By Rachel Massey, SRA AI-RRS
Woody Fincham, SRA
We dream of seeing appraisal reports that stand-alone and are of themselves, self-sustainable as written. That market analysis, while a single component of many that make up an appraisal, is done in a manner that is robust, clear and narratively driven. How many reports have we seen that fail to state anything of real weight in them? More frequently than we would like to admit, we review reports that are nothing more than checkboxes and statements with no real support. We both look over reports that have some fundamental failings, ones that really make us question how well researched the data actually is in the report as a whole. Many of the cracks that we see begin with the market analysis portion of the report.
In this installment, we are going to look at market analysis and offer some insight on what we believe should go into a well-supported appraisal report. This installment is a rather lengthy one, but lays the groundwork for the next few installments. We often see appraisal reports that do very little to support the indications stated on the 1004 report. A cogent and well-supported market analysis is the foundation of a well-written report. The valuation process identifies the most basic flow for developing an opinion of value.
Jim Amorin, MAI, SRA, AI-GRS, and former president of the Appraisal Institute offered this quote about residential market analysis:
“Residential appraisers are required to be local market experts. The amount of research that they need to perform is much more in depth and specific than that of a general appraiser. Often times, a general appraiser uses regional level data, where a residential appraiser will need to have an in-depth knowledge of just a few blocks (Amorin, 2014).”
Clients should be retaining appraisers to provide that specialization and knowledge that only local and experienced appraisers can provide.
(The Appraisal Institute, 2014)
There are no shortcuts or work around, yet we see very limited market analysis in many reports. USPAP requires that appraisers adhere to two specific types of reporting options: Restricted Appraisal Reports and Appraisal reports. Most appraisal work is performed for lenders and requires the use of the Fannie Mae developed forms. Per USPAP, the Appraisal Report requires a summation of the analysis performed. Our contention is that many appraisals performed for the GSEs do not rise to the level of summation of market trends, which is the basis for market direction and sets the tone of the appraisal.
(Fannie Mae, 2014)
Fannie Mae has provided the profession with an interpretation of a minimum amount of information that they believe is significant for lenders to use. We think what FNMA ended up requiring is an executive level summary that just touches on points, and not complete summations of analysis. For those not familiar with an executive level summary: it is a summary type that touches on the 10,000 foot level rather than the on the ground perspective. Why do we take that stand? With the release and required addition of the 1004MC addenda, Fannie Mae realized that enough impetus was not being placed on a market analysis.
Many in the profession opine that the new addenda does not adequately reflect an adequate analysis as it is limited or does not work with rural and other heterogeneous data sets. We agree with those opinions in spirit but will go on to say that Fannie Mae was probably trying to make a square peg fit into a round hole. The 1004MC is an attempt to drive appraisers into an analysis of the market, but it is often too narrow in scope to be adequate, and should not be the sole basis of the appraiser’s analysis of the market.
An appraisal report should explain the data analyzed in such a way that is not misleading. When Fannie Mae or a client asks for specific things that may enhance or diminish sections of a report, it falls on the appraiser to reconcile what is being done. In a standard 1004 report, most appraisers now have to fill out the neighborhood section on page one, the appraiser must complete an inventory count in brevity on the top of page two and also complete the 1004 MC addenda. Depending on how each appraiser goes about completing each of these three sections, they can indicate different conclusions. It is a best practice to discuss each of the sections in your market analysis narrative in a supplemental addendum. Other items one should avoid glossing over are days-on-market for the comparable sales selected versus the actual averages indicated in the 1004 MC. USPAP now requires market time and exposure time explanations placed in the report. Much of this can only be covered through writing actual sentences and paragraphs and cannot be conveyed at any level of detail by simply checking boxes and making minimal commentary.
We dream that our clients want to, and need to, know what is happening in the market as of the date of the appraisal. These clients don’t want to rely on national media and Case-Schiller reports (no matter how good they are) because they realize that in all things real estate, the market is basically local. By local, we mean that the region where the property is located sets the mood for the market. A region can be broad, such as an entire county or even a set of counties. It can be as narrow as the submarket directly related to one employer as the base. The market that relates specifically to a property is much narrower than the region and can be as narrow as a couple city blocks. Our clients value an appraiser with this local expertise and knowledge.
Our clients can understand and depend on the report because it is developed and presented in such a way that the reader can follow our logic about the market Many appraisal reports are performed for residential lending, and a key component of lender work is assisting the lender in identifying risk associated with the collateral they are lending on. There is a need for the end-user to have all the facts and not just the barest of the facts. It can also be said that more clearly written reports will help the appraiser when dealing with unintended end-users that inadvertently end up with the reports as well. While not the impetus of this article, clear communication in the report prevents unintended conjecture from being made by the intended and non-intended users. No one should walk away from an appraisal report without understanding the market mix and preferences of the consumer. This leads into the highest and best use (HBU) analysis and extends into which approaches to value are most relevant and why. Like any well thought out research paper, an appraisal report should start broad and work towards a finite result. This is true for the report as a whole as well as each component that makes up the report.
To offer an out-of-the-box suggestion to lender clients and AMCs, your industry would be greatly benefited to try to retain appraisers on staff or through contract positions to read and vet appraisal reports. After the Dodd-Frank (and the preceding HVCC) act went through, many lenders pushed out valuation management to AMCs. Many AMCs, and some lenders through staff positions, utilize low-level clerks that are not certified to appraise to look through reports. This results in poorly vetted work. Some also utilize review appraisals from other appraisers, but these are often to have a supporting value not to obtain a true review of an appraiser’s report. The consistently low fees that are pushed on appraisers to take review assignments evidence this. In most cases, the lender/AMC wants a reviewer to do a review and provide an opinion of value for less money than the original appraiser did the first report for. Considering a review on the lender choice form 2000 is both a review AND an appraisal, it is nonsensical at best.
In other words, seek out quality and stop trying to cut costs.
When you treat valuation professionals like a hurdle, rather than a partner that enhances your ability to do business, the market reacts by letting the under-achievers rise to the top. Your collateral deserves vetting at a high level and makes sense to your overall risk assessment. Your stakeholders will thank you and adding a small additional level of cost to hire quality appraisers will pay you dividends. Rather than seek out those that will only give you answers that your origination staffs want to hear, look for those that are confident enough to give you hard answers to difficult questions. The reason we mention this in a blog about market analysis, is that you can begin to discern how good an appraiser is by reading their market analysis; also by how they approach highest and best use and most especially how well the approaches to value are explained and supported.
Pointers from the Authors:
We are going to cover two facets to the market analysis. One will be the macro –level, national to regional and sometimes city-level facets of the market analysis. The other is the micro-level. This covers the market segmentation that the subject falls into at a very specific level. Micro-level analysis deals with the smallest group of consumers that will consider the subject property and other competing properties as a group.
I have worked in a valuation practice that does all types of real property on the fee side, and currently I work in an office where I manage both residential and non-residential real property appraisers. I have seen how valuation works and it is enlightening to see the overlaps between the two sides. It does not matter what you are appraising, the valuation process is the same. All the academic concepts and fundamentals apply. All three approaches apply, HBU analysis applies and market analysis is certainly applicable for any valuation report.
Many residential appraisers have never seen, much less done, a narrative format report. When one is being paid to perform a narrative format report, it is easy to justify the pages most appraisers spend on discussing the many items that one should in the market analysis section. Frankly, many appraisers believe that narratives should be bulkier and more robust than a report created using a modular form. I disagree. A proper market analysis for residential lending reporting should include much of the same information that one would expect to see in both length and content as a narrative style report. With that being said, let us look at the macro side of things.
The best place is to start broad with national information distilled down to regional then down to the local level. Why start at such a high level? Most of the time, you are dealing with lender staff that is located far away from your market. They know and understand things from a high level, so starting with national trends helps draw a picture for them of your area. No two areas of the country are the same, but every market is affected by what happens on a national level. In my market analysis, I start out with national data, and then move to the state level, then to regional, before I finish with local data and analysis.
This normally should include a brief overview of the market historically. How it fits into the regional and state level indicates why consumers are there, coming there, or possibly leaving the region. What high-level employment events are occurring? Is a major employer slated to open anytime soon, or is one ramping down for a reduction in force or worse, close? Any regional programs such as transit related items, cross community programs and any major development that may create additional demand or diminishes demand in housing is a generally a great topic to include.
What drives residential demand? Many would say that employment levels are a direct driver. We all saw that after the lenders tightened up on credit requirements post 2007; available mortgage products affect the market directly because they can limit effective purchasing power. These are both important items to discuss, especially in a market that may have transitioning market conditions.
Regionally, public transit may or may not be a factor in consumer consideration but touching on whether it is or is not helps paint a picture for the reader. In markets that have no public transit, linkages, and distances to support services and commercial areas are considerations. I have seen this firsthand with petroleum prices increasing, many commuters changed to hybrid cars or moved closer to work. Chances are that subdivisions with direct or quick access to commuter routes have a better marketability than ones that require extensive drive time or access via small rural roads. As you look at communities farther away from employment centers and support centers, prices generally decrease to account for the distance.
Many regional markets have competing local markets. Why would some consumers prefer one to the other, and how does the consumer resolve this? Is there foreclosure competition? Is there new construction options? How do public school districts play into the considerations? Market mix is also important to cover at this level. What is a typical improvement for the area and what is the ideal improvement. Is the consumer preference transitioning; which will lead into the HBU analysis later on. Consumer preference speaks to the marketability of the property, and gets back to how risky is the collateral being leveraged against.
While certainly the wider national market has relation to what is happening at the University of Michigan or the Beltway, it does not set the stage for the nuances in the values around them. This is the same in most markets.
Since our lender clients are intelligent, understand that markets are both regional and local, and are driven by the wider economy, we offer some food for thought. This relates to the danger of reliance on the 1004MC form, which was developed by the GSEs in order to try and get appraisers to actually analyze the market. Instead we believe there needs to be more analysis, and not just charts and graphs, but a true analysis by the appraiser.
The reason the 1004MC form can be misleading, is that it requires, if done properly, that the appraiser analyze the competition. Unfortunately, in most markets, the competition is not very robust, and so an appraisal will often use five to ten sales (or less) over a year to come up with a trend analysis. This is simply not a sufficient number of sales to be meaningful. Relying on limited data, over a limited period, is not going to result in meaningful information, and at the worst can be misleading.
How do we analyze the market on a more local level? We pay attention to the number of sales that are occurring; the type of sale that is occurring (for example more REO properties or fewer);the days that these listings are on the market cumulatively; the list price to sales price ratio, median sales price, and median sales price per square foot. In addition, we both consider the contract-to-listing ratio to be very meaningful in measuring market activity at the time of the appraisal, and even predicting a short-term movement (normally a few weeks in the future). We may break out the macro to include a data such as a school district, down to the level of only generally competitive properties. Through doing so on most appraisals, we are able to see the market changes that are happening quickly. Even looking at a market as segmented, comparing REO to arm’s length sales is meaningful, such as the example below which shows how distress sales are lessening in one market:
Another useful way to perceive the market revolves around visiting Sunday Open Houses simply to see the amount of activity that is present. Doing so in one’s core market is beneficial in many ways, but mainly in seeing how much activity is happening as well as having the opportunity to view ones future comparable sales first-hand. The interaction with the agents is priceless, and the visibility is a great way to market.
While writing a market analysis that includes macro level information can be a huge project, it can be updated periodically. Once you have established the major trends that have recently occurred, those that are presently happening, and those that are likely to happen, one only needs to edit and update it as often as shifts occur. This increases one’s ability to defend the report if needed, but it also increases one’s perception as a professional. Expert-appraisers should be performing this level-of-work. By giving in to the pressure from scope creep and just checking boxes and making ambiguous statements in the report you are giving in to the commoditization that lenders and AMCs want to push the profession towards.
If all that we offer are reports that contain only executive level summaries, it is hard to have a debate about how fees have been pushed down since Dodd-Frank paved the way for AMCs to capitalize on lender work. With USPAP moving from summary report to appraisal report, it is best to explain each facet of the report in a professional and thorough manner. Move away from the intention of the lender and especially the AMCs to force the profession into a commoditized service by not giving in to the pressure to do less work, but by doing more. We know that seems counter-intuitive, but throwing your hands up in the air and doing less than credible work by just checking boxes and user vague boiler plate narrative just makes it seem like anyone can do it.
Amorin, J. M.-G. (2014, April 2014). (W. Fincham, Interviewer)
Fannie Mae. (2014, April 13). Appraisers. Retrieved from Single Family: https://www.fanniemae.com/singlefamily/appraisers
The Appraisal Institute. (2014). The Appraisal of Real Estate. Chicago: The Appraisal Institute.