There’s an old joke about a man falling from a 50-story building. As he passes the 25th floor, someone yells: “How are you doing?” And the man replies: “So far, so good.”
Which makes me think, he might have been an appraiser.
Our industry, like the real estate market that we value, is in the midst of a fundamental transformation that many members of the industry have yet to come to grips with. While there are some encouraging signs that the national decline in home prices may be slowing, there are a number of ominous signs that suggest that the recovery may be “bumpy” and that going forward the real estate market will behave differently than what we had been accustomed to. All of which will continue to make valuations more challenging.
Not too many years ago, when home prices were only going up, and lenders were primarily focused on volume (remember those more tranquil days), there was a school of thought that questioned the value of appraisals. Sure, collateral valuation was important, the argument went, but less so than credit scores. Of course, lenders, investors and regulators have since re-learned the painful lesson of the importance of accurate collateral valuations.
Ironically, as appraisals and other forms of valuation are now more relevant than ever, our industry finds itself not only in turmoil, but also in the spotlight. Homeowners and their agents (mortgage brokers and realtors) are vociferously complaining about low values for refis and blown sales deals. There are new rules governing the selection of appraisers. Servicers and investors are looking for more efficient ways to value a sea of distressed assets. Lenders and GSEs are requiring appraisers to do new kinds of analysis (though not always for more money.) And tensions are at an all time high between independent appraisers and appraisal management companies (AMCs).
The New Normal for Real Estate
Undoubtedly, the residential real estate market will eventually hit bottom and begin to show positive appreciation again. Many economists predict this will occur in the middle or later part of this year, assuming of course that the recession ends and employment picks up. This second point is still a pretty big “if” and many economists are worried about a “W” shaped economic recovery, which of course would change their predictions on housing.
We are still in the midst of a massive foreclosure event in the US. Depending on which statistics one follows, there have already been 3-4m foreclosures over the past 18 months and there could be an additional 5-8m more. The impending foreclosures are either directly in the pipeline or in a shadow pipeline, meaning late payments or other early indicators. As of last November, First American CoreLogic estimated that shadow inventory – unlisted REO and potential defaults – stood at 1.7m units up from 1.1m at the beginning of the housing crisis.
Other unknowns that could affect housing price recovery:
- Government intervention – If loan modification programs gain traction, they could reduce foreclosures. This would support housing prices in many areas and reduce the overhang of shadow inventory. As we saw last year, programs like the first-time homebuyer program can ratchet sales up or down. Currently, thanks to the Federal Reserve and the Treasury, interest rates are at levels last seen when Elvis, who would have turned 75 this year, was having his “American Idol” moment on Ed Sullivan.
- The return of the secondary market – currently the GSEs and FHA are purchasing nearly 90% of all mortgages in the US. Will the private secondary market return anytime soon? It would certainly help high-price markets on both coasts.
- Commercial real estate – One major challenge on the foreseeable horizon is a significant devaluation of the commercial real estate market. In many areas, we are seeing the edges of this already. As with the residential market, it experienced significant increases over the past years and there continue to be some predicting a significant decline. This would continue to fuel the “new normal” economy.
While it would be possible to go on in this vein, it’s safe to say that our current condition, the new normal, will be around for quite a while (best estimate 1-3 years). I believe the current Administration will do everything within its ability to help bring stability to housing prices, employment and availability of capital. This will help and hopefully, eventually, bring us into a different landscape.
Valuing Property in Unsettled Markets and Times
Enough with the big picture, let’s look at the challenges faced by appraisers, underwriters and others whose job it is to answer what sounds like a simple, straightforward question: What’s this home worth today?
In some states and MSAs, looking at sales comparables, the tools appraisers must rely on, means looking almost entirely at distressed sales. Does this in turn result in lower valuations than sellers, homebuilders, mortgage brokers and real estate agents would like? Certainly. Many of these affected parties have shared their unhappiness with the media and with bloggers. They point fingers at cautious lenders and at AMCs. They seem to forget that housing prices nationally have declined by 20-30% from their peak in 2006, and in some hard-hit states, like California, Nevada, Florida and parts of the industrial Midwest, prices are frequently down even more.
Some experts believe that when the recovery comes, the biggest gains will be in some of the most depressed states, like California. But in most parts of the country, the gains, when they come, will be closer to historical norms, not like the double-digit jumps of the recent bubble.
Interestingly, in spite of Fannie Mae [stock FNM][/stock], Freddie Mac [stock FRE][/stock] and other large lenders saying that the new appraisal ordering changes are an improvement (e.g. Freddie Mac recently told appraisers and lenders that the quality of the appraisals they received in the second half of 2009 showed a 15% improvement),the state and federal legislators seemingly are ignoring this positive feedback and considering new regulations on AMCs.
Broaden, Don’t Narrow, Options
Generally, there are only four valuation and pricing approaches found in the US market: 1) Appraisals 2) Broker Price Opinions (BPOs), 3) Automated Valuations Models (AVMs) and 4) Hybrid products and statistical analysis. Let’s look at each one separately.
Appraisals are the most widely known and accepted approach to value individual properties. On the origination side (sales and refinances), appraisals have been the “gold standard” for many years. (Just for transparency, I have been an appraiser for 28 years and am very well aware of the training and experience necessary.) Appraisers have been regulated and licensed since 1990 and there are well-developed professional standards, trainings, and enforcement methods to encourage competency.
BPOs are also widely utilized in the country, but their main users have been servicers and default managers. Approximately 10m BPOs were completed in 2009 according to industry estimates. BPOs are performed by licensed real estate brokers on industry-accepted forms.
AVMs are utilized in great numbers by lenders or portfolio managers who wish to get values on their groups of properties, as well as consumers, who can simply obtain an AVM through the internet.
Finally, hybrid products can combine any combination of appraiser, real estate broker or real estate professional with database searches and analysis. Again there is limited use of these in the origination market.
While the accuracy and quality of each type of product is still in heated debate, general wisdom often associates the most expensive products (appraisals) as the highest quality and accuracy and AVMs as the lowest. Typical price and time for each product is listed below:
- Appraisal - $350-$450 - 5-7 days (interior inspection)
- BPO - $75-$125 - 2-3 days (exterior inspection)
- Hybrid - $30-$75 - 1 day (desk product)
- AVM - $3-$20 - seconds
For a servicer who is responsible for selecting and paying for these products, the three components of cost, time and quality need to be balanced. For example, as a property is going towards potential foreclosure or perhaps modification, the lender may just want a snapshot of the probable value. A general idea may be good enough for that purpose. And the lender would currently be able to choose a quicker and less expensive product, which should ultimately benefit the consumer.
One significant current challenge in the market is to keep valuation and pricing options open for the lenders or other market participants. There has been significant pressure brought to bear on the State and Federal levels by appraiser associations who prefer to be the ONLY ones who can value or price properties. While this is understandable from a partisan point of view, it does not take into account the good of the whole. Lenders will have different purposes at different moments in the default process, and they should have all options at their disposal. It is still not clearly proven which method is most accurate in what circumstances. In addition, time and cost need to be considered.
It is very important for all market participants, including consumers, that lenders can carefully evaluate the properties in their portfolio and have the option to choose the products and approaches that turn out to be the most accurate and reliable and cost effective. This includes new product development with market participants including appraisal management companies, appraisers, software developers, AVM providers and others.
There’s no question that appraisers are being asked to do more work than ever before and that their work product is undergoing more scrutiny. For example, Fannie Mae recently instituted the 1004 MC (market conditions) form which obliges appraisers to provide specific comparable sale and listing information and analyze market trends. Although appraisers were expected to do this before, it is now required in a specific format.
Lenders and their agents, AMCs, are also using new analytical tools to get a 360-degree view of the collateral risk that they are assuming. They can now project housing price trends down to the ZIP code level, look at foreclosure and REO inventory, and even look at past transactions involving the subject property to see if it has been involved in fraud.
Over time, it is not at all inconceivable that lenders will expect appraisers to use these same tools to improve the quality and accuracy of their reports. Certainly, many of the larger AMCs are already doing this. Today, many appraisers still don’t go beyond the the minimal demands of the current GSE forms. But the new normal will demand it. Likewise it will behoove appraisers to utilize the new technologies that make for more accurate and more efficient appraisals.
Finding Ways to Work Together
Finally, our industry needs to find more things that we can all agree upon, and fewer that divide us. There is no question that consolidation has accelerated in the mortgage industry. Whole sectors of the industry are gone. Today, the top four lenders control 50+% of the entire market. And this year, that origination market could be the smallest it has been in a decade. Meanwhile, the number of residential appraisers has remained constant. Something’s got to give.
The Home Value Code of Conduct and the new Federal Housing Administration (FHA) letters unquestionably make it more difficult for small, independent appraisers to market themselves to originators. But the code and letter also serve a valuable function: they eliminate pressure on appraisers to hit-the-number or else. This is good for all appraisers and it restores transparency and confidence to the market.
Clearly, the new regulations are a subject that parts of our industry will disagree upon for the foreseeable future. That’s understandable. But when we attack each other in the press or lobby against one another, this controversy erodes confidence in our industry and the quality of our work. Hopefully, our experience in 2009 will be a passing aberration, and not the new normal.