Low Appraisals Put Crimp Into Brisk Realty Market
With home developers resorting to lotteries to pick their lucky buyers, and with brokers’ inventories of unsold homes shrinking at a dramatic rate, no one can seriously challenge the argument that the dramatic plunge in mortgage interest rates has the current real estate market “coming up roses.”
Roses complete with at least one “thorn’--a thorn that reaffirms the validity of Murphy’s Law: “whatever can go wrong, will go wrong.”
And what’s wrong with today’s real estate market, realtors say almost unanimously, is that appraisals of market value are coming in so low--unrealistically low in their opinion--that deals assumed to be as good as closed by buyer, seller and realtor, are dropping like flies.
Logically, that is, a would-be buyer prepares himself for a down payment that will reflect 20% of the sales price of his new home. In the instance of a $180,000 house, he assumes that the appraisal will come in at about $180,000, that the lender will loan him the 80% balance, or $144,000, and that he will have to come up with $36,000 for the down payment.
If, instead, the appraisal comes in at $160,000, that’s the figure the lender uses in determining his 80% financing ($128,000) and, unless the seller scales down his asking price, the buyer faces a down payment of not $36,000, but of $52,000, and an appraisal 11.1% under expectations that results in a down payment requirement 44.4% above expectations.
“Appraisals traditionally come in a little bit low so the appraiser can cover himself, but not enough to blow the deal,” according to Realty World’s Joe Veigel in Long Beach. “If it’s a couple of thousand low, it’s no problem, but I’ve got any number of transactions in escrow right now, and I’m very concerned about every one of them.”
And while Paul J. Joseph of Sherman Oaks, president of the Southern California chapter of the Society of Real Estate Appraisers, concedes that “there are always cases where realtors may have a problem with an appraisal--it’s been that way since the Year One,” a survey of local realtors suggests that, far from being an occasional, isolated difference of opinion, the current gap between prices being asked for real estate, and the appraisals being returned on them, is pervasive.
“It’s a problem, all right,” Joel Singer, the California Assn. of Realtors’ director of research, said, “And I’d like to hope that time will solve it because we’ve had it before, but there’s no certainty in that hope.”
The “why?” of it is a jumble of freakish timing, coupled with cumbersome, time-consuming mechanics; personnel shortages, and regulatory and traditional constraints on the appraisal process. And, hanging over it all: the ghost of past mistakes, and a sort of Catch-22 situation where both realtors and appraisers agree that a closer cooperation between them could sharply mitigate the problem--but which both back away from.
The taproot of the problem itself isn’t under debate: A real estate market that has rapidly turned around since the first of the year and an appraisal industry--strained by the demands on it--that is working with “comparables” that are at least four to five months out-of-date and that don’t reflect the present realities of the market.
“Appraisers, like economists,” the CAR’s Singer said, “frequently miss the trend, either going up or coming down. And they’ve been slow in realizing that the market is heating up, particularly in Southern California. Prices in the first quarter of this year are at least 10% above those in the same quarter of last year. And the appraisals coming through today are clearly understating prices that are actually being obtained in legitimate transactions.”
“In the Fairfax area,” according to realtor Ben Lesser who, until he sold out to Merrill Lynch Realty last year, headed his own brokerage, “we’ve got about 200 transactions on our computer but when you print them out, you’ve only got one closing showing that’s as recent as this past February.
“The other closings go back to the end of last year, and they show properties selling in the $170,000 to $190,000 range that today are fairly priced at $230,000 to $240,000. And, if they come in with an average appraisal based on those end-of-’85 closings, they’re going to come in way low.
‘Definitely in Up Market’
“I’ve got a meeting with an appraiser in about an hour, and I simply don’t know what I’m going to show as comparables.”
And realtor Fred Sands noted that “you’ve got appraisers who are looking at a data base of depressed real estate sales --a ‘worst’ market scenario--instead of what’s actually going on now. We’re definitely in an up market and there’s simply no question that prices have moved up and that there’s a tremendous amount of activity going on out there.”
It’s a theme echoed by Realty World’s Veigel. “Here, in East Long Beach, the price of two-bedroom homes has jumped maybe $15,000 to $20,000 in the last six months, but because of the heavy refinancing load the lenders are experiencing, its taking anywhere from 60 to 75 days just to get an appraiser out to look at a property. As a consequence, properties that have sold in that time period can’t be used as comparables.”
Because of the time-crunch--perhaps two months to get an appraiser on the scene and four to five months to close a transaction--”we’re so anxious to get an appraisal,” Merrill Lynch’s Lesser continued, “that we’re happy to see anyone come out.
“There just aren’t enough appraisers. So, what are they doing? They’re sending out 18- and 19-year-old kids just out of school, bringing them in from Orange and Ventura counties, and they just don’t know the area. They don’t know that the price of a property on one side of Beverly (Boulevard) can be 10% different from one just like it on the other side.”
‘You’ve Got a Real Problem’
“Where you’ve got an appraiser,” Sands said “who doesn’t know the subjectives, you’ve got a real problem. If you look at Beverly Hills and take one ‘comparable’ near Santa Monica Boulevard and another on Sunset Boulevard, you can have a difference of $500,000 to a million in price--and yet they’re only three blocks apart.
“Or take Coldwater Canyon--two houses across the street from each other--but one’s got a Beverly Hills address and the other’s got a West L. A. address. So you’ve got a built-in difference of about 7% in price. And when you’re talking about houses in the millions, it’s a tremendous gap. Maybe you’ve got one that’s a ‘tear-down,’ but there’s another just like it a block away that’s got $2 million in improvements in it.
“It’s not hurt us too much because we’ve got our own in-house appraisal capabilities, but we’re hearing a lot of flak from the marketplace . . . about deals falling through. We’re coping with slow, inaccurate appraisals at a time when prices are moving up. The appraisers are simply overworked and aren’t taking the time to find more comparables.”
But why this slavish, almost exclusive reliance on the part of appraisers only on “comparables” (similar properties in terms of size, location, construction and amenities) that have gone through escrow, have closed, and the sellers have cash-in-hand? And reflecting closings, realtors charge, that in today’s hot market are four to five months out of date?
Deals in the Works
There doesn’t have to be this preoccupation with comparables, according to Singer: “Actually, that’s only part of it. The appraiser has a place on his appraisal form to adjust the price for a whole lot of market conditions--including deals that are in the works.”
“That’s right,” Robert Morin, chief legal counsel for the Society of Real Estate Appraisers, conceded in a telephone interview from his office in Washington “All the appraiser is saying is: ‘Bring us the data--if you say that in a particular area appraisals are lagging behind, give us a half-dozen signed contracts demonstrating that you’re actually getting the prices that you allege you are getting.’
“An appraiser won’t give signed contracts the same weight he will a closed deal--a true comparable--but he can use them.”
But enter the Catch 22 situation: “We try to show them (the appraisers) the things we have in escrow,” Sands said, “but they invariably say: ‘Yes, but what if it doesn’t close?’ ”
Or, even more likely, Veigel said, “when the appraiser calls the real estate office and asks for this information, there’s a reluctance to tell him what’s sold until it actually closes escrow because if you do--and then the deal does fall out of escrow--someone will know what dollar figure the seller had come down to in the negotiations.”
New Federal Guidelines
But time glitches, a shortage of appraisers and natural secretiveness aside, there are still other factors behind the present gap between appraisals and selling prices, according to Fred Case, a professor of real estate in UCLA’s Graduate School of Management. “You’ve got new appraisal guidelines that have been laid down by the Federal Home Loan Bank Board (the governing body of the nations S&Ls;) and by Fannie Mae and Freddie Mac, Case said.
“The FHLBB, for instance, now wants appraisers to address the subject of ‘cash equivalency’--that is, how much cash will the lender get out of the property in the event of foreclosure? And that’s usually about 20% below market value. And then of course, too, you’ve got the lenders putting downward pressure on the appraisers.
“They’re trying to hedge on interest rates--afraid that they might get caught again during this return to fixed-interest rates, and so they’re adding in a little extra hedge.”
At the same time, too, Case added, the secondary lenders, Freddie Mac (the Federal Home Loan Mortgage Corp.) and Fannie Mae (the Federal National Mortgage Assn.), are putting their own downward pressure on appraisers by insisting on a change in the definition of “market value” from the old “highest price which a property will bring,” to the new “most probable price which a property should bring.”
New Methods Used
Although these new definitions, insisted upon by the two agencies dominating the second market for mortgages, were supposed to take effect later this summer, “they’re already being used, right now,” Case said.
“Almost without exception, lenders are specifing that they want the appraisal done under Regulation 41B standards (‘most probable price’). Lenders are very conscious of the lawsuits surrounding them and they’re saying to themselves: ‘we’d better be doing the prudent thing, whether it’s the law, yet, or not.’ ”
“And, although rarely spoken, appraisers today live under a nervous cloud--of an earlier time in the market from which they emerged with egg on their face by virtue, as now, of trailing the market, but in the opposite direction.
“They got into terrible trouble in ’79 and ‘80,” Case explained, “because they didn’t catch the downturn in prices and were still using comparables in their appraisals that suggested that prices were still going sharply upward--particularly with income property--and lenders were hurt badly because of it.”
‘Their Neck Sticking Out’
And it’s a point that the SRA’s Morin also emphasized. “Appraisers have an obligation to demand hard data . . . they’re not in the business of killing deals nor in ethereal wishful thinking. It’s their neck sticking out there--subject to misrepresentation and criminal fraud.
“The realtors sure won’t stick their’s out, and that’s the problem. If a federal regulator calls an appraiser in and says: ‘Demonstrate for us where you got the comparables to support your estimated value,’ and the appraiser says ‘I talked to a couple of realtors on the street,’ the regulator’s going to laugh him out of town, and he deserves to be laughed out of town.
“Let me ask you one thing about that situation in ’79 and ’80 when the market turned down so fast: Why weren’t the realtors then dying to get the appraisers this sort of information the way they are today? Appraisers now aren’t as optimistic about the direction of real estate prices as they were in ’79 and ’80.”
“It’s always been a problem,” Case admitted. “Appraisers have to do their appraisals on historical bases. And, traditionally, when they do wake up to the change, it’s too late. It’s a little bit like what they say about the dinosaur: The tail died long ago . . . the head just found out about it.”
