The Appraisal Foundation Responds to August 12 Wall Street Journal Article
On August 12, 2011 the Wall Street Journal published an article entitled “Judgment Call: Appraisals Weigh Down Housing Sales.” The Appraisal Foundation has submitted a letter to the editor in order to clarify several aspects of the article.
We are contacting you in reference to an article written by S. Mitra Kalita and Carrick Mollenkamp that appeared in The Wall Street Journal on Friday, August 12, entitled “Judgment Call: Appraisals Weigh Down Housing Sales.”
As the Congressionally-authorized organization that establishes appraisal standards and appraiser qualifications in the United States, we feel compelled to address several aspects of the article that we feel should be clarified for your readers.
First and foremost, it is critical to understand that appraisers do not establish property values; they simply reflect the actions of buyers and sellers in the marketplace. An appraiser’s job is to “mirror the market” by analyzing competing homes that have sold, are in the process of selling, or are available for sale. One key component in appraisal theory is the Principle of Substitution, which essentially states that knowledgeable and typically motivated buyers would not pay more for a property if similar properties are available in that marketplace at a lower price.
In appraisals performed for federally-regulated financial institutions (where most of the funds for home loans come from), appraisers are required to base their opinions of market value on a specific definition 1, which consists of the following criteria:
The most probable price which a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller, each acting prudently, knowledgeably and assuming the price is not affected by undue stimulus. Implicit in this definition is the consummation of a sale as of a specified date and the passing of title from seller to buyer under conditions whereby:
(1) buyer and seller are typically motivated;
(2) both parties are well informed or well advised, and each acting in what he or she considers his or her own best interest;
(3) a reasonable time is allowed for exposure in the open market;
(4) payment is made in terms of cash in U.S. dollars or in terms of financial arrangements comparable thereto; and
(5) the price represents the normal consideration for the property sold unaffected by special or creative financing or sales concessions granted by anyone associated with the sale.
The article states “One of the conclusions from the housing bust: The appraisal system was broken. One of the conclusions some have drawn from the struggling recovery since then: The appraisal system is still broken, but in a different way.” The article also quotes Columbia Business School economist Chris Mayer as saying, “Lenders are ‘instructing appraisers to be a little conservative, and that responsibility on the one hand is seen as credit tightening and, on the other, as exacerbating the housing problem.’” It is important to recognize that all state licensed and certified real estate appraisers in the U.S. are required by the Uniform Standards of Professional Appraisal Practice (USPAP) 2 to be independent, impartial, and objective, and to perform assignments without bias. Furthermore, as alluded to in the article, the federal Dodd-Frank law enacted in 2010 mandates appraiser independence, and establishes penalties for lenders and other parties who attempt to unduly influence an appraiser.
In most home purchase transactions, this mandated impartiality can often mean that the appraiser is the only participant that doesn’t have any “skin in the game.” In other words, virtually all of the other parties to the transaction only benefit if a sale is ultimately consummated. This often makes the appraiser an easy target for disgruntled parties to the transaction. In any market, there are buyers who may pay more for a property than it is actually worth. This may be due to a buyer’s lack of knowledge about a marketplace, a particular fondness for a property, or a whole host of other factors.
The article also refers to the increasing presence of appraisal management companies (AMCs) in the industry, stating, “The result has been that appraisers with less experience or who are unfamiliar with a community – but who work cheap – are getting assignments while more experienced appraisers are going out (of) business. That, say critics, is producing appraisals that are less accurate.” The article goes on to quote Leslie Sellers, immediate past president of the Appraisal Institute, as saying, “The people doing it are the ones who cut overhead to (the) bone, are working out of basements and many of them are not properly educated.” Although we believe this is true to a certain extent, we are also aware that a large percentage of appraisers that have left the business in the recent past are those with less experience; those that had entered the appraisal profession only within the last few years. In fact, many trainee and licensed appraisers left the business because they were unable to successfully obtain certified status, which many clients and user groups (including all appraisals done for the Federal Housing Administration – FHA) began requiring as their minimum qualification level for real estate appraisers.
The article also states, “Others complain that appraisers are using foreclosures and other distress sales as comps when coming up with estimates.” In marketplaces where many of the properties that are bought are distress sales (e.g., foreclosures, bank-owned properties, short sales, etc.), it is not only permissible for appraisers to consider and potentially use these sales as “comps,” but appraisers are required to determine the impact this activity is having in the marketplace. This is due to the fact that distress sales may very well impact the value of more “conventional” sales, because many buyers are reluctant to pay more for a property than the price level set by the distress sales (note the reference to the Principle of Substitution made previously). And if the number of distress sales (or properties available for sale that could be considered distress) becomes so significant in a marketplace that it represents the only activity occurring, the distress activity actually becomes the marketplace.
In some markets appraisers can document a “bifurcated” marketplace. That is, a market where home sale activity occurs at the distress level, as well as activity occurring above the distress level. In these bifurcated markets, it may be more likely that the appraiser’s opinion of market value may meet or exceed a home’s pending sale price. However, that does not relieve the appraiser of the obligation to consider and analyze the distress sales.
Lastly, the article states, “Another complaint is that appraisers are increasingly relying on automated valuation models, or AVMs…” While it may be true that some appraisers utilize AVMs as one tool in assisting them at arriving at an opinion of market value, it should be made clear that very few appraisers rely on AVMs when developing appraisals. Some lenders or user client groups may opt to utilize AVMs – some as preliminary indicators of value prior to ordering an appraisal – but it is generally not the appraiser that utilizes information collected and analyzed from AVMs when performing appraisal assignments.
While it may certainly be true that some parties are frustrated when an appraisal does not meet their needs to consummate a transaction, the independence of the appraiser is seen by many as a benefit, in many cases preventing an individual from overpaying for a home. Just because two parties agree on a price for a property, it does not mean that price represents the market value of the property (see the Definition of Market Value referenced previously). We believe the appraiser’s impartiality is an appropriate and needed “check and balance” for these transactions.
We greatly appreciate the opportunity to comment on this article, and are hopeful you will be able to share our sentiments with your readers.
John S. Brenan
Director of Appraisal Issues
The Appraisal Foundation
1 Interagency Appraisal and Evaluation Guidelines, December 10, 2010
2 USPAP is developed, amended, and promulgated by the Appraisal Standards Board of The Appraisal