I need to begin with a disclaimer –– I am not criticizing appraisers.
I have worked with appraisers for my entire 30+ year career in this crazy business. By and large, I find appraisers to be honest, informed, hard working, and decent people.
Being an appraiser is akin to being an umpire –– you have to ‘call ‘em like you see ‘em.’ When an appraiser (or umpire) does their job well, no one says a thing. But when we feel that they are wrong, man do we make sure they hear about it.
It comes with the territory.
However, the criticism (in most cases) is unwarranted because appraisers are following rules that were written decades ago for markets that bear no resemblance to the markets we operate in today. In other words, the protocol that an appraiser must follow is what leads to the inaccuracies, not the appraisers themselves.
And so my real beef is with appraisal process and how the rules that govern them have failed to adapt –– not with the individuals who perform them.
In the same way that I love my friends in medicine, but hate everything about going to the doctor, or in the way that I love cars but abhor the act of buying one, it is possible to respect the individuals but hate the industry.
And thus, my issue with the appraisal.
The Definition of Appraisal
Investopedia defines a home appraisal as ‘an unbiased professional opinion of a home’s value.’
Wikipedia defines a home appraisal as ‘the process of developing an opinion of value for real property.’
Merriam Webster defines an appraisal as ‘a valuation of property by the estimate of an authorized person.’
Notice a theme?
Every definition said roughly the same thing –– an appraisal is the act of some qualified individual offering their opinion of the value of a thing.
But note that none of the definitions imply that an appraisal is concrete, absolute, or without debate. No, each definition includes words such as ‘estimate’ and / or ‘opinion.’ In other words, the appraiser’s conclusion, while researched, is still subjective.
True Story –– During a recent visit to a home from an appraiser, the appraiser made the comment, ‘Wait until all of these foreclosures come out’ implying that his opinion was that the market was due for a crash once the Covid forbearance protection period ended. Do you think that the appraiser was allowing his own personal biases to impact his opinion of value? Of course he was, and not shockingly, the appraisal came back at less than the sales price.
Yet, despite the fact that every definition implies some level of subjectivity, mortgage lending rules treat the appraised value as if it were absolute.
It is this belief that the appraisal is an absolute value (not a subjective one) that is actually doing more to prevent homeownership, especially amongst the first time buyer, than to promote safe lending practices.
A Brief Description of the Process
Ok, oversimplification warning –– so don’t beat me up. I am omitting much of the nuance in the mortgage process for brevity’s sake.
If you are borrowing money to purchase a home, you are required to get an appraisal. Once you have ratified a contract with a seller, your lender will require a licensed appraiser to visit the home, confirm most of the relevant facts (size, age, condition, beds/baths, etc.), and then offer their opinion of the value of the home.
The appraiser uses other recently sold homes nearby (called ‘comparable sales’ or ‘comps’) as the basis for their opinion.
When completed (typically a few weeks depending on the time of year and volume flowing through the system), the appraisal is submitted to the lender in standardized report form and the appraiser guarantees its authenticity.
Once received and approved, the lender uses the appraiser’s opinion of value to determine the amount of money they will loan against the property.
So Why Do We Have Appraisals?
The appraisal is required for two basic reasons:
- To protect the bank from LOANING TOO MUCH money on a poor purchase decision (i.e. –– the buyer paid too much for the home and the bank is now at risk by loaning more than the home is worth.)
- To protect the lender from FRAUD by having a buyer and seller agree to an inflated sales price and split the proceeds.
For anyone getting a ‘conventional’ mortgage (which is the overwhelming majority of the loans underwritten today), an appraisal is required.
Lenders figure that if they limit the loan amount on any individual home to some percentage of the home’s appraised value, then they limit their exposure to loss in the event that the purchaser does not pay, and they have to foreclose.
By never lending more than the value of the property, lenders lower their risk profile in each loan they underwrite and minimize their exposure if a loan does go bad.
In theory, the appraisal seems like a pretty good idea.
How We Got Here
Now for a trip back to the olden days …
I know this is difficult for the Realtor young’uns, but imagine a time when there was no online MLS, no Zillow, and no online tax records (it wasn’t that long ago, I promise). Every home that was available for sale arrived each week printed out and bound ‘phone book style’ with one small and grainy black and white photo and about a few really basic metrics (price, size, age, bed, bath, lot size, garage) to try to help you figure out if it was worth going to see.
I am not kidding (and, yes, I am that old that I used to look up houses for sale in the MLS book, thank you.)
Furthermore, each quarter, you got another book containing each home that had sold the prior quarter (aka –– ‘The Comp Book.) Again, no Zestimates, no other AVMs (valuation algorithms), no online tax, no CMA (Comparative Market Analysis) function in Matrix … nothin’.
Valuing properties was difficult and required both a tremendous feel for the market AND a ton of research. And that was precisely what appraisers did –– they performed the nitty gritty due diligence that any lender should perform before loaning hundreds of thousands of dollars to anyone.
All of the tools we have at our disposal today (tax, MLS, Zillow, zoning maps, other AVMs) did not exist and thus it was the appraiser’s responsibility to not just gather, but vet the information they used in establishing a value for the property.
So not only was establishing a home’s value was far more labor intensive prior to 2000, identifying fraud was also far more challenging because the lender didn’t really have a way to fact check the appraiser.
One would think that loan fraud and terrible appraisals were commonplace during these prehistoric times, wouldn’t one? Guess what, they weren’t –– but more on that in a moment.
2008, the Year the Appraisal (Should Have) Died
From a lender’s perspective, having an impartial professional 3rd party vet the contract price to make sure we aren’t making a mistake or getting scammed seems wise, right? If we (the lender) limit our loan to less than the appraised value, then we lower the cash we have at risk, right? And if a scam artist is tempted to try to defraud us, knowing that an impartial 3rd party is going to check things out, maybe the idea isn’t such a good one.
I offer you 2008 as a rebuttal.
Beginning in 2008 and ending sometime in 2012, nationwide home values fell between 30 and 40%. Mortgage fraud was rampant and foreclosure rates skyrocketed.
How well did appraisals protect the system at its most vulnerable and important moment? NOT. AT. ALL.
Think about it –– the same home that was appraised at, say, $500K in 2008, was likely appraised at closer to $350K only a year or so later. And I did mention that the home that appraised for $350K in 2010/11 was probably worth $400K by 2013?
Both appraisals (the one in 2008 and the one in 2011) were technically correct in that they met the standards of the industry by using three recent comparable sales and making the appropriate adjustments, but in reality, neither one was worth the paper they were printed on.
Why? Because a snapshot of the market values over the past 90-180 days doesn’t matter much if the inputs to the market are about to fundamentally change.
So, if a practice can be both technically correct, yet 100% wrong at the exact same time, how valuable is it?
The answer is rather obvious –– it isn’t.
The Appraisal and the First Time Buyer
So now place yourself in the shoes of the first time buyer.
You’ve done exactly as asked –– you’ve guarded your credit like a pitbull, you’ve paid down the credit card balances to $0, and you’re still driving the old Camry with 300,000 miles (to avoid the new car payment). And despite overwhelming college debt, you’ve managed to save $50,000 and you now qualify for a home priced up to $400K.
You start shopping for a home.
One morning, you get notification that a perfect starter home for $379K has hit the market. You are stoked as it is everything you want and it is below what you qualify for!
You put in an offer for the full asking price –– and are subsequently informed that not only was your offer one of 15 others, it wasn’t even considered because your loan requires an appraisal. The offer that was accepted was for $385K ($6K over the asking price) and one where the purchaser was able to waive the appraisal requirement (they paid cash.)
IT. HAPPENS. ALL. OF. THE. TIME.
Sellers know that when prices get bid up, people who require appraisals are not safe buyers because if the appraiser values the home at less than the contract price, then the deal is in jeopardy.
So what does the seller do? They take the deal without the appraisal contingency.
This is a COVID Thing, Right?
Now, it is trendy to think that this is a COVID thing –– it isn’t.
COVID has impacted many markets in many ways, it is just that much of what COVID has impacted was already a trend. In other words, COVID is not an agent of change as much as it is an accelerant of change.
Think about it:
- Telecommuting isn’t a new concept –– COVID simply made it a necessity for many.
- Zoom was founded well before COVID (2011) –– COVID just accelerated its adoption and use.
- The death of brick and mortar retail was already well underway –– COVID just increased the rate.
- The demand for vacation property was already growing –– COVID just gave us the excuse to finally go ahead and live where and how we want to.
And of course, the logjam at the point of entry for affordable housing isn’t a result of COVID. Scant affordable inventory was an issue well before COVID showed up –– COVID just made it sooooo much worse and finally shone a light on an issue that was already approaching crisis status.
The struggle for first time buyers to secure property into the teeth of multiple offers was playing out thousands of times well before the COVID real estate frenzy. So the idea that once COVID is gone, the problem will be too, is an incorrect assumption.
A Lagging Opinion
Here is the core issue –– somewhere along the line we forgot that an appraisal is subjective.
Ask five appraisers to value a home and I guarantee that you will get different answers –– sometimes shockingly so. Every appraiser is human and the comps they choose and the adjustments they make are subject to interpretation and bias. That is simply the nature of humanity.
True Story –– I once had a luxury loft for sale in an emerging warehouse district. The lender required 3 different appraisals before they accepted the value. Not only did each appraisal differ from the prior one, each one got progressively higher. They eventually got the idea that the property was worth what the purchaser was paying for it –– but it underscored how varied professional opinions can be.
Furthermore, an appraisal looks to the past for its information and when markets are accelerating, the past will always produce values below the present. (And the converse is also true –– when markets are falling, appraisals tend to come in above the market value. When appraised vales are greater than market values, the lender is in far more danger.)
So not only is there subjectivity baked into the value due to human nature, using past sales to compute present values means the appraised value will lag the actual market value.
What is the result? Because lenders accept the appraised value as gospel despite evidence that appraisals are created by humans using data that is aged, the buyers who require FHA and other first time homebuyer programs are unable to write competitive offers. In effect, the very programs that were created to help the entry level buyer make the leap to home ownership come with strings attached which prevent that very outcome.
I think that sucks.
Home Ownership is Critical
Studies show that the average homeowner has a 50X greater net worth than the average renter. It doesn’t take an economist to understand why –– equity in a home is one of the primary ways we build wealth.
The segment of our population living in perpetual tenancy is not only getting jacked by rising rents, but they have missed out on one of the great periods of home price appreciation in our nation’s history.
The rich keep buying real estate and the poor keep losing bidding wars. The long term implications of which are an increase in the wealth gap and a reduction in upward mobility –– neither of which leads to economic stability in the long run.
The Market Needs an Upgrade
In the same way that I don’t need the mail delivered every day, or a landline, or a department store where I can buy jeans, a chainsaw, and a mattress, ‘appraised value as an absolute’ is a relic of days gone by.
Yes, I fully acknowledge that the mortgage market in the USA is the envy of the world and that our housing market is one of the most liquid markets anywhere. I also acknowledge that we have some of the highest homeownership rates on the planet and a highly functioning mortgage market with all sorts of mortgage options is largely the reason why.
So my criticism needs to be tempered by the fact that our mortgage market works insanely well –– flaws and all.
That said, the way we lend money for purchasing homes was designed for a market long gone –– and the appraisal as an arbiter of absolute value is wholly out of touch.
And let’s not forget that they also don’t offer any real protection against fraud or foreclosure –– as 2008 so ably demonstrated.
Am I saying that we should not require an appraisal at all? No. I am saying that the appraisal is not the absolute gospel that it is purported to be and as long as lenders continue to act as if it is, those who rely on debt to purchase are at a distinct disadvantage. The lending environment has changed substantially since the appraisal was instituted and the need for the appraisal to be used in the fashion it is has run its course.
I challenge the lending programs to update their rules and regulations so that the borrowers who need these loans the most can actually use them to purchase houses.