The Evolution of Appraisal Risk

Real estate appraisals have been a hot button issue over the past few years.

First, appraisers were implicated as a contributing factor to the real estate bubble in the mid 2000s. The line of thinking was that they were focused less on the accuracy of their results than on their next deal.

Garden ArchesNext, the government responded by clamping down on the appraisal process to prevent lenders and real estate agents (who were both also implicated in the bubble) from exerting undue influence. Lenders have to hire appraisers indirectly through an appraisal management company. And although real estate agents have to let the appraisers into a home, we aren’t supposed to talk to them.

Then the real estate market headed south, with a dramatic decline in market activity (number of transactions), and a more gradual decline in prices. Appraisal risk became an important consideration when selling real estate in this new environment.

Would the home successfully appraise to the contract price? If no comparable properties sold within the past 6 months, then the appraiser was in a difficult position. Even if they were able to identify a value by making adjustments to not-really-comparable homes, there was still the risk that the bank’s underwriters would reject the appraisal. We saw this happen to our clients.

Sellers often had to reduce their price if a home didn’t appraise. Buyers were few and far between for a while, and sellers often felt they had to do whatever it took to keep a deal together. Since mortgage companies would require buyers to contribute more cash to the deal (in order to preserve the lender’s loan-to-value), and buyers were very reluctant to “overpay,” the easiest answer was to reduce the purchase price to the appraisal value.

With buyer activity heating up in some towns, appraisal risk is evolving. Multiple offer situations are becoming more common and buyers seem willing to pay a premium for thoroughly updated, rarely available homes. It’s classic economics – supply is low and demand is high, so prices go up.

The new wrinkle is that even if a listing agent has three bids at essentially the same price for a home, the appraisal may come in much lower because the historical data isn’t there to support a new, higher, price. In a regional real estate environment with flat or falling prices, how will the appraisers account for pockets of rising prices?

One development we’re seeing is buyers taking on the appraisal risk in order to get the home under contract. They’re willing and able to bring additional cash to the deal in order to keep the lender happy just in case the appraisal doesn’t work out in their favor. Not all buyers have the cash, but those that do can sweeten their bid a little bit by dropping the appraisal clause from the offer.

It’s an interesting development, and something we’ll continue to monitor to see how appraisals continue to evolve.

3 thoughts on “The Evolution of Appraisal Risk

  1. Interesting… you would think there could be a way to use three similar offers in justifying the market value of a house….

  2. Yes, you would hope that could be evidence in support of a value. But how do you prove to an appraiser that the bids exist and are legitimate?

  3. Readers Note…this is an inaccurate statement:
    “Lenders have to hire appraisers indirectly through an appraisal management company.”

    No lender is ‘required’ to use an appraisal management company (AMC) per the old HVCC – now replaced with the Dodd-Frank Appraisal Independence Requirements.

    These directives/laws say that the lender must ‘separate’ the production side (the sales people) from the appraisal ordering side (the appraisal placement) of the business.

    So lenders CAN have their own in-house appraisal ordering department as long as the sales people cannot influence the appraiser selection. But a great number of lenders chose to use AMC’s and close their in-house department after the HVCC was mandated. However, some are bringing the function back in-house due to poor managment of appraisers by the AMC’s.

    Because the AMC’s are not regulated in the same way lenders are, some AMC’s are far worse than the good ones. Most AMC’s siphon off (steal) a portion of the appraisers fee, so appraisers are earning less than they once did…..but are also having to do more work to complete appraisals. Many experienced appraisers are leaving the mortgage lending side of the business as a result.

    The AMC fee stealing process is not a good business model for the long term health of independent appraisers.

    RE Agents can help by lobbying for the return of typical appraisal ordering where the appraiser’s fee is honored by the lender, instead of having ‘middle men’ steal a portion. Lenders could not, and can not, keep a portion of the appraiser fee per federal lending regulations to pay appraisal ordering department overhead.

    But AMC’s operate outside that process, claiming that they are separate businesses. In reality, they are legally the agent of the lender, and should be regulated in the same way the actual lender is.

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