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The Appraiser’s Role in Today’s Real Estate Transaction

We are honored to have Chip Wagner, an icon in the appraisal industry and our good friend, as a guest blogger today and tomorrow. Tomorrow, Chip will discuss the impact distressed properties have on housing values. Today, Chip defines the role of the appraiser in today’s real estate transaction.  – The KCM Crew

I have been saying for a couple of years while real estate values were in decline, my bigger concern was going to be when this market stabilizes and tries to improve.  In my February 2011 eNewsletter, I stated:

“My concern has been that once the real estate market hits bottom, it will be a difficult transition into an improving (appreciating) market after 4-5 years of decline. This seems to be happening right now, with much of the difficulty being the distressed market activity competing with the arm’s length transactions.

While there are no fool-proof solutions to these challenges, it is important for the real estate community to work together with appraisers valuing properties to help them understand the nuances that are occurring from market to market.”

It seems we have reached that point in the real estate market.

The appraiser is challenged with finding comparables, and once potential comparables are identified, there is a great amount of time attempting to identify the “terms” of the sale – was it an arm’s length transaction in which both parties were equally motivated?  Was it a relocation transaction where a corporate owner was attempting to shorten the time on the market to find a buyer?  Or was it a distressed sale in some way – a short sale, a foreclosure, or a court-ordered sale.  Regardless, the pool of comparables is both limited, and muddied.

Are there appraisers that are inexperienced?  Yes.  Are there appraisers that do not know how to read a market?  Yes.  Are there geographic competency issues? (appraisers going outside of their market to areas they are not familiar with)  Yes.  Are appraisals killing deals?  Yes.  But there are far more appraisers that do know what they are doing and we are trying our best to provide an independent, unbiased opinion of the market.

Are clients directing appraisers to be more conservative as suggested in the WSJ article?  Nonsense.  Appraisers cannot be an advocate for anybody, or they jeopardize losing their license and livelihood.  I’ve never once in over 21 years have had a client tell me to be conservative or they need the value to be low.  The client cannot tell us what comparables to use that could lead us to an inflated or deflated value.  Was that game being played prior to the real estate recession?  Yes, clients were asking appraisers to push the values upward – (most commonly in cash-out refinance appraisals, not purchases).  But in the past 3-4 years, no client is asking the appraiser to be conservative or low in their numbers.

Are government regulations and lender’s special underwriting requirements interfering with the process?  Absolutely!  The regulation with the HVCC and the Dodd-Frank act have good intentions but unintended consequences that are not protecting the appraisal profession, but rather putting restrictions on what we can do and how we run our business.  State appraisal boards are cracking down on bad appraisals and the word is getting out to the appraiser population that their work better be on the up and up.  Underwriters have the final say in making loans on behalf of the lenders.  I have heard of countless stories of appraisals coming in with value opinions that are reasonable, but underwriters rejecting or changing the final value opinion.

What is the solution?

There really is none as long as the market remains complicated.  Real Estate professionals are expected to give their opinion of the market based on what other properties are listed for and eventually sold.  About a year ago, Fannie Mae asked appraisers to include one active listing (or pending sale) in their appraisal reports, and some underwriters are now asking for two.  This is very important clue as to what is happening in the market – a listing, or better yet a property that is under contract can help support an increase in the market, or even stabilization.  It can also support declining values.

The Real Estate Principal of Substitution, defined states: “that when several similar or commensurate commodities, goods, or services are available, the one with the lowest price will attract the greatest demand and widest distribution.”  If the 3 sales comps suggest a value of $200,000 and 3 listings or pendings suggest $185,000, then the market is in decline.  Conversely, if the 3 listings or pendings suggest a value of $210,000, then the market is increasing.

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16 replies
  1. Bob Pace
    Bob Pace says:

    Thanks for this well expressed overview of what we in the business are dealing with . I do agree properties on the market do need to be considered in value opinion .

  2. Geo Gervasi
    Geo Gervasi says:

    While I agree and applaud most of the article Al, I completely disagree with your analysis of listing/pending/sold comps as to the market incline or decline. Many listings are overpriced and therefore in my analysis, hold little or no weight in value/market determination. And, as far as pending sales go, 15% to 20% of pending or UC properties wind up canceled or denied. The pending/UC metric is unreliable in my 9 years of valuation experience. I examine local micro economic indicators and data to determine specific market performance as well as overall macro pictures that influence price and value. I usually ignore listing/UC prices, unless they are very realistic- and those are few and far between in my markets and areas of CNJ/NNJ.

  3. Brenda
    Brenda says:

    Do you have an opinion about VA appraisals. As a real estate agent who has been dealing with appraisals on all different loans, VA, FHA, Conventional. I have found the VA appraisals to be especially low. I was just wondering your thoughts on this?

    Thanks for the article…we have seen this problem in the Charleston area. We have a new Boeing Facility, which is bringing in many new transplants for jobs. And we are stabilizing in the under $400,000 range. However, foreclosure are still a problem. Although, the foreclosures are being absorbed quickly, if priced right.

  4. David Mott
    David Mott says:

    The topic of “cost to build” never comes up in the appraisal process, although it is a tool of the appraiser (I saw this on an appraiser’s form). What hurts the market the most is an appraisal that comes in lower than the cost to build (and purchase the property).

    Whether it’s a city property in a subdivision, where you have basic water, sewer, power, phone, cable, etc., all connections right at the street, or especially if you have a property in the county where you have to put in a driveway, septic system, well, and pay for power poles and transformers, etc., the cost to build should reflect these items in addition to the actual cost of the home.

    Additions, improvements, outbuildings (like a garage), as well as neglect could adjust the price accordingly.

    Outside of this cost to build value is possibly the greatest variable, and that is the location and or size of the lot.

    In my opinion, after the cost to build approach is used to derive the actual value of the main structure (the underwriter’s target), then lot value could be determined by the neighborhood or vicinity. If an acre is $100 or $100,000, it should be reflected in the appraisal.

    Apartments and condos should not be used to comp single family homes and vice versa.

    Last but not least, if the appraisal is significantly different than what the county has appraised the property for, or what the insurance company has the property appraised for (rebuild rate), then a flag should be thrown.

    Not using the cost to build approach has killed the construction industry. Why would anyone in the industry bother to build anything if it is not cost effective? If the appraisal comes in lower than the materials list alone to build a structure, how on earth can the labor cost be justified?

  5. Brian
    Brian says:

    David, it sounds like you have not actually looked at many appraisals. The cost approach is widely used as one approach to value. Apartments and condos are never used as comparables for single family detached homes (fee simple) or vice versa. The market does not care if a builder can’t build and make a profit. the market only cares about the principle of substitution, as Mr. Wagner described. That is why we have seen so little new construction in many area of the country over the last few years.

  6. Larry
    Larry says:

    David Mott: in reference to what you wrote. You can not possibly be a real estate professional, am I correct? It may do you well to help your frustration to talk to a real estate professioanal to get a handle of your thinking about real estate and the way things really work. You are all mixed up when it comes to this topic.


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