Real Estate Valuation. Art or Science, or neither?

Thirty years is enough time to change your beliefs more than once. When it comes to reasonable expectations of real estate appraisals, the pendulum swing is immune to the laws of physics. Conservative outcomes last for a while until they swing back to a more liberal result. There is no reason to expect the swing right to equal the distance of the swing left, and there is no reason to expect the pendulum to swing back when it appears to stop moving in one direction. Picking up speed in the same direction upward requires some additional force. It’s that force that’s not readily apparent.

Objectivity is a factor in arithmetic, opinion is not. Appraised valuation has room for arithmetic and subjectivity is a factor. In the run up to the collapse of the real estate industry and human crisis it caused we saw homes coming on the market at prices unheard of in high demand areas. Buyers rushed to compete with offers at these inflated prices and above. Rules of underwriting were disregarded to approve loans where the appraiser reached beyond the limits to satisfy the banker, buyer, and real estate agent. As the crisis unfolded, we expected the trend to reverse and move back to guideline compliance.

With two consecutive years of inventory shortage the trend began a slow move toward the liberal interpretation of underwriting guidelines. As of the end of last year, trend has picked up the pace and appraisals appear moving ever further from conservative practice to liberal subjectivity. Or maybe, something else is happening. The evidence is the evidence. Homes for sale at prices unsubstantiated by comparable home sales in a neighborhood received Offers at prices driven by competition, not by recent sales. I expected to see more sales derailed by low appraisals as had been the issue in recent years. That may not be happening. Either appraisals are supporting the price, and underwriting is accepting the appraisal, or buyer’s are making up the difference by increasing their down payment…and not by a little.

As we get underway in 2019 I’m going to be careful about being certain of anything related to valuation. Rules are rules and we all can read. But subjectivity and common sense are unpredictable and as long as facts can be are overridden, it’s best to be open minded to possibility.

Facts Matter

Things are better than we think according to the author of  Factfulness   Hans Rosling.

Experience and history influence our feelings, and our feelings contribute to our conclusions. Thinking about situations being better than we think as it’s applied to real estate work, two areas where we go quickly to experience and history are assessing the coming market conditions, and pricing. If Hans Rosling’s theory plays out in our business, our industry’s perspective of the coming market conditions might be less accurate, in a negative way, and our opinions of value may be a bit low when experience is given more value than facts.

What does the real estate industry tell the public every spring? Buy now because interest rates are going up. Sellers? Sell now because the market’s going to take a dip. It’s easy enough to look at the factual historical data and see if we’re right more than not (I think not).

How diligent are we at scrutinizing the facts, as they relate to appraised valuation, when answering a question of our opinion on value? The outcome of a transaction is affected by the conclusions buyers and sellers reach influenced by our opinions. How costly is it to the parties when one of us offers a value opinion based on what we think rather than what we know to be factual? Learning to make value adjustments, and then applying that exercise before speaking might be worth the effort.

Reasonable and Logical Value Opinions

The appraiser must provide appropriate comment(s) reflecting the logic and reasoning for the adjustments provided… Selling Guide FannieMae.com  Adjustments to Comparable Sales.

Prices offered for homes last year were at times neither reasonable or logical. Home sellers were ecstatic and would-be buyers were anything but. I don’t know what the market will be in 2017 and I’m not going to guess. If we assume the next six months will be more or less like the first two quarters of 2016, it will be wise to pay attention to this publication MGIC How to Review an Appraisal. Mortgage underwriters have a critical role in protecting the lender who does not have the enthusiasm for the risk of owning properties at undocumented prices…if worse comes to worse (again).   Inflated values documented in appraisals are well documented as a contributing factor to the collapse of the last housing bubble. The prepared underwriter looks at each appraisal with a critical eye. Adjustments for amenities, improvements, location, market conditions are open for discussion. While there are not limitations or guidelines associate with net or gross adjustments, it’s the underwriter who will decide on behalf of the lender if the adjustments used by the appraiser conform to the neighborhood.

The listing agent or buyer’s agent who has a reasonable and logical method for comparing relevant sales to a subject property, using value adjustments, may be highly valuable in the process if avoiding hurdles and surprises is important. Creating a spreadsheet that functions similar to a uniform residential appraisal  form is a start. The art  to produce more or less useful results from that spreadsheet is to use dollar amount adjustments that would be acceptable to underwriters. Considering there are no published standard adjustments, we’re on our own to use numbers that are reasonable and logical to the underwriter … a person we do not and will not know. It’s all reasonable and logical. Or magical.

I have a spreadsheet I started using in 2014. It’s not perfect because it’s not the unknown underwriter, but to document the evidence and add some logic to the illogical process of pricing property, it’s a reasonable tool.

 

 

Appraisal Contingency…A dangerous poison pill

Seller beware. Wisconsin’s Offer to purchase (WB-11) includes an escape clause for the Buyer. The Appraisal contingency on page 5 of 9 of the Offer to purchase allows the Buyer the right to terminate the contract if the appraisal indicates an appraised value for even one dollar ($1.00) less than the purchase price. That’s an easy exit and great risk an informed Seller would probably not accept. Savvy listing agents will catch this poison pill before the owner accepts the Offer.

What, you say buyers are unlikely to terminate an offer for an appraised value slightly less than the purchase price? OK. I agree. However, what else is on the table if the Buyer has a right to terminate the Offer? Oh, I don’t know, how about EVERYTHING? Consider this. The appraisal gets to the buyer 30 days from acceptance of the Offer. We’re probably 15 days from closing. The Seller is not in a strong negotiating position at this late date, and all of the other buyers who’s offers the Seller didn’t accept are gone. An inspired Buyer may choose to ask for more than a price concession. The closing date, included items, repairs, credits, new inspections, testings are open for discussion.

In competition, (Seller’s market)Buyer’s and their Buyer Agents are wise to soften the appraisal contingency if it has to be included. Below is a condition Buyer’s can add to their Offers to make their Offer more palatable to the Seller, and it’s a condition thinking-ahead listing agents will discuss with the Seller before an appraisal contingency Offer is accepted.  (Counter-Offer)

Appraisal Contingency page 5 of 9, lines 264 through 269. In the event said appraisal indicates the appraised value is not equal to or greater than the purchase price, Buyer shall deliver to the Seller the appraisal report and an Amendment to change the purchase price to an amount not less than said appraised value. This amendment shall include no other conditions and allow the Seller at least 24 hours from Seller’s actual receipt of the amendment and appraisal to accept. Acceptance of this amendment satisfies the Appraisal Contingency. The Notice of termination provided for in the Appraisal Contingency shall not be sent to Seller by Buyer prior to the expiration of Seller’s deadline for acceptance of the price change amendment.

IMPORTANT: Seller is not obligated to accept the price change amendment, and may deliver a counter proposal to Buyer. In lieu of the price change amendment, Buyer may give Notice to Seller that the Appraisal Contingency is satisfied.

That’s a lot of words. You might have a better idea, but this is more safe for the Seller and still provides the Buyer with the protection the contingency is intended to provide.  It may be necessary to talk to the other agent to make sure they understand this modification.

Side Note: The current WB11 is old. We were still in the recession in 2011 when the form was introduced. Comparable sales were few and far between. Buyers had a distinct advantage (Buyer Market) and they could shift risk to the Seller. The appraisal contingency was almost non negotiable. When the market shifted to a Seller’s Market, this appraisal contingency, already firmly embedded in the contract and common practice started to work against Buyers. Those who did get their Offers accepted with this contingency found themselves in surprisingly strong negotiating position. We can do better than to end up far down the line, away from the crowd of buyers, and all alone with the Seller, standing between a rock and a hard spot.