Thursday, July 14, 2011

Appraisal Magic

by Osman Parvez
Appraisal Magic.   That's what Boulder real estate attorney Oliver Frascona calls the rather curious way that real estate appraisals manage to hit or slightly exceed the contracted purchase price.

It wasn't an offhand comment.  I've heard him say this in front of dozens of agents and I've heard him repeat this in several continuing education classes.  With over 35 years of Colorado real estate law experience, not to mention a sterling reputation in the real estate community, do you think he might be on to something?  I tend to defer to his judgment.

A History of Appraisal Fraud
As pretty much everyone knows... before the real estate meltdown, appraisers were cherry picked by lenders and influenced by brokers.   A handful of fraudsters were artificially inflating appraisals, bringing in phony buyers, and running away with the closing proceeds.   Independent appraisals were anything but independent.

The result was much needed reform, including a system where lenders can no longer select the appraiser and brokers are prohibited from direct contact.  

The Appraisal Merry-Go-Round
Appraiser in Training
The current system of lender ordered appraisals involve a round-robin selection of the appraiser.   The appraisal firm is paid a set fee, whether or not the appraisal is accurate, and with no regard for whether the deal closes or not.   While this increases the independence of the appraiser, it also means there are no rewards for high-quality work and no punishment for lousy work.

Can you imagine hiring your employees by round robin?   Would you even take a chance on a hair dresser selected by random chance, with no tips allowed for a job well done?

For the bank, these "good enough" appraisals are fine because they only need to justify an 80% Loan to Value (LTV).   Plus, the lender isn't risking their own money and plans to sell the loan on to Fannie or Freddie.   For buyers taking the ultimate risk, these "good enough" appraisals doesn't really cut it.   Buyers are putting their hard earned money at risk and they don't want to purchase a home for more than the market will bear.

The Buy Side Appraisal
Buyers can engage their own appraiser, just like a lender, but unlike the bank they can choose who they'd like to perform the analysis.   Yet seasoned home buyers and sophisticated investors know that appraisals are not always an accurate indication of a property's value.

The reality is that one appraisal can vary wildly from another, especially in a small market like Boulder.  When a buyer agrees to pay for one, often reluctantly, most feel the appraisal should come in higher than the contracted purchase price.   With costs approaching $400 for this supposedly professional analysis,  experienced buyers paying cash are hesitant to pony up for it.   Unlike the appraiser they hire, they've already been inside other available houses  and often seen what's already sold.   For this reason alone, most would rather do their own analysis.


As I've written many times on this blog, the best way to get comfortable with the market is to see the houses and track what's been selling.   A key reason you're hiring me as your buyer's agent is that my market experience plus time with me discussing comps will help you understand market conditions and help you feel confident that you're getting a good deal.   That's what I offer each and every one of my buyers.    


The Sell Side Appraisal 
Sellers will also occasionally have an appraisal done.  Their hope is that an appraisal which comes in higher than the asking price will help them lure a buyer seeking value.   Of course, if the appraisal doesn't come in higher, they have the option of reducing their asking price or disregarding the appraisal entirely.  There is nothing forcing a seller to reveal a low appraisal to the buyer.

In some cases, a high-appraisal justifies the price but only if the comps are fair (recent and representative of the property in question).   Serious buyers who have done their homework are already aware of the property's value and for the reasons mentioned above, are likely to disregard an inflated appraisal entirely.  For this reason, sell-side appraisals are highly suspect.  

Appraisers Don't Write Checks
I had a deal fall apart yesterday, based on what appears to be an inflated appraisal.   Of course, I'm not mentioning names or addresses here.   It's a small real estate community in Boulder and I certainly don't wish to compromise future negotiations by being a thorn in the side of another broker in Boulder.   My simple wish is for appraisers who stand behind their work to be willing to buy the house they've appraised at that value.   Or, if the house is unable to find a buyer at their appraised price in a given period of time, agree to refund not just the appraisal fee but a penalty for being wrong.

Now that would be a system of risk and reward I'd buy into.  Sadly, the flow of funds to an appraiser is truly one way.  

Cover MY Tush
A final note.   For all buyers, paying cash or otherwise, my standard advice is to go ahead and get the appraisal.   For CYA purposes, I must recommend this action, despite a lot of evidence which points to its clear lack of value to cash buyers.    My way of paying penance for being forced to recommend something of dubious value is to offer extensive analysis and review of the comps.    We'll analyze and discuss, analyze and discuss until the cows come home if it helps you feel more comfortable with your investment decision.     Although Boulder's market is healthier than most, ultimately you will take the risk of owning a high value asset in an uncertain market.  My goal is to help you understand and feel confident in that decision.

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Note: Our goal is to provide exceptional service to our clients. The ideas and strategies in this blog post are the opinion of the writer at the time of publication. We recommend careful and complete due diligence before buying or selling real estate or other investments. Consult with your professional advisers before making financial decisions. This article is not intended as legal, tax, or investment advice. 

6 comments:

  1. As it turns out, Louisville KY and Ford Motor Company are having a round robin for hiring opportunities for 17000 applicants for a couple thousand job openings. Imagine that.

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  2. Another consideration - I've had appraisers tell me that the flat fee the banks are now paying are often not adequate compensation for a thorough, accurate appraisal. Most appraisers want to do a good job, but they have had to cram more appraisals into their days just to make the same money they did in the past, which increases the risk of questionable data.

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  3. Mr. Parvez,

    I have come to expect better from you than this shoddy, misinformed slam against the appraisal community. While there may be a few appraisers out there that are suspect (just as there are in any industry, yours included) most are truly trying to do a good job and accurately represent the current market.

    You state that the appraisal firm is paid whether or not the deal closes or not. While this is true, it is usually true once. Meaning that if you or your firm consistently fails to appraise properties at the contract price, guess what happens? You mysteriously get booted from that bank's list of approved appraisers, so there are rewards and punishments.
    Also, banks get to decide who is and who is not on there approved list of appraisers, no one else, so it isn't as random as you state.

    You state that banks are accepting "good enough" appraisals, well, shame on the banks for accepting this substandard work. They do have options like appraisal reviews or eliminating bad appraisers from their approved list.

    As far as fees are concerned, lets stack up appraisal fees with the ridiculous fees charged by realtors. The $400 an appraiser gets turns into about $15 per hour if they take the time to do it right, why don't you divide your fee by 15 and see how many equivalent hours you would have to spend on one project to earn your 2.8%? You'd get one deal per year done.

    Also, when it hits the fan, who's the first one everyone eyeballs? Is it the realtor? no, its the appraiser. So for $400 an appraiser gets to guarantee his work, be open to lawsuits and to losing his license and be despised by everyone involved.

    And as far as "Apprasial Magic" well, if you've done your job correctly and so has the other realtor, that is precisely the number the appraiser should come up with, it is the MARKET rate for that home. Anyone who tells you they can dial in an appraisal to something greater than 3 - 5% of the current market value is full of it, no one is that good, sorry.

    I'm here for you, Osman, to honestly and respectfully answer your questions, but this article is full of inaccuracies and half-truths, you usually do a much better job.

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  4. Ok, I'll buy that most appraisers are trying to do a good job but their opinion on market value is often flat wrong because they haven't been inside the comparables, they usually don't even visit the active competition, and they don't take any real risk. The easy thing for them to do is appraise the property at the contract price, which essentially amounts to a stamp of approval, not a true independent opinion of value.

    At least we can agree that they are underpaid.

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  5. Ooh - Burn!

    Anonymous has it right. Realtors have little to no risk and reap most of the rewards in these transactions. Unfortunately this is the way of our capitalist system - less work/value? More pay! Case in point: Architects and builders are the professionals who truly add value in the real estate game, turning raw commodities into useful things (buildings). Architects typically charge 8-12% of construction costs to design and administer the construction of a house. This fee covers 100's of hours of labor - likely 1,000 or more for a custom home. Realtors always speak of the hours and hours of time invested in the sale of a house. Add em up then...how many?

    The appraiser has skin in the game (reputation) and is paid peanuts.

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  6. STILL trying to deflect? We're talking about appraisals here, not the value added by Realtors, Architects, Builders, Plumbers, or your cab driver. We're certainly not talking about our "capitalist system," comrade.

    Look, I know this isn't what you want to hear but the truth is that appraisers have very little skin in the game. They're also underpaid for the work they do and they take very little risk. In a thinly traded market like Boulder, for unique assets like historic homes in particular, their valuation is appraisal magic more often than not. And for the bank, maybe appraisal magic is good enough. For a serious home buyer, it's not.

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