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What goes up must come down – nowhere is that more true than in banking and real estate. Bubbles have led to busts more than once with housing prices sinking faster than rocks.
Now the fallout continues, with the emphasis in this recovery on the appraisal process. Appraisers are a necessary third party with no financial ties to the transaction. Buyers, sellers, real estate agents and mortgage lenders – all have a financial stake in the outcome of a deal. Appraisals higher than the agreed-upon sales price don’t cause a problem, except maybe regret on the part of the seller for not holding out.This happened in New England in the late 1980s and again nationwide during the Great Recession. Home prices had been in a spiral, rising steadily as lending requirements loosened and real estate was considered a sure investment. There were even articles claiming that there was no bubble. Complicating the issue was the mortgage securities market, which made a lot of people rich as these sure things were bundled and sold.
It’s when appraisals are too low that a chain reaction is set off that often causes the deal to fall apart. Banks use appraisals to value the collateral, in this case the property. They’re required to lend prudently – within value to loan parameters – so they’re not left with a portfolio that has to be sold for pennies on the dollar.
A low appraisal means a lower loan and a cash differential between sales agreement and mortgage. If the buyer can’t, or won’t, come up with the difference, then the deal is done. Sellers lose out and so do real estate agents.
In the early days after the recession, many appraisals were considered too conservative, at least in light of existing mortgage amounts being refinanced. Real estate suddenly became a buyer’s market, with sales prices plummeting. Since appraisers are required to use comparable properties, this led to a general downward trend. In this situation, housing builders weren’t able to recoup even the actual cost of building.
In 2009, mortgage giant Freddie Mac tried to prevent another bubble by focusing on appraisals. The Home Valuation Code of Conduct (HVCC) attempted to make it difficult for lenders to pressure appraisers into giving them the “right” value.
Since HVCC pushed lenders toward appraisal management companies, many felt the resulting appraisals lacked the local market area knowledge and experience formerly provided by independent appraisers. Buyers and real estate agents could only communicate with appraisers or receive reports under limited circumstances.
Fortunately, in the view of many, HVCC has been sunset due to the Dodd Frank Wall Street Reform and Consumer Protection Act. However, in early 2015, an initiative by Fannie Mae went into effect, again focused on appraisals. According to Fannie Mae, Collateral Underwriter (CU) is “a proprietary appraisal risk assessment application developed by Fannie Mae to support proactive management of appraisal quality.”
Lenders who work with Fannie Mae are required to enter information from the appraisal about the subject property into the system. The database assigns a risk score to the appraisal, identifies issues and provides up to 20 comparative properties.
The lender is required to address any problem areas with the appraiser, who is required to justify the value assigned. One main flaw of the system is that it uses census blocks as a geographic identifier.
Neighborhoods with vastly different values can co-exist in a census block, which makes this method less than reliable. Instructions for CU warn that there may be “potential property or local nuances,” and that in rural areas, a greater distance or time period may be required to identify sufficient comparable properties on the part of the appraiser.
A situation where CU questions an appraisal means more work for the appraiser as well as a ding on their reputation. In light of the extra time and effort, fees are likely to increase. Deals will also be slowed down as appraisals are adjusted.
In recent months, Mortgage News Daily has seen a number of concerns expressed by lenders about extremely conservative appraisals. An example is a property appraising for $30,000 less a year after a sale although the value index rose in that area. These low values are causing many deals to fold, both refinances and purchases.
With an eye to CU, Mortgage Daily News suggests that appraisers may presently be extremely cautious in an effort to avoid questioned appraisals. At the same time, the appraiser pool is shrinking. According to the Appraisal Institute, between 2006 and 2012, the industry lost about 9,000 professionals. In addition to the market slump, increased industry regulation and oversight is making real estate appraisal a less than lucrative choice, industry experts say.
Proper valuation of real estate benefits everyone and contributes to a more stable market. It remains to be seen if CU will help or hinder that situation. – Elizabeth Penney, M.B.A.