“New-home size falls prior to and during a recession as homebuyers tighten budgets, and then sizes rise as high-end homebuyers return to the housing market in relatively greater proportions.”
Robert Dietz, NAFIB chief economist
TOP STORY: The All Important Appraisal
Remember the old expression about buying a pig in a poke? For the uninitiated, it means purchasing something without knowing its true nature or value. In years gone by, bankers often found themselves the owners of such pigs – collateral for a loan that wasn’t all it was cracked up to be.
It wasn’t that banks ever lent money willy-nilly. They were local, they knew their customers, often on a first-name basis, and were familiar with local housing markets. Still, their information about values, whether land, houses, equipment, inventories, or anything else that might be used as collateral, tended to be both anecdotal and random.
When it came to mortgages, banks frequently employed what were called “windshield appraisals.” A bank officer drove by the house to make sure it was standing and likely to remain that way. Fie or she might know the house down the street (which looked to be a little bigger but not as new), sold six months ago for X dollars, and one in the next block was for sale for Y; still it was a leap of faith to conclude the house was worth the loan amount and write the mortgage.
Estimating the value of a house is the classic example of apples and oranges. No two houses are alike and the dimensions along which they can differ number in the dozens – house size, plot size, location, features, age, condition. Two homes built at the same time by the same builder with identical floor plans and sales prices can migrate to different price points in a very short time.
Strangely there isn’t much information available about the history of formalized appraisals. Valuations of some items, such as ships or timber, were documented in the 1600s, but on line we found several scholars casting a net for some historical data on residential appraisals. We do know that the practice was institutionalized enough that, by the mid-1930s, both the American Institute of Real Estate Appraisers and the Society of Real Estate Appraisers had formed, intended to standardize the appraisal process, professionalize training and set ethical standards.
Despite the appearance of these professional associations, appraising had a wild west appearance for some time. Licensing and/or certification was handled, or sometimes ignored on a state – by-state basis and appraisers and lenders had, shall we say, a companionable relationship. Appraisers depended on the banks for work and lenders, especially after they started selling loans and their risk into the secondary market, had a vested interest in getting loans written. It was not uncommon for an appraiser to find a way to boost a property’s value a bit if it helped the lender accomplish that and, at the same time, encourage ongoing work.
Tightening the Reins
Bank regulators found a lot of unusual appraisals, especially for large commercial properties, in bank files after the savings and loan crisis. This, in the words of the American Society of Appraisers itself, “added billions of dollars to the catastrophic losses suffered by the thrift deposit insurance fund.” In response, Congress passed the Financial Institutions Reform, Recovery and Enforcement Act of 1989, known as FIR – REA which required the states to establish appraisal certification standards for federally related banking transactions. Standards were tightened further after the housing crash, and more distance was established between lenders and appraisers.
States, prodded by the banking regulators, have established fairly uniform requirements for appraisers. Becoming licensed typically requires 165 hours of formal education from a certified school, passing an intensive exam, and serving 2,000 hours in an apprenticeship type position over or within five years.
Appraisals are now required for nearly every mortgage, although there is sometimes some wiggle room when it – comes to refinancing. The homebuyer is charged for this service and is entitled by law to receive a copy.
Parsing the Process
Appraisers use, on paper at least, three types of value analysis. The cost approach is an estimate of what it would cost to replace the property, exclusive of land value, as of the date of the appraisal, less physical deterioration, and any functional or economic obsolescence. The income approach estimates the value supported by the property’s earning power (rents less expenses), providing an objective estimate of what a prudent investor would pay. However, it is the third analysis, the sales comparison approach that is used almost exclusively for valuing an owner-occupied home.
Lenders require the appraiser to complete the value analysis on the Uniform Residential Appraisal Report which condenses a lot of the data into a checklist. The form requires the appraiser to provide a description of the neighborhood (type, general condition, open space, other available properties, price trends) and the site (size, available utilities, zoning, flood zone status.) But the focus of the form is the house itself.
The house is evaluated from several perspectives. There is a legal description which includes the type of deed and its location in the public record, the tax assessment and current property taxes. The physical description is exhaustive, including age, size, and style; materials used in construction, room counts, systems and their condition; and special features such as a pool, or energy efficiency measures. It also records the presence or absence of a basement and attic, the location of rooms relative to grade, and an assessment of the overall condition.
If the appraisal is for a sale, the appraiser reviews the purchase contract, looking for seller concessions or any unusual inclusions (i.e. sold fully furnished) or exclusions (grandma’s crystal chandelier is leaving with the sellers) affecting the value.
Property deficiencies are itemized, especially if they affect livability, and the appraiser notes if the house conforms to the building code and to the neighborhood. He or she also obtains information on any prior sale or transfer of the subject in the previous three years.
AGING AND DISRUPTION
“The countdown to a demographic inflection point has begun. By 2030 every Baby Boomer alive will be over 65, and by 2035, older people are projected to outnumber children for the first time in U.S. history. This could put housing in the cross-hairs of both policy and economics.
Will new models that go beyond today’s age-targeted ones, like assisted living, emerge to meet changing demands? If so, who will generate value and profitability from these new opportunities? Will it be those investing in, developing, designing, and building housing today, or will some kid working out of a garage disrupt the industry. Will the solution to housing and demographics be the new Uber? John McManus, Builder
Pricing in Differences
The meat of the appraisal however is the sales comparison. It utilizes at least three comparable properties or “comps” that are nearby and have recently sold. “Recent” and “nearby” may be determined by the lender and can change with varying market conditions. This is where an appraiser’s life can get complicated.
As we noted earlier, no two houses are the same and the recent and nearby requirements means a true comp can be exceedingly difficult to find. Therefore, the appraiser must reduce the differences between the subject and each of the comps to a dollar amount which is then added to or subtracted from their respective sale prices.
Suppose that the subject property is an 1,800 square foot home with three- bedrooms and two baths, under contract for $450,000. The appraiser’s visit reveals it to be in excellent condition with relatively new systems.
The appraiser finds three reasonable comps, all built near the same time and located within a mile of the subject property. One appears on paper as being nearly identical and recently sold for $398,000. Upon driving by however, (bear in mind the appraiser does not view the interiors of the comps) the appraiser notes that the house is badly maintained, with peeling paint and a worn and patched roof. He adds $15,000 to the value of the comparable to approximate a higher sales price had the property been in better condition. A second comp has three baths so the appraiser “takes away” one, subtracting $9,000 from its $477,000 sale price. The third comp which sold for $480,000, is 500 sq. ft. larger than the subject property, so is adjusted by $20,000, bringing the “comparable” sales price down to $460,000.
Note there are no absolute standards for these adjustments. They are left to the appraiser’s discretion and his experience and knowledge of the local market. The same applies to the way he reconciles the three resulting values for the comps, $413,000, $468,000, and $460,000. He or she could take an average of the three, coming out with a value of $447,000 or could give additional weight to one property, perhaps based on a closer resemblance to the subject, similar neighborhood conditions, or a more recent sale.
Sometimes appraisers find their choice of comps controlled by the lender who might, for example, put a constraint on the distance from the subject property. If prices seem to be softening, a lender might insist on using very recent sales. During the recession both appraisers and lenders were confronted with large numbers of distressed properties; foreclosures or short sales with substantial discounts. Many properties might also have deteriorated or been damaged on the inside – which appraisers wouldn’t know. Buyers all too often found their potential purchases did not appraise out because of the available comps.
R.I.P.? NOT QUITE YET
The experts have stopped just short of writing obituaries for shopping centers, while developers debate about what might happen to all that empty space. Housing gets a lot of votes. But like Mark Twain, retail’s death may have been greatly exaggerated. A survey by Situs has found both tech-savvy Millennial and their less-so elders still do most of their shopping in stores. While 24% of respondents reported doing more than half their shopping via computer or phone, 40% say they use ecommerce less than a quarter of the time, including 6% who say they never do so. Situs found that competitive pricing and excellent customer service can keep them coming to brick and mortar emporiums. Situs Newswatch
Second Guessing the Appraiser
Most appraisers have a high degree of confidence in their work and adhere to a code of ethical standards that requires their opinion be an honest one. If an appraisal comes in too low to meet financing requirements a buyer doesn’t have a lot of options. He or she could acknowledge overpaying for the property and be grateful for learning this in advance. The alternatives at that point are to invoke the mortgage contingency and look for another house, or to ask the seller to accept a lower price.
The buyer could also ask the lender if a second appraisal is possible. Not all will allow this, and if they do, it would likely be at the expense of the buyer. It is possible the lender would average the second value with the first, perhaps not measurably improving the situation.
A seller can slightly improve chances the appraisal will reflect the purchase price. Appraisers are not supposed to be influenced by superficial appearance, but a neat and clean exterior, and an exterior free of rubbish and with recently manicured landscaping could move up a notch in the appraisers required analysis of condition, a check mark in one of six boxes, ranging from poor to excellent.
It also doesn’t hurt for the appraiser to know the roof isn’t just new, but with a 40-year warranty, the stove is top of the line, and the furnace has the highest energy rating available. One can prep the listing broker with this information or leave the appraiser a list of improvements.
Recent underwriting rules from Fannie and Freddie along with the existence of “big data” may soon make a true appraisal a rarity. A desktop appraisal is one where an appraiser substitutes tax and MLS information and data bases of other sales in lieu of a property inspection. They are on the cusp of wide acceptance, but rules for using them are still in flux.
When making an offer, buyers should remember that their opinion about what a home is worth isn’t the one that counts. Pay attention to the comps your real estate professional provides (which are not likely to match those used by the appraiser) to get a feel for the market. Then give yourself a little wiggle room with the loan-to-value requirements of your mortgage before making any offer.
Driverless cars are poised to hit the roads and could spur some big changes in where we live and work. Will they increase the trend toward earless households thus increasing the value of living near transit hubs? Or will people mind commuting less if they can read rather than drive?
If cars can drop passengers and zoom off, what happens to parking spaces and parking lots? They currently consume more land than Delaware and Rhode Island combined. This could free up space for building more housing and commercial buildings in densely packed cities. Ely Razin, Forbes