Real estate appraiser Basil B. Clements didn't even come close when he estimated the total value of 20 1/2 lots in the Hollywood Hills at $380,500 in late 1980.
It was an appraisal that American Home Mortgage, a Newport Beach real estate investment firm, used as the basis for a $250,000 real estate loan. Today, the loan is in foreclosure, the properties are for sale for $70,000 and American Home Mortgage is being liquidated by a court-appointed bankruptcy trustee.
Clements, whose office is in Orange County, declined comment. "That's all in the hands of the trustee," he said.
The case is only one of thousands of real estate loans made across the country in recent years that have been based on questionable land-value reports. Such appraisals can be found in the problem-loan files of the nation's financial institutions, from the biggest banks to the smallest savings and loans.
As a result, the largely unregulated real estate appraisal business, for years a safe and obscure way to make a living, is under unprecedented attack.
Intense scrutiny is coming from legislative, regulatory, banking and law-enforcement officials seeking the causes of the problems at financial institutions that have failed or sustained severe losses. And some of the sharpest criticism is coming from appraisers themselves, who say many of their peers are at best incompetent.
The most common complaint is that the appraisal reports--like Clements'--prove far higher than the property's true value. And inflated appraisals coupled with high-risk real estate lending are a sure formula for financial ruin, lending experts say.
The appraisal industry's reach extends into nearly everyone's life. County assessors use appraisers in calculating property tax bills, and people in the midst of divorce often retain them to decide property fights. Competing appraisers are used to settle disputes between government and property owners in eminent domain cases, and many private buyers and sellers of property seek independent opinions of value.
Potential for Damage
But appraisers are most often used by lenders, who need land-value reports to justify their loans on single-family homes, apartment and condominium projects and commercial properties. And it is here that the potential for damage and abuse is greatest.
The problem is particularly acute in California, where bad real estate loans are a major reason why federal banking regulators have taken over eight savings and loan associations since April. The assets of these institutions total more than $11.9 billion.
"Virtually all savings and loans with lending problems are related to fraudulent or inflated appraisals," one banking regulator in California says.
Bad loans underwritten by inflated appraisals slash lenders' profits, cut their stock values and strain deposit insurance funds that are ultimately backed by taxpayers.
"The appraisers are as important as certified public accountants," said Fred Case, a real estate professor at UCLA. "They're dealing with a lender's major assets."
Financial Corp. of America, parent of the nation's largest S&L;, found hundreds of inflated appraisals when it recently re-evaluated its loan portfolio and wrote down the value of its assets to market value. In one case, FCA had accepted a $500,000 assessment on a boat dock that turned out to be worth about $5,000.
"We lost a half billion dollars on overvalued property," FCA Chairman William J. Popejoy said, referring to the Irvine-based company's $512-million loss in 1984's fourth quarter. "Most of those appraisals couldn't have been on target, or we wouldn't have lost all that money."
In another case, Dallas County real estate appraiser Larry Wayne Hutson pleaded guilty in April to preparing more than 400 inflated appraisals for several lenders in Texas and Arkansas. Among them was Empire Savings & Loan Assn., of Mesquite, Tex., which was declared insolvent by banking regulators last year and shut down.
A close look at the appraisal industry today reveals several basic problems.
Often Willing Accomplices
By most accounts, it is a fragmented business in which conflicts of interest are a way of life and professional standards apply only to the minority who choose to accept them. As a result, appraisers have too often become willing accomplices in the risky lending against which they are supposed to guard.
To be sure, most appraisers are competent and honest, experts inside and outside the industry agree. Most gain experience in real estate sales or in bank or S&L; lending before becoming full-time appraisers, giving them an understanding of property values and of a lender's need for realistic appraisals. The industry's defenders say that no one can accurately predict the fluctuations of the real estate market and that most of the appraisals that look bad now were supportable at the time they were written.
But even top appraisers concede that their ranks are sullied by a too-large minority who can be depended on to deliver an opinion tailored to the client's wishes--for a price. As one Los Angeles banker put it, "You can find someone to say anything you want to hear."
Dugald Gillies, Sacramento lobbyist for the California Assn. of Realtors, told a California legislative hearing that it's easy to find appraisers who will "customize" valuations, depending on who's paying the bill.
"Today, in eminent domain proceedings, appraisers . . . will testify in court to widely disparate values. Caltrans (California Department of Transportation) has a list of appraisers which they will use who can be expected to be conservative--to come in low. Professional condemnees' attorneys have another list--liberal appraisers who will come in high. And fees, while carefully not contingent, are related to reputation and expectations," Gillies said.
Need for Certification
So widespread is the problem that many industry insiders are calling for a nationwide system of certification or regulation to weed out the untrained and unethical. In only a quarter of the states, not including California, are appraisers regulated in any manner.
"There's no enforcement. No licensing. No real requirements. Anybody can set himself up as an appraiser," said Hugo Drumm, vice president for professional standards for the American Institute of Real Estate Appraisers. "Every group has a few bad guys, but it's hard as hell to get at them without licensing."
But licensing of appraisers won't protect a banker from greed or carelessness. Lenders often view appraisals as an afterthought, a file document to justify the loan in case the bank examiners ask questions.
"There were a lot of financial institutions who had a good customer and wanted to make the loan," Drumm said. "The appraisal was just a necessary evil, something they needed because of the regulatory agencies."
Inflated appraisals are sometimes tolerated because they may mean higher fees for everyone involved in a property sale--the real estate broker, lender and appraiser. Other conflicts of interests have arisen when an appraiser has had loan-generating duties or executive authority at a savings institution.
Scheme to Defraud
Leo Peterson, for example, was fined $5,000, barred from the appraisal business for a year and sentenced to two years in prison last year for his role in a scheme to defraud Beverly Hills-based Gibraltar Savings & Loan Assn.
Court testimony revealed that Peterson, who was both an independent property appraiser and an outside loan agent for Gibraltar, was bribed to include inflated property values in loan files submitted to the thrift. Peterson was paid $2,000 by a borrower for each phony appraisal, court records show.
Appraisers calculate market value using several standards, including sales of comparable properties in the neighborhood, the building's replacement cost and the projected occupancy rate of an apartment or office building.
But market value is subjective and mercurial because the variables are many and the formulas are imprecise. As a result, appraisals of the same piece of property can vary enormously.
For example, Bank of America reappraised hundreds of properties that it came to own as the result of an alleged mortgage securities fraud that cost the bank $95 million late last year. The bank claims in several lawsuits that it was victimized by an investment scheme devised by a firm called National Mortgage Equity Corp. and based on inflated appraisals and phony loans.
When B of A took a closer look at the properties supporting the loans, it found that most were valued at two or three times their current market value. The appraisals also showed wide discrepancies between B of A's in-house appraisal staff and outside appraisers hired by the bank to provide second opinions.
The reappraised properties included:
- A single family home in Tustin which was valued at $1.5 million by NMEC, $933,000 by B of A, and $475,000 by an independent appraiser.
- A 33-unit apartment building in San Bernardino which carried a NMEC appraisal of $2.6 million, while B of A valued it at $2 million and an outside appraiser said it was worth only $1 million.
- A 41-unit building in Los Angeles appraised by NMEC at $9.4 million, by B of A at $4.1 million, by an outside appraiser at $3.2 million.
Many appraisers defend their work by pointing out that their land-value reports appear high today because inflation has been squeezed out of the real estate market.
'Nobody Ever Complained'
There was a time in the late 1970s and early 1980s when it didn't matter if the appraisal was high because inflation would eventually justify the estimate. As industry consultant William Kinnard put it, "Nobody ever complained about us when real estate prices were going up."
"A piece of property worth $250,000 today with a $200,000 market value report done three years ago doesn't mean the appraisal was a bad one," Kinnard, a former real estate professor at the University of Connecticut, says. "It just means the market has changed."
But it does appear that the appraisal process has also been widely abused in recent years. Inflated appraisals have played large roles in the problems of financial institutions ranging from well-known Bank of America to little-known San Marino Savings & Loan, court documents show.
In the case of San Marino Savings, now defunct, banking regulators have charged that Orange County appraiser John J. Brennan "grossly overstated" the market value of 17 apartment buildings in California and Texas. The properties played a pivotal role in the government takeover of San Marino Savings in early 1984.
The appraisals stated that the buildings were worth more than $243 million, when in fact they were worth less than $110 million, according to a lawsuit filed last spring by the Federal Savings & Loan Insurance Corp.
'Handy Way . . . to Categorize'
Roger Saevig, Brennan's attorney, defended the appraisals, saying they reflect the value of the buildings as pre-sold condominium projects, whose sales value is substantially higher than apartment buildings. "This is just a handy way of the FSLIC to categorize this transaction as something fraudulent," Saevig said.
In the Hollywood Hills case, the lots aren't worth anywhere near $380,500 because the hillside is too steep for building, according to Dennis Schmucker, the American Home trustee. Though the appraisal report does note that the lots "drop off steeply," Clements estimated lot values at between $14,000 and $35,500 apiece based on the value of two neighborhood properties, contrasted with their current average sale price of $3,400.
American Home investors lost nearly $4 million on properties appraised by Clements, Schmucker told The Times.
There are as many as 200,000 appraisers in the United States belonging to dozens of independent professional societies, most of which have no membership requirements or education standards. "A new (professional organization) pops up every day," UCLA's Case says.
The two major professional organizations, the Society of Real Estate Appraisers and the American Institute of Real Estate Appraisers, count more than 25,000 members between them.
Groups Have Standards
Both associations, based in Chicago, have educational and professional standards and bestow several designations indicating levels of competence. But even these are not immune to ridicule.
MAI is the top designation of the American Institute. Officially, it means Member, Appraisal Institute; industry critics allege it stands for "Made as Instructed," meaning that the appraisal will be whatever the client wants it to be.
To become a certified MAI, appraisers must have five years experience, have a college education or have passed a college equivalency test, and have passed a series of examinations. Only an estimated 3% of the nation's apraisers have an MAI designation, the American Institute says. But the cynicism about the designations has become so pervasive that many financial institutions rely on their own in-house lists when they want to hire an outside appraiser.
California lawmakers have tried to deal with the problem of lack of regulation several times in the past two decades, most recently last year. But all efforts to impose mandatory training, minimum appraisal requirements and ethical standards have been blocked by the opposition of real estate brokers, who fear losing their own unregulated appraising business.
'Total Lack of Standards'
A California Senate Office of Research study released in June urged state lawmakers to try again to address "the total lack of appraisal standards and minimal competency required of appraisers."
The report estimates there are 25,000 California real estate appraisers doing about $500 million in business each year. If national figures apply here, only about one-tenth of California appraisers belong to a professional organization with educational and ethical standards required for certification.
"Aside from the fact that many of these people have a real estate license, the appraisal business is for the most part unregulated," the study said.
It is the consumer who ultimately suffers, the report concluded, whether by paying too high a price for property or being forced to get costly second and third opinions of value.
"It is important to remember purchases of property are the largest investment most people make in their lives and appraisal error usually traps the unsophisticated investor. The cost of bad appraisals is always passed along to the consumer in some form or another."