The Appraisal Foundation Responds to August 12 Wall Street Journal Article

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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.

August 17, 2011
The Editor
The Wall Street Journal
1211 Avenue of the Americas
New York, NY  10036

Dear Editor:

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.

Sincerely,

John S. Brenan
Director of Appraisal Issues
The Appraisal Foundation
(202) 624-3044
john@appraisalfoundation.org

cc: S. Mitra Kalita – mitra.kalita@wsj.com
Carrick Mollenkamp – carrick.mollenkamp@wsj.com

1 Interagency Appraisal and Evaluation Guidelines, December 10, 2010
2 USPAP is developed, amended, and promulgated by the Appraisal Standards Board of The Appraisal

The Appraisal Foundation Responds to August 12 Wall Street Journal Article

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