I just fielded a call from a potential client who was curious about how an appraiser would go about extracting an adjustment from the market, in this case specifically basement finish. In the discussion I explained that there is no factor that appraisers use, but that we turn to the market to try and show us what buyers are paying. Because different markets can act quite differently, I thought putting up a couple of examples of this type of extraction might be useful, both to my potential client, as well as my audience in general. The following show two different examples of an extraction for basement finish, one in Ann Arbor related to a generally newer house in the $400,000 or so price range, and the other in Lincoln school district in the under $200,000 price range. Both use the same methodology and both show substantial differences in final results, which is why an appraiser cannot just provide a number. Instead the appraiser has to look at the market. The first sample I went back two years and narrowed my market data to houses between 2000 and 3000 sqft, built between 1990-2010 on the west side of Ann Arbor (used areas 82, 83, and 84) and then downloaded all these sales to Excel and segmented the sales between houses with finished basements and without. The results were 37 sales without finished basements and 62 identified with finished basements. I looked at median and average sales price differences and median and average amount of basement finish, and came up with between $21,647 and $24,500 difference in price favoring those with the basement finish, and between $24.24 per sqft and $27.75 per sqft of basement finish. This provided me with some support for my adjustment. I don’t recall what my adjustment was, but I think anywhere between $20,000 and $25,000 is supported based on this data. That and in my experience, basements in this area cost about $40 per sqft to actually finish. Here is what it looks like on a spreadsheet: The next example is using sales in the Lincoln school district, and in this one my isolated properties were between 1,200 – 1,700 sqft in size and built between 1985-2010, also going back two years. I had 48 sales without basement finish and 36 with basement finish, and the median difference in price was $8,953 and the average price difference was $14,420. The median size of finish was 625 sqft and the average size of finish was 703 sqft, supporting adjustments per sqft of $14.32 to $20.51. As you can see, there are differences in price between the areas and the sizes, as would be expected. Cost remains about the same to complete. Each appraisal may be different, and the numbers found here in these two samples could change depending on how far back the appraiser goes on their data research and what they set as the perimeters for the data search. I offer this to you, my readers, as a simple study showing how I often go about trying to extract an adjustment from the market. A final word of caution; I would not expect to see an appraiser put this analysis into their appraisal. They will likely do it, and say something in the report about the adjustment being analyzed through market data. This is what they likely mean, but won’t put the actual results into the report, instead they will have it in their files, be it in the office in general, or specific to an appraisal they were working on. Hope you all enjoyed this simple explanation, and if you have questions about appraisals and appraisal processes, please feel free to contact me. Easiest way to reach me is via email at rach mass at comcast dot net.
February 13, 2015
Editorial by Woody Fincham, SRA
Over the next several days I will be posting up my thoughts on the recent Fannie Mae Lender Letter Lender Letter LL-2015-02. This is part 2. Part 1 is here.
So let us dive in to looking at that Lender Letter. Each of the quoted sections comes from the Lender Letter, which is cited above this. Following each are my thoughts on the quoted section.
“CU does not accept or reject appraisal reports or characterize an appraisal as “good” or “bad.” The CU risk score and messages pertain to risk and identify potential defects in the appraisal report. The lender is not obligated to “clear” or “override” the CU messages. The messages are meant to be used as red flag messages that lenders should use to assist with their appraisal analysis and inform their decisions based on a complete analysis and understanding of the appraisal report.”
I think this clarifies some of the biggest concerns to what CU is and is not. Most large lenders and appraisal management companies (AMCs) have been using all sorts of third-party review rule sets and data pools for many years. So this is nothing new under the sun. It really is the first time they are pulling in data that is verified by appraisers. It has the potential to be a good thing, but it could very well be a bad thing. It will depend on how the lenders use it in their respective review processes. It is certainly bad for appraisers if they approach it the same way that they approached the 15% and 25% adjustment guidelines. I will not get into the old adjustment guidelines to deeply yet, but we all know that many lenders were set in stone about the 15% and 25% guidelines when Fannie Mae was not. Yet lenders and AMCs still required adherence to those guidelines in some cases as hard and fast rules.
Working in a market as I do in Charlottesville, VA I understand where some concern would come from in the appraisal community. Much of my personal work involves complex residential assignments. From what I gather from those I have spoken to at Fannie Mae, and what information I have read about CU, I imagine many of my reports will become a four or five in their system. I deal with properties that require regional research because they are status homes: essentially unique and custom to the market. I would assume that these types of properties represent less than 5% of that MSA, and transfer infrequently. The market is also small on the urban-side and voluminous in the rural and transition from suburban to rural type properties; acreage varies greatly. The fact the MSA is in the Appalachian Mountains and that Fannie Mae requires segregation of finished basements from above grade living area; an overwhelming number of homes are built on slopes that have basements. I think you see that unless I am in a planned neighborhood or condominium development, it is unlikely my work product can be seen as conforming. By circumstance, these properties will rate high in risk.
If I felt like my ability to perform work would be affected by the CU rick scores, then I would be up in arms as well. Many of my colleagues believe that the CU risk score will affect them. While I cannot say that it will (or will not), if AMCs/lenders decide to use the information to benchmark appraiser quality it could be a nightmare for some appraisers. When you get to my thoughts on the 15% and 25% adjustment guidelines, later in this piece you will see more of my perspective on this. I could be wrong, but I am not going to be overly concerned… yet. Until I see things happen contrary to Fannie Mae’s stated position, I will defer on an alarmist attitude.
“CU does not provide an estimate of value to the lender. CU provides a numerical risk score from 1.0 to 5.0, with one indicating the lowest risk and five indicating the highest risk. Risk flags and messages identify risk factors and specific aspects of the appraisal that may require further attention.”
I know many appraisers were convinced that this was not the case. Many were positive that Fannie Mae was going to assign scores to the individual appraisers. It is easy to see why that would be a concern, as the last major Fannie Mae policy change dealt with the Uniform Appraisal Dataset (UAD). Appraisers are directly monitored on consistency of data for comparables with the UAD, but not with CU.
It is easy to mix it all up. If you submit data in violation to their UAD standards, that does affect you. The CU rating score does not. It is relative to the report itself, not to the appraiser. With that stated, AMCs and lenders COULD use consistent high-risk scores on reports as a means to stratify appraisers as problematic from those that get lower ratings. If this type of comparison was made a tracked, it could affect me. I do not compete with the typical mortgage-use appraisers in my market. Plenty stay in homogenous subdivisions and I cannot do the work that they do at the price points they do them. If their resulting reports are lower-risk scores by the nature of the conformity these properties present versus the types of properties that I typically work with, I will be seen as an inferior appraiser. Fannie Mae may state their position on such things but that does not mean the lenders and AMCs will not distill and extend the information they see further.
This is getting into the realm of conjecture; as such, there is not a whole lot of merit to it at all. It does make one stop and ask questions though. I try not to worry about things that I cannot control so I will leave such thoughts alone for now. But I will come back to the way lenders took the 15% and 25% adjustment guidelines out of context and altered the profession. I will have some more on that later, of course.
“CU’s selection of comparable sales considers the relevance of each potential comparable sale based on physical similarity, time, and distance. The selection process is not based on the relative “risk” or sale price of a comparable sale nor is there a “lower is best” approach. In fact, CU may assign a high risk score to an appraisal when the model identifies alternative sales that are potentially more relevant than the comparable sales used by the appraiser, regardless of whether the alternative sales are higher or lower in price.”
This certainly is concerning for appraisers. Appraisers are paid to perform the research and when we do it, we can get defensive about someone questioning it. Call it professional pride, but this can be a catalyst to incite negativity among us quickly. It is probably a good idea that appraisers write their reports with the above in mind. Part of this may be addressed by including commentary regarding ideal and typical improvements for the shared competing market.
Since the risk flags are triggered by not using properties that are more similar on paper, commentary may need to change to deal with these items in mind. Canned commentary certainly will not work in many situations. I know this means taking the time to write custom commentary in every report, but with enough foresight, it is easy enough to build a template that is set up as a skeleton to which specific report comments can be added. I have also suggested to a few colleagues, when asked, that they approach this similar to ERC (employee relocation) reporting. Possibly embedding a chart of all the comparables surveyed from MLS prior to distilling then down to the comparables in the actual report. I realize this is more work, but if we start seeing lots of kickbacks on this issue, this might be a way to avoid it.
The way CU is setup, at least how it has been explained thus far, is that data is stratified by census block groups (CBG), which goes into the next quote…
“CU takes location into account using Census Block Group levels, which are subsets of Census Tracts. This is the most viable proxy for location in the absence of standardized neighborhood definitions, and more effective than use of arbitrary distance guidelines. Fannie Mae is not suggesting that appraisers use Census Block Groups to define comparable search areas, but appraisers remain responsible for indicating when comparables are from outside of the subject neighborhood and for addressing any differences.”
This has caused quite the banter in social media appraisal groups and pages. There are all kinds of issues with this concept. The most obvious one is that appraisers do not stratify by CBGs normally. It would be great if the software companies could create or add a way to also tag which CBGs each comparable comes from or address it in the rules set reviewer in each of the form packages. This would at least allow a streamlined tool to allow the appraisers to comment on this item. Perhaps even a data point that could appear in MLS data. Most addresses are geo-coded now, so it would be an assumingly easy thing to do by over laying the CBG maps to existing maps.
Obviously, Fannie Mae chose this methodology because neighborhoods will vary market to market. My concern with it comes from the staff reviewers at lenders and AMCs (Quality Control or QC Staff) that are not familiar geographically (geo competency) with the area. This certainly gets back to USPAP regarding writing the report at level commensurate to the intended users. Explain away would the obvious answer, but that also require the readers and QC Staff to read the reports thoroughly. I often hear from folks involved in QC review that they prefer cogent writing and brevity. From some of the reviews I have personally gotten from lower-level QC staff (unlicensed appraisers); it seems many struggle with common terms in real property economics. I struggle with dealing with those that gloss over when I use terms such as linkage, commercial zones, obsolescence, etc.
This also still sets up the appraisers to deal with non-appraisers applying arbitrary guidelines. While distance guidelines are now going to be relaxed, in their stead I dread the likely possibility that QC Staff will want CBG differences addressed. A bit later, I will address the sun setting of the 15% and 25% adjustment guidelines, but one has to see the possible pitfalls with CBGs that the lender-leveraged adjustment guidelines created. QC staffs need to be well trained to deal with this. Nothing prevents individual lenders and AMCs from requiring more than Fannie Mae’s suggestion as to how to implement the CU into their work processes.
“The risk analysis performed by CU is for exclusive use by the lender in their analysis of the appraisal report. After completing a thorough review, a lender should be able to have constructive dialogue with the appraiser to resolve specific appraisal questions or concerns. Although the lender may use output from Collateral Underwriter to inform its dialogue with appraisal management companies and appraisers regarding appraisals they supplied, the CU license terms prohibit providing these entities with copies or displays of Fannie Mae reports that contain CU findings, including without limitation the CU Print Report, the UCDP Submission Summary Report, or any other CU report. The lender must not make demands or provide instructions to the appraiser based solely on automated feedback. Also, the CU license terms prohibit using it “in a manner that interferes with the independent judgment of an appraiser.” Fannie Mae expects the lender to use human due diligence in combination with the CU feedback, and will actively follow up with lenders who are reported to be asking appraisers to change their reports based on CU feedback without any further due diligence.”
Fannie Mae is pretty clear the impetus is not to strong-arm appraisers with the feedback and analysis done by the system. There is a real desire to keep human beings in the mix from Fannie Mae’s side. The possible disconnect I see will be on the competency of the QC Staff. The way many AMCs and lenders approach QC reviews is by hiring unlicensed staff people and expecting them to understand what valuation professionals do. Each appraisal is different and finding comments buried in a 20-50 page report is arduous at best; I can struggle with it and I have performed hundreds if not well over a thousand reviews in my career. The tactic that most QC staff uses now is simply kick to out a report because they cannot find a comment, or how the appraiser addresses the issues up front, and rely on the appraiser to point it out. There are already copious examples of appraisers stating they are often already addressed in the original report. Unless there is some reengineering of the process, this will only get worse as now the QC Staffs will be armed with more data.
One thing that we have already seen from CU is the copying CU comments being sent to the appraisers. I have seen several examples from colleagues where something was flagged in CU and no human review was done. No dialogue was attempted between the QC staff and the affected appraiser. Fannie Mae has made it clear that the CU scores and flags are meant to be dealt with by QC staff actually having dialogue with the appraiser. Instead, what we are seeing so far is many QC Staff people are simply copying and pasting CU comments and sending them as a standalone engagement for revision or commentary for the appraiser to deal with. That is not creating dialogue; it is asking the appraiser to the work for the QC Staff. One would think, after reading Fannie Mae’s letter that the expectation is for the QC Staff to check the report in question before calling on the appraiser to do anything. If the appraiser has reasonably commented or dealt with the issues of concern, they should be good to go.
Much of this is going to remain an issue with AMCs and lenders that continue to utilize the services of uneducated and undertrained QC Staff. Large lenders and AMCs that process lots of volume expect an awful lot of their QC Staff. Each appraisal, if written well, is stand-alone research project. It should be read and understood with the same care it was prepared. Pulling in someone that has never read an appraisal report as an hourly reviewer and expect them to get through the jargon and concepts that are summarized in a mortgage use report is counter-intuitive. Either the Lenders or AMCs need to start hiring competent and credentialed valuation professionals, or spend the resources needed to train raw talent. Both aspects are expensive, and neither is an option with the current compensation structures in the mortgage and valuation overlap of space. We will certainly discuss fee levels in depth a bit later.
“Fannie Mae does not instruct or suggest to lenders that they ask the appraiser to address all or any of the 20 comparables that are provided by CU for most appraisals. It is also not Fannie Mae’s expectation that appraisals should contain only CU’s top-ranked comparable sales. In the majority of cases, there may be no material difference between comparable sales utilized by the appraiser and those identified by CU. Before asking the appraiser to consider any alternative sales, it is imperative that the lender analyze the relevance of the sale and determine if the use of such sale would result in any material change to the appraisal report. If the lender determines that there would be no material change, then they should not ask the appraiser to make revisions. Fannie Mae expects CU to enable lenders to accept appraisals “as is” with greater confidence.”
The previous comments I have made are applicable here, too. The disconnect lenders had, again the adjustment ratio guidelines come to mind immediately, understandably make appraisers wince at this idea. The biggest concern, here again, is that QC Staff must be at a level of competency to understand that suggested comparable sales are just that, suggestions. The way this was handled pre-CU was to send an appraiser comparable sales that were not used and ask the appraiser to then comment on not using them or to possibly also include them. Of course, the comedy often ensues when the appraiser replies back that, “Two of the three comparables you sent me to consider are already in the report.” This type of real world scenario proves that where Fannie Mae may need to concentrate some of this reengineering of the process is on those that do review and QC work.
Not to plug the Appraisal Institute (AI), but this may be the very reason that the AI created the new review designations, AI-GRS and AI-RRS. Review is a completely different animal than Standard-1 and Standard-2 reporting. I understand that hiring such professionals is a higher cost, which means more cost to the consumer, but let us face it; you get what you pay for. At the very least, if the lenders want to have a positive outcome from the QC side, it should be built around utilizing well-trained professionals and the review designations are a step in the right direction in my opinion. And it really may not need to be at the consumer’s dime so much as maybe it should come from the lenders. The last I looked the larger lenders have no problems posting profit reports.
I spoke with a chief appraiser with a major AMC last week. He informed me that they have three levels of human reviewers. The first level is a combination of using technology to flag potential issues and areas that may need more in depth analysis. If there is enough need to elevate it upwards, it is then looked at by a non-licensed staff person. On the next and final level, a human being that is licensed is involved. It is apparently an effective way to do things, but even their internal processes still leave some room for improvement. When so much volume is handled by any given entity, and cost is always the biggest concern, it is impossible to hire but so much real talent. I will come back to cost a little later when I discuss fees and compensation.
End of part 2.
Stay tuned more to come over the next week. If you have any suggestions or want to share some war stories, please send them over to email@example.com.
 “Lender Letter LL-2015-02,” Fannie Mae, https://www.fanniemae.com/content/announcement/ll1502.pdf (February 2015)
All Three of us worked on this piece. I won’t post it in the entirety yet as it’s brand new today and should be given full look at through the publishing site. But if you happen across it here, please click through to read it.
OK, so what does the Cost approach tell appraisers (at least, those who are willing to listen) about the market? The listening is in the analytics.
Consider, first of all, the site value as if vacant. This is a separate appraisal within the appraisal. If the appraiser does not know to a professional certainty the value of the subject site as if vacant, how can that appraiser adjust the comparable sites (as if vacant) to it? It is ironic that, to adjust the comparable site’s value to that of the subject, the appraiser must know, to the same certainty, the value of the comparable site as if vacant, too. Assuming three comps and a listing, then the appraiser goes thru this site-as-if-vacant analysis five (5) times. If the appraiser is listening, an analysis five (5) sites deep will tell the appraiser an abundance about a market.
Now, consider the entrepreneurial incentive/profit aspect of the analytics of the Cost approach.
Too many appraisers have fallen into the trap of saying there is not such a profit or incentive in the cost approach since the sale of the property is from one retail buyer to another. It is not a sale from a builder/developer to a retail buyer. This is true. It is true, yet it is also thunderously irrelevant. An appraiser builds the house new on paper. Don’t new houses sell (hopefully!) at a profit from the developer/builder to a retail user? Since it is physically impossible to construct a used house, the analytics of the Cost approach assume a new house first. Therefore to estimate the reproduction or replacement cost new of a house and not include an entrepreneurial incentive or profit is to fail to take a step the market commonly takes. How reflective of the market is that?
For grins and giggles, assume a 15% entrepreneurial incentive to the cost new before any depreciation. This is a trail balloon the appraiser floats to see if there is such a reward in the market. If the market will not pay such a reward there is, by definition, an external obsolescence factor in the market. This is a market condition which the appraiser has an obligation to describe within the report. Yet, if the appraiser is not willing to measure the market to see if such a reward is present, how can s/he report it? The analytics of the Cost approach show if such a reward is present. The analytics of the Sales Comparison approach do not and cannot.
A blog such as this one is not the time or place to present a long article on calculating depreciation. The point is that while FannieMae, et al, no longer require a Cost approach to be part of an appraisal report going to them, whoever said the analytics of the Cost approach should not be part of an appraisal? FannieMae surely did not. How can an appraiser listen to, and then interpret the market, if s/he ignores two-thirds (Cost and Income approaches) of what it says?
Given there have not been all that many flat residential real estate markets in the past 10-years, how market-accurate, then, are the published tables? SR2-3 requires appraisers to certify to the fact that the statements of facts in an appraisal report are both true and correct. If there have been essentially no flat markets in the last 10-years, how can we certify our depreciation is both true and correct if the published depreciation tables are based on a flat market? If markets are dynamic, but the published tables assume a flat market, how accurate are they?
Another issue with the published tables is their self-recognized inability to speak to the appraiser about functional obsolescence and external or locational obsolescence. Appraisers know there are three components to accrued depreciation. Yet they depend on the published tables to conclude as to all three of depreciation’s components. These tables do not and cannot estimate the latter two forms of depreciation. In addition, it is a logical fallacy to assume a property has only one form of depreciation (even, sometimes, in a new one).
The Comment to SR1-3(a) is very clear about unsupported assumptions. If the appraiser does not engage in the analytics of the Cost approach, how is the appraiser sure there is no functional obsolescence? If the appraiser does not engage in the analytics of the Cost approach, how is the appraiser sure there is no external or locational obsolescence? If the appraiser does not engage in the analytics of the Cost approach, how can the appraiser certify that everything in the Cost Approach is both true and correct? Falling rents and/or falling multipliers may indicate the presence of these other two components of accrued depreciation. However, how many appraisers, via the residential income approach, go to the effort to read the market’s tea-leaves?
To professional appraisers, then, the issue is to extract accrued deprecation from market data. Published tables may be a help with depreciation’s age-life component, true. But they cannot aid the appraiser with conclusions as to functional or locational/external obsolescence. These tables simply cannot calculate them; the appraiser must extract them from the market evidence. Yet, unfortunately, many do not. And, equally unfortunately, many appraisers do not understand when, where, and how to account for an entrepreneurial profit/incentive. Because of this lack of competency, therefore, many appraisers do not understand the market since they are unable to listen to it.
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.
This blog is a re-post of a recent blog by our own Woody Fincham, SRA. It was originally posted on the Appraisal institute’s Opinions of Value blog located here.
Why “Just Any” Residential Appraiser Will Not Do
The following is a guest blog post by Woody Fincham, SRA, principal, F&M Associates, Inc.
With so many appraisers vying for low-fee appraisal management company and lender-related work, many AMC-centered appraisers are starting to compete for non-lender work.
Most consumers don’t understand the need for experienced and designated appraisers outside of lender use work. It’s the appraiser’s responsibility – and in his or her best interest – to remind non-lender clients that hiring a designated appraiser is worth their time … and, most importantly, their money.
Attorneys, financial experts, homeowners and other non-lender consumers and users of residential appraisal services should tread very carefully when selecting appraisers. There are two distinct groups of appraisers in residential valuation: appraisers who perform primarily mortgage related work and those who work with non-lender clients. It pays to be able to discern between the two groups.
What is the difference?
Non-lender residential valuation is a market niche, often best suited for experienced appraisers who think outside the box. These assignments include appraisal reports performed for situations such as wealth-management, divorce and other litigation related needs. Often, intended users need to find the most qualified and experienced appraisers. Well-vetted experts are most applicable when testimony is a possibility or when looking at unique properties. Selecting an appraiser limited to only experience with lender related work could result in less than optimal results.
Take attorneys, for example. They need someone who can write reports well enough to be seamless and defensible, but also handle cross-examination in a trial or the craziness that can be a pre-trial deposition. It takes a good professional to write the report, but an even better one to be effective on the stand or to help with pre-trial preparation.
Often, during the interview process in pre-trial or in court testimony, the appraiser must be able to communicate complex valuation theory to a jury or a judge who may have no understanding of such things. In other words, the appraiser must become an effective teacher in addition to being a good report writer.
Many residential appraisers who work primarily with lenders − especially since the housing crisis emerged in 2007 − are required to stay confined within a limited scope of work. Lenders often require appraisers to utilize comparable sales within a very narrow window of time, a small geographic area, and to not exceed lending guidelines when adjusting comparables sales.
This can be problematic when dealing with situations that often, or may, end up in court. The cost for an attorney to reorder a better report, or to pay a well-qualified appraiser to assist in pre-trial analysis, can get expensive quickly. Even worse would be finding that across the courtroom, the opponent hired the appraiser he or she should have hired.
What is the Takeaway for Consumers?
- Be willing to ask an appraiser why they are a better choice than the other appraisers you are considering.
- Ask for a resume and check references.
- Take the time necessary to make sure the appraiser is well qualified, beyond just the minimum qualifications.
- Look strongly at professional designations such as the MAI, SRPA and SRA designations.
- If you are looking for pre-trial consulting that involves the review of another appraiser’s report, the new Appraisal Institute Review Designations are a great place to retain talent:
- AI-RRS for residential reviews, and
- AI-GRS for non-residential reviews.
We are two appraisers separated by a three- hour flight or a nine-hour car ride. We have never met in person, but have come to know one another through social media. We are designated and recognized experts in residential valuation in our respective regions; both have had successful careers working in various positions within the profession; we are separated by enough distance that we experience completely different market stimuli. We subscribe to doing valuation work the right way. The way it should be done: defensible and well supported. Yet, we (and many others in the profession) are watching it being dismantled by the lenders, appraisal management companies (AMCs) and even from within the profession itself. This is not the way that it should be, yet we still stick to our guns and we dream about how it should be regardless of the present reality.
We share a dream:
Like any great dream, it is lofty, challenging and worthwhile. We dream that we can make a living as fee appraisers, doing our jobs the proper way. The dream is to take the time to analyze the problem to be solved; research the market thoroughly including market trends; interview the market participants; analyze the sales and extract market adjustments; and then report the opinion of value in a way that the client can understand the thought processes. Within this, there will be good support for conclusions and the appraisal will make complete sense to the reader. It will not leave gaping holes or questions. The opinion of value will be well supported by sales that are both inferior to the subject as well as those that are superior (and ideally equal). The appraisal will address the current market conditions and the active competition as well as the closed and pending sales.
Analysis is what we do, refined by the appraisal process, tempered by ethics and integrity all rounded out by participation in a profession that is carried out by like-mined and well-intentioned practitioners.
The dream continues:
Our clients will truly care about the analysis and it will be meaningful to them. They need something of substance, and not simply paper for a loan closing package, or simply a report for a divorce or bankruptcy proceeding. The client understands that the valuation is based on fact, but in the end is an educated and well-supported opinion. The client understands that each report is a unique and extensive research project that is custom designed. The client is comfortable with the opinion of value because they reached out to a well-qualified and experienced appraiser; one that is rewarded the report because they are respected professionals, not just another step in a loan closing process or the cheapest one they could find.
We realize this is getting into the lofty and idealist side of things, hence the title of the blog. What this series is going to focus on is some of the challenges appraisers face, and how we should handle them. There is constant pressure on appraisers to adhere to scope of work enhancements from clients. While we may mention customary and reasonable fees and the dynamic that the cost of business plays in the appraisal process in the course of this series, this is about what appraisers should be doing after they accept an assignment.
Rachel has years of experience reviewing appraisal reports working within the lending world as a staff reviewer and manager, and in the fee world through her private practice. Rachel has recently earned the new residential review designation with the Appraisal Institute. Woody has been doing private fee review work for years and also has to review reports for tax assessment appeal as part of his position within the assessor’s office in Albemarle County, VA. Between our combined experiences, we will focus on some issues that we see pop up repeatedly throughout various reports that have made their way across our respective desks over the years.