Playing Games with Appraisals and Value

I’m starting to see a lot of this, so I thought it worth a short blog at least.

Now that houses are starting to sell, at least at the cheap end, there’s a lot of talk about value and how foreclosure sales are not representative of the true value of a house. It’s couched in lots of different ways but that’s the snake oil that people are trying to peddle.

Let me give you a couple of examples. The first is from the Curious Capitalist blog.

I was listening in on a conference call about this new survey of people’s attitudes towards buying foreclosed houses, when RealtyTrac’s Rick Sharga mentioned that, nationwide, foreclosures are selling at a 31% discount to nominal market value. Every time the National Association of Realtors puts out a release about falling home prices, the trade group mentions that prices are depressed because of foreclosure sales—but that’s a heftier discount than I imagined. Sharga mentioned that in certain areas—like Riverside and San Bernardino in California—folks are picking up houses at some 20% of what those homes sold for previously.

Note that phrase “discount to nominal value”. I’ve never heard the term “nominal value” used to describe the value of a single family home before. I suspect what this fellow is trying to get at is that the foreclosures are selling for 31% less than the prices that owner occupants are asking for their houses.

Now it may be true that a foreclosure may require some money to repair defects but then again so might a traditional resale. The hard fact is that value is best determined by comparing similar sales and adjusting for any significant defects. It is not determined by declaring that the prices of resale homes only constitute the real or dare I say “nominal” value.

The second example of this line of thinking comes from CNBC’s Diana Olick. She wrote on her blog:

Thanks to the new surge in foreclosures after all those moratoria expired, many appraisers are comparing regular existing properties to foreclosure sale properties. “Appraisers are now more likely to compare new homes to foreclosures, which can be ‘apples and oranges’ in many cases,” says John Burns of California-based John Burns Real Estate Consulting.

In some markets, appraisals are contributing to price deterioration. Home builder analyst Ivy Zelman reports on a builder in California who says that it “had to drop prices on all sales in process 8 percent at one community due to appraisals coming in too low.” The same in Florida.

“We believe that overly-conservative appraisers could potentially prolong the process of price deterioration, as builders attempting to push price may encounter appraisal prices well below contract due to foreclosures and other distressed sales,” writes Zelman. “This issue is exacerbated by the recent Home Valuation Code of Conduct instituted May 1st, requiring third-party appraisals on all GSE-approved loans.”

I first got wise to this growing appraisal problem well over a year ago, when a Realtor told me she was having trouble with a sale in Bethesda, MD because the appraisal came in below the sale price. That was well before the real crash in credit, and Bethesda is not exactly a hotbed of foreclosures. I think appraisals are getting far too little attention in the jambalaya of housing rescue plans, and they may just be the hottest ingredient.

Notice the same meme? Foreclosures are bad comparables so ignore them. It’s apples to oranges. That’s a nice analogy and sounds like the writer knows what they’re talking about but note they don’t support the assertion with data or even a logical argument.

Olick’s blog post is more troubling though because she suggests that appraisers are being overly conservative and that makes them part of the problem. She has a big soapbox to talk from so that kind of propaganda gets a big audience. It’s tailor made for populist politicians.

Let’s get something straight. If distress sales are rare and do not comprise a meaningful percentage of resale housing then it is legitimate to ignore them as comparable properties as part of developing an opinion of value. If, as they do in many communities, comprise forty and sometimes over fifty percent of the sales then it is not under any circumstances acceptable to ignore them. Additionally, appraisers are bound to use judgement in rendering a value opinion. If they see elongated marketing times and rising NOD’s in a neighborhood they have to factor that into their calculations and that might well mean using foreclosure sales as comparables.

One of the things that got us into this mess was appraisal fraud. One national builder is already the subject of a class action suit for allegedly having rigged the appraisal process. The last thing we need is RealtyTrac or Diana Olick agitating for loser appraisal standards.

Keep this in mind. If you decide to buy a resale house and pay “nominal value” the neighbor next door who bought a foreclosure is always going to have a lower cost basis than you do. You will be reminded of that fact when you both decide to sell your houses.

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