Real Estate Appraisal Under Fire - Again

In recent years there has been criticism of the real estate appraisal industry, and some deservedly so, but appraisal is a critical function of lending because it establishes the value of collateral. For many decades this function was handled by human appraisers but in recent years computer generated valuations have come into being. Known as “AVMs” or “Automated Valuation Models” these are property valuations computed using sophisticated equations or ratios combined with public information on the physical characteristics of a home and recent sales.

I have personally tested the value conclusions of one AVM and found that the sales data was inaccurate and the conclusion way out of line with the current market. But that was only one AVM and others may be more accurate than this, but not according to many other authors. There has been plenty written by human appraisers about AVMs so I will cover them mostly as a means to understand what’s been happening in appraisal for years now.

The rationale for the invention and widespread use of AVMs was lower cost and greater speed that a traditional human generated appraisal. This is reasonable provided that the AVM product does indeed deliver this. There is no question that AVMs are much faster.

They generate a report in a matter of seconds. But as in every other form of computation, the old axiom of “garbage in garbage out” applies and the sales information used by AVMs is often scattered or unreliable to the point that such data was never be acceptable if used in a human generated report, which is held to a much higher standard of reporting and accountability. The most likely use for an AVM would be for a recently built home in a neighborhood where there is a high degree of similarity among the homes there, along with a large number of recent sales available to the AVM.

An AVM would not be suitable in the case where the subject home is customized, located in an area with considerable variation, where the home is in a level of condition significantly above or below the norm for the area, or other situations that could only be uncovered by a human observer. AVMs have their place in the real estate industry but so do humans and AVMs have been cited as a good reason to get rid of traditional appraisals.

One criticism of traditional human appraisals is that they are not a “value-added” product, meaning that an appraisal report does not add any monetary value to a transaction in dollars and cents. But appraisals were never meant to add anything to a transaction in that way, any more than a regulation does. The value of the appraisal lies deeper than the numbers on a closing statement.

Along with the value-added critique is the notion that when an appraisal comes in at or above the sale price of a home, the appraiser is not telling the reader anything he or she does not already know, and since appraisals so often do come in at or above the sale price, they are not necessary. This is a false concept and can be demonstrated by a simple analogy.

Consider an appraisal that estimates a value below the sale price of a home to be like a traffic ticket and the appraiser to be like a policeman. Under ideal circumstances, a traffic cop does not write a single speeding ticket because people are driving within the speed limit. Human nature being what it is, it’s a sure bet that if everyone knew that the local authorities had decided to remove the cops off the roads, a large percentage of drivers would speed up, accidents, injuries and fatalities would increase, and that sooner or later the police would be back.

The very presence of a visible policeman on the road does a great deal to hold down violations and accidents. If the police are writing too many tickets, we know something is wrong and that the system is not working, but when tickets are at a minimum we know that the system is probably working. The same is true with real estate appraisers. Their very presence does a lot to foster stability in the marketplace and keep ripoffs and financial tragedies in check.

Like the traffic cop, the appraisal is a filter that things pass through to weed out problems. The advent of a large number of appraisals coming in below sales prices tells us that something is really wrong in the markets and that the system is not working. Chaos is developing or perhaps hyperinflation is causing prices to accelerate too rapidly. The appraisals are telling us things are out of control.

Appraisers have always been on the forefront of real estate issues, and they have traditionally been a voice for reason and caution. Every appraiser I know has been alarmed for years at the wild west lending practices that are now at the very heart of the economic disaster we have experienced not only in the US but across the globe.

This is something that no AVM has done or will ever do. Had regulators listened, understood and acted upon the advice given by the major appraisal organizations for many years, there would not be trillions of dollars in bad loans out there, most of our great financial companies that are now gone would still exist and the taxpayers would not be bailing others out to the tune of hundreds of billions of dollars.

Appraisers knew better than to make inflated loans to unqualified borrowers, and about the hyperinflation and bubble that would result. but were outmanned and overwhelmed by massive amounts of capital pouring into the markets and regulators without the political will or desire to do their jobs.

In order to assure the integrity of their own profession, appraisers also begged regulators for decades to help them create a workable firewall between themselves and unscrupulous lenders, but to no avail. The solution to the firewall problem has now been addressed courtesy of Mr. Cuomo in New York, who took on Fannie Mae and Freddie Mac and created the Home Valuation Code of Conduct (HVCC). This agreement has caused many large lenders to stop hiring and maintaining appraisers themselves, turning this responsibility over to Appraisal Management Companies (AMCs).

The management companies hire and maintain lists of appraisers who are assigned jobs for lending requests. A lender submits a request to an AMC who submits a request to an appraiser on their list. A firewall. However, the AMC does not work for free and will charge the lender anywhere from $300 to $500 for the appraisal, but will turn around and pay the actual appraiser much less, often as much as 50% to 75% less. In some cases, the AMC will receive more for assigning an appraiser job than the appraiser will receive for doing it. There is nothing illegal in this but there is something detrimental in it, and that is quality. When you drive down the price, the quality goes with it.

Appraisers who used to receive the entire fee for a job will be forced to accept much less. Many of the best appraisers will simply get out of the industry. The net result will be a lowering of the quality of appraisal work. You get what you pay for. This phenomenon is not new. It happened back about 1990 when state licensing of appraisers was created. Prior to that, any lender who sincerely wanted to get the best quality of appraisal services chose those who had earned credentials through the major appraisal organizations. Appraisal designations like the SRA and the MAI really meant something to consumers of those services. But along came mandatory uniform state licensing that began with promise, but which leveled the playing field by requiring minimal experience levels and passing grades on tests that were much too simple and easy to pass. The highest level of licensing was obtainable by the least qualified applicants.

This was accompanied by an abandonment by the lending industry of any standards for hiring an appraiser other than having the appropriate license. The result was that seasoned, experienced appraisers with vast knowledge were now on an equal competitive footing with people of minimal skills and experience who were willing to cut prices drastically for their services. So many of the best, who could no longer compete, simply retired or found other work and got out of appraisal. Meanwhile, many state licensing agencies were woefully under staffed and under funded to provide adequate monitoring and enforcement of licensing statutes. The predictable result was appraisal services that declined in quality that has taken many years to recover from.

Human generated professional appraisals are a valuable and necessary part of real estate. The major arguments against them can usually be demonstrated as false or guided by some form of bias that does not benefit the taxpayer or the consumer. The appraisal industry can and should be restructured in ways that can increase quality and reliability without destroying the livelihoods of those who choose this work.

Harry E. Davis is a Texas state certified residential real estate appraiser in business since 1975 and serving the Austin Texas metro area. His web site is located at Austin Texas Appraiser. Services are available in other Texas cities at Round Rock Texas Appraiser