Bankers’ Hours column: An evaluation of the state of appraisals
We hear some rumblings out there that the art and science of appraising may be sliding back into its laissez faire, pre-meltdown attitudes.
First, real estate appraising is neither a science nor an art, but rather a compendium of math, observation, experience and common sense, with the latter comprising about 75 percent of the mix. Then you layer that with an icing made up of government regulation, guidelines and some pretty serious penalties for noncompliance, at least relating to residential evaluations, and you end up with a very strange cake indeed.
I’ve been looking at appraisals for over 50 years, and I’ve even done some — incompetently, I assure you. I’ve seen some very bad appraisals and appraisers. However, I can’t say that I saw more in the early 2000s than I did in, say, the ’80s and ’90s. Most of the appraisers I’ve known have been professional, honest and responsible. You certainly can’t apply my favorite lawyer joke to the profession: “It’s 98 percent that make the other 2 percent look bad.” (You can’t apply it to lawyers, either. Some of my best friends are attorneys, and, yes, I’d want my daughter or sister to marry one.)
Fannie Mae and Freddie Mac, the financial giants that buy and package into securities most of the residential mortgages made in the U.S., have instituted very strict appraisal criteria in the aftermath of the financial crisis. On top of that, every major lender and originator have well-staffed appraisal review units that meticulously vet the evaluations supporting the residential mortgages they produce, so it’s hard to see how shoddy work, if it does exist, can get through the filter. But of course it does happen.
It’s a lot easier to be a creative writer with a commercial real estate appraisal. That’s because there are professional standards that evaluators are expected to meet, but no federal regulations that carry penalties for violations. The worst that can happen to the commercial property appraiser is maybe getting kicked out of a trade association (unlikely) or getting sued (more likely).
There are lots of ways to game an appraisal, but they’re not hard to spot, nor is the research required, if any, to spot it difficult. A classic way to game an evaluation is through comparable adjustments.
The residential appraisal process is designed to arrive at a property’s current market value. Naturally, similar properties that have sold are analyzed with the logical conclusion that, if the appraised property is selling for $300,000, and three other like houses in the same area have an average sales price of $300,000, then the sales price of our appraisal subject is right on.
But generally, the homes aren’t exactly alike, so adjustments have to be made for superior or inferior elements of the property. These factors can include all kinds of items, from location to square footage. Small adjustments are an integral part of the appraisal process. But large ones, of, say, 30 percent, 40 percent or even 50 percent, are red flags. That means that the appraiser can’t find comparable properties, which is a problem in itself, or is pushing to arrive at a predetermined value. On paper, an appraiser can make a $300,000 house look like a million, and it does happen from time to time.
Another trick is to play games with location. This is pretty much a ploy used in urban markets. For example, say that a “comparable” is two miles from our subject. In measured distance, two miles isn’t much, but in actuality, the comp is several economic light years away. New Orleans can demonstrate this quite dramatically. The Garden District is the Big Easy’s uber wealthy enclave. Just a few blocks away is a large public housing project. A sale, say, three blocks in a certain direction is almost certainly not comparable to Archie and Olivia Manning’s digs.
Finally, an appraiser can just give an inflated value to some property feature where none is justified. I heard about a situation recently that involved an old Denver metro area warehouse that had been converted into a marijuana wholesale facility. The owner was shocked when a hard money lender told him that the 50 percent to value loan that he, the owner, thought he was seeking was really 100 percent. It seems that the appraiser had given square footage value to a partial mezzanine that had been recently added to provide more work space. And in this instance, it seems, the appraiser had a reputable, and prestigious, designation from the leading national professional association.
So-called hard money lenders will lend only on commercial or investment properties. I know of one very astute practitioner in that realm who eschews appraisals altogether, and relies on his own research involving comparable sales, and, again common sense.
Do I think that we’re seeing more low-quality, or even fraudulent appraisals than two or three years ago? Only in the context that more appraisals are being performed, because more properties are being sold, and some markets are pretty hot, nationwide. I’d guess that the ratio of bad valuations, and shady evaluators, to the total transaction base hasn’t changed much.
Padding appraisals has always been something of a cottage industry that’s enhanced somebody’s bottom line, at least for a while.
Pat Dalrymple is a western Colorado native and has spent almost 50 years in mortgage lending and banking in the Roaring Fork Valley. He’ll be happy to answer your questions or hear your comments. His e-mail is email@example.com.