $20k less. You can’t justify a higher price just because the builder won’t break even – not my problem.”
While I agree that an appraiser is not to give a misleading report so that the builder won’t lose money, I’m going to have to strongly disagree with the broad brush that was used with REOs and New. If Ben had said that there were other non distressed arm’s length new construction that were similar selling for $20k less, then I would agree. But you have 2 factors that you are not factoring.
1. New construction, (aka C1 UAD rating) vs Previously owned (aka C2 rating). Like new cars, people value new over used. Same can be seen with homes. Why do you thing that Fannie makes appraisers label new as C1 condition and previously owned, like new as a C2 rating. If your subject is new…you need to compare apples to apples. On that note, you can’t use land sales with construction costs. You need to compare a completed construction open market sale. You also need to use other developers to avoid scams, inside dealings, straw buyers, etc.
2. Using distressed sales as comps. More often than not, there is a market reaction towards a REO and Short Sale. This needs to be taken into consideration. The bank did not want to own that house, they are not in the RE market and they have a huge problem on their back with all these foreclosed homes and they need to get them off the books. It is a distressed sale. There is undue stimulus to sell these properties. One of the conditions of Market Value is that the appraiser is to find the most probable price the subject house would get in a sale of typical buyer/seller motivations and without undue stimulus to sell. Often you have a bifurcated market where you have 2 values happening between the traditional seller without undue stimulus and a lender sale. The buyer knows the bank has to sell and they have the unfair upper hand with them. There is also a stigma attached to bank sales. They are “as-is”, special warranty deed, non-disclaimer, vacant for God only knows how long, sales. I like to think of them as a box of chocolates ***cue Forrest Gump*** Banks are a pain in the rear to deal with, the agents are often extremely difficult to talk to as well. Lien problems, title problems…all sorts of nightmares that people tell. I won’t even get into the physical conditions that are found.
Market Value talks a great deal about motivations of the buyer/seller. Have you ever called the bank and asked what their motivations were. What made them price it like they did…how many foreclosed homes are on their books, etc??? I’m sure many of you are laughing the deer in the headlight look you would get. You could always ask the agent for a good laugh, too. In any event, REOs are unverifiable.
All these factors that affect value must be considered. You can use C2 homes as comps as well as REOs (you’re not required to)…but should you use them, the market reaction needs to be checked and make appropriate adjustments so that it is a reflection of the most probable price of the subject’s new construction without undue stimulus. MV does not say to find the most probable price of a distressed USED house sale. There may be a “TON” of REOs in the market and driving the prices down. Of course, the prices of the non-REOs will reflect any influence they have in the market.
Lori Herrington
May 3, 2012 at 11:18 am
We had an appraisal done to do a re-fi on our home. When the appraisal came back it was 20k less than what we expected. Upon a thorough review we found that the appraiser “rounded down” on each room in the square footage measurements, leaving off 80 sq feet as compared to 4 other previous appraisals that concurred the real and actual sq footage of our home.
Additionally, they did not add value or even acknowledge the fact that we had an outdoor kitchen (complete with sink, fridge and built in grill) nor the fact that we had well water on the property. The comparables they used were all homes that were similar in age to ours…..however these homes had not been remodeled/upgraded as ours has. Several years ago we updated the home and included a gourmet kitchen complete with custom cabinets and granite countertops. All of the comps had the type of cabinets you would find in a low end apartment. and the flooring throughout our house is new, nice quality hand-scraped hardwood floors, where as the comps all had old out-dated carpets. (we also have several friends that are real estate agents, so I KNOW that there ARE comps of houses sold within 15 miles of my home….same age, remodeled similarily…..that SOLD for $10.00 a square foot higher than the value of our appraiser gave us in her report).
In addition to ignoring the value of materials used inside our home (many more not listed). The appraiser gave us a price per square foot matching the lowest of the comps that she used…..with no explanation as to why the lowest number was used….not even an average. We do not have an abundance of foreclosed homes in our area….the housing crisis affected our area minimally as we are far removed from large metropolis areas. My husband is a banker and has worked with this appraiser on several other deals recently where they just failed to recognize a room in one home, gave innacurate square footage, valued a brand new home as old vs. new construction, on and on. Although the appraiser’s supervisor and owner of the company agreed that the mistakes were made on our appraisal as well as the others they flat our refused to make corrections. We brought them 3 prior appraisals to prove the square footage inaccuracy and provided them with copies of true comps.
We had to pay $450.00 for this! I am outraged that they can handle business in such a way and have no one to answer to. My fear is that this type of problem will continue to go on unanswered and house prices in our area will start trending down based solely on bad appraisers. Any suggestions?