Appraisal of the Industry

Of course any one who has bothered to open USPAP, or read the preface of any appraisal related book is very likely familiar with the valuation process.

Of course the application of this definition and process is where the fun begins.

Definition of the problem…

If I do not complete this report within the allotted 48 hours that has been so gracious allowed by the high pressure client I will likely never see another assignment, my children will be forced to work the street, and my wife will trade me in for someone respectable like a used car salesman or an insurance guy.

Preliminary analysis…

I could just grow “a set” and tell the client that 48 hours is entire too short of a period but then that would mean that I would not be compliant with this demands and could severely limit my ability to do the small unimportant things, like pay rent or eat.

Data Collection…

Conducting several phone calls to other real estate appraisers, I have determined that the vast majority of residential appraisers who have focused on federally related mortgage transactions have found themselves in the same boat, and not one of us realized that we have all booked passage on the Costa Concordia or the Titanic, for those of you too busy appraising to keep up with recent events.

Highest and Best Use Analysis…

Legally permissible, certainly there is nothing illegal about a lender or client asking the near impossible from an objective licensed professional so that they will be inclined to simply make the deal work not taking the actual time need to make sure all elements are properly analyzed and reported, but if I continue this line of thinking I will terribly digress… so moving on to the next test.

Physically possible, although it is physically possible to inspect a property (measuring, noting the placement of windows, doors, walking the foundation, noting the roof from each and every angle from the street, taking photographs of the subject from each angle, the mail box so the lender knows I can read the proper address at the time of inspection, the street scene so the lender can see the subject does conform to the neighborhood, photos not too close, or too far away, with the proper exposure, walking through each room, turning on light switches, noting the location and condition of electrical outlets, the window frames, the type and condition of each window, the type and condition of the floor cover, the walls and ceiling the ceiling fixtures, the door and door frame, the plumbing fixtures, turning on the water and flushing each toilet, noting any and all deferred maintenance, noting any condition that would be considered detrimental to market acceptance, and highlighting any condition that would be considered unsafe, unsound, or lacking security for the current, or future occupants, noting the functional room arrangement and making sure there is a flow to the plan allowing for privacy to the private rooms (bedrooms and baths) and the public rooms like the kitchen, dining and living have proper egress without crossing through a private room) and of course inspection the crawl space (foundation if appropriate) and the attic space to determine the type and degree of insulation, the condition of the rafters and cross beams, and make sure the mechanical system is in place and functioning. Driving through all minor arterial thoroughfares, and interior residential streets, as well as driving the neighborhood boundaries to determine the neighborhood influences so that a proper description can be provided to the ultimate user of the report. Photographing the competing sales and listings for any and all properties that are to be used in the report, and of course holding on the “best comparables” so that when the underwriter or reviewer calls and says “don’t you have any better comps?” you can say, “Why of course I do, I was hoping for you call!”

Financial feasible, since the fees are now lowered and filtered through a middleman, or should I say are now customary and reasonable the appraiser is forced to work much more efficient, and group inspections so that the bus route covers the majority comparables and the final inspection of the day is close to the Wal-Mart where he or she works a night.

maximally productive, well obviously the only way to become maximally productive is to just generate 1,000’s of reports through the appraisal management company mill, disregarding little things like full disclosure or analysis, afterall hitting the number and getting the next assignment is the only way to succeed in this game…

… Ok, I believe I the level of my frustration should be painfully obvious by now – the truth of the matter is that fact is actually much stranger than the above fiction. There are many appraisers out there who have started businesses to make money and not to keep up the purist attitude and safeguard the profession and the general public. What? An appraiser that wishes to make money and not pursue a career as a public servant to make sure that J.Q. Public is well protected? This seems unimaginable.

Now before anyone gets their nose out of joint, remember I am a second generation appraiser. I fully know that there are 100’s of us who do seek to maintain and promote the integrity of this profession and who sacrifice literally tens of thousands of dollars each year in turning down, pushing away clients, or out right rejecting proposed assignments that would compromise their level of integrity or professionalism.

Still – the residential appraisal industry has been changed to such a degree that the largest clients out there are simply using their AMC of the month or the year, to whip the appraiser’s into shape. Exerting pressure though an agent by restricting work, is still exerting pressure. Even though it has become customary it is definitely not reasonable.

ok – rant concluded…

See you around the water cooler!

UncleZev

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Back to Basics – part 2 -The Cost Approach – An approach to value, without worth, really?

The foundations of appraisal were based upon three independent approaches to value. A system, when developed correctly, presents a check and balance within the report. The idea being that when an appraiser takes the time to develop each report, the data will show three independent motivations and three separate value conclusions. Nonetheless, the conclusions will support one another because the underlying principle for each approach is the principal of substitution.

For the purposes of valuation or real estate appraisal, the principle of substitution is defined by practical application. Simply the idea that a prospective purchaser will pay no more for a property than the cost of acquisition of an equally desirable substitute  having equal utility and acquired within an equal amount of time. This principle  is accurately assumed to be the underlying principle of the direct sales comparison; however, it should be recognized that the principal of substitution is also the underlying principal for the cost approach was well.

The cost approach, when completed in a serious and professional way, is not only crucial to the appraisal of residential real estate, but also crucial for an underwriter to properly understand other factors that influence the value of the subject. Additional principles that are in play within each real estate market, but few people take the time to identify  these factors or understand their effects. A few of these principals will be listed below, in an attempt to help the average user of an appraisal gain a deeper appreciation for the thought process that goes into each appraisal report.

The Principals of Anticipation, Balance, Change, Conformity, Contribution, Progression, and of course Substitution are the basic tools of analysis that go into the professional analysis of each report.

Anticipation is the underlying fountain of the Income Approach to Value, but it also reflects the motivations of prospective purchasers of residential properties and has a foundational effect within the Direct Sales Comparison Approach as well. The income approach is of course a reflection of the present worth of anticipated income. The Direct Sales Comparison (or Market Approach) reflects what competing purchasers are willing to pay for the anticipated benefits that are attributed to a particular property, or characteristic, like quality, appeal, or location. These motivations are carefully considered when understanding a property and how it relates to its market.

Balance recognizes that the value of a property reaches its greatest potential when the four agents of production achieve the state of equilibrium. The four agents, being labor, management, capital, and land. When these agents are out of balance (in residential properties) you see a loss of value due to an over or under-improvement to the land. This principal comes into play when determining the proper highest and best use and remaining economic life. All three approaches to value are affected by the Principal of Balance.

Change is inevitable – except from a vending machine.  ~Robert C. Gallagher, but I digress. Change is continual therefore an appraisal is only reliable as of the date of value. The very next day, a plant could open in the town that would employe 1,000 workers increasing the purchasing power of the community and creating a demand for immediate housing, or the opposite could happen as well. Nothing ever remains the same in this world, this is a principle that affects all things not just real estate appraisal. It is this principle that lenders today are very concerned about as they are wanting appraisers to decipher the market conditions and decide which stage of change the marketplace is in (i.e. growth, stability, or decline).

Conformity states that maximum value is generally realized when there is a reasonable degree of neighborhood homogeneity. That is to say social and economic characteristics should be harmonious, deed restrictions and/or land uses compatible and property types reflective of these factors. Generally speaking the elements of conformity are not planned, but are borne out by the market forces that shape a community over time. Successful neighborhoods that thrive and enjoy stable or increasing values are communities that have developed amenities that are supportive of the overall needs and expectations of that community.

Contribution reflects the market reaction to a physical improvement of a property, not its cost. The best and well-known example is a swimming pool that today can easily cost $50,000 to $85,000 for a pool with a heater, and filtration system, and spa, and water fall, and all the “accoutrements” relevant to the enjoyment of a swimming pool. But the market generally resists the real cost of such improvements. The amount the market is actually willing to pay is known as the contribution value, of course the loss of value (or buyers resistance) should be shown as functional depreciation, but that is for a different discussion.

Progression, this principle is a politically correct way to discuss the basis for external depreciation and reflects the marketplace today with many REO properties on the market. This principal teaches that when properties of similar quality are adjacent or associated within a particular market area, the inferior properties will benefit from the association of the superior properties. That is to say you have an equal number of inferior and superior homes, the prices of the superior homes can benefit the inferior homes. The inverse is also true. The prices of the superior homes will regress due to this association.

When these principles are understood, employed and correctly analyzed the appraiser is then able to give insight not only to “the three best comparables” but why the market behaves in the way that it does and an appraiser can then anticipate future expectations making certain assumptions about performance based upon previous trends and reactions.

Unfortunately, this material was not sexy, or alluring, but I hope that those underwriters, operations managers, lenders, regulators or even appraisers who may not have had the best training will find some benefit in the information that I have provided above. It is critical for all to you know, understand and acknowledge. Nothing I have presented in this blog, is an original thought and I take no credit for the thoughts or analysis.

I have drawn from several years of study and instruction to give this summary of some of the foundational basics of appraisal to enable the users of our reports a brief insight and hopefully, new-found appreciation of the thought and time involved in the production of a real estate appraisal.

See you around the water cooler!

UncleZev

 

Highest and Best Use

In todays marketplace, I am left wondering exactly what the highest and best use of a residential real estate appraisal really is. It would seem that I have finally reached a point in my life where I have lost my Mojo for the profession.

Intellectually I can say that the use of the real estate appraisal is as valuable today as it was back when lenders were actually lending their own money and really cared about receiving an honest opinion of value.

At that loans were sought, but only in situations of need because someone needed to buy a home or a building for a very specific reason. Entire generations of people were content to stay out of debt and save for their dream home. In a large percentage of cases, lives would be spent saving money only to have to roll to the next generation. People who were finally able to buy their homes took pride in the actual unencumbered ownership.

If an appraisal was required for tax, insurance, mortgage, estate or “God forbid” divorce purposes there was not a tendency to pressure the outcome because people genuinely wanted to know the value of the home.

In contrast today, people do not save for anything. If they do not have cash they find a way to afford the payments for what they want from clothes, to toasters, to cars, to houses. We live in an instant and disposable society and if an honest appraisal is conducted that does not meet the whim of the consumer then, the appraiser is labeled as “bad” or barraged with reconsiderations until such time as they cave in or flip off the client.   Of course when the loan goes bad, the lender is not judged, the borrower is not prosecuted. The appraiser is labeled as “bad” and if they are lucky they only lose future work. If the make too many deals, the FBI gets involved.

Am I suggesting that America has made its own brand of criminal “the appraiser” and the prosecuting them for following the pressure that was imposed upon them? Actually, yes that is exactly what I am suggesting.

For the record, I have fired more clients than I can remember and because of my sense of honor and ethics my wife and children have been deprived some of the finer things in life so that I could hold my head up without shame when I look myself in the mirror each morning.

But as I pour over file after file after file, I can not help but ask myself what exactly did all of my folderol accomplish in fighting the good fight and standing firm for my sense of right and wrong?

Lenders simply found other appraisers to make the deals. When I changed my practice to fraud investigations, all I really did was find myself surrounded by literally tens of thousands of appraisal reports that presented appraisal opinions that were gladly accepted by the lenders until things got challenged and then the “bad” appraiser caused the bank to fail.

I would like to think that this just burn out talking, but it seems to me that for the purpose of mortgage lending the highest and best use of the appraisal is to line the bottom of the loan file until they need someone to blame.

See you around the water cooler!

UncleZev

Rotten Apples

When I was quite young my father taught me a principal that I would now like to present to my readers. “What is the value of a rotten apple?”, he would ask. The puzzlement of my lurid imagination would often take the conversation way off track. But through his patient, instructive way he would gently push and pull me back on track to properly evaluate the question.

If you consider for a moment that a rotten apple attracts bugs or worms then perhaps you could account for the possibility of selling these critters as bait; however, this certainly can not be the answer. There is a certain oder to the rotting fruit that will also detract from its appeal.

It cannot be eaten or sold, the colorants may be useful in the making of dyes, but certainly not to the extent of other more vibrant fruits. “So what is the value of a rotten apple?” I would finally ask.

The answer of course is that to wrong person, a person without the ability to look into the future, a person without basic understanding, or a person who lacks time and patience, this fruit is worthless.

However, to someone who understands the nature of fruit, who has forethought and the ability to see beyond the now, a rotten apple can be worth quite a bit. The fruit itself is useless, but it has seeds. Its seeds can be cultivated and grown into a successful orchard and over time this worth can far exceed even the most ambitious expectations for an experienced investor.

So what does this have to do with real estate appraisal? Perhaps nothing, or perhaps it helps us to understand that even the most useless property has value as long as we take the time to understand the nature of the property, its location, and its potential highest and best use which, with the proper diligence, can recognize value for future generations.

Of course this may be more applicable to real estate investors, than real estate appraisers; however, in this economy I believe it is time for appraisers to put their knowledge to work and begin to plan for their futures by purchasing and managing properties for themselves. Of course and of course, I am in no way suggesting an appraiser buy something that he has appraised. This would be completely unethical and someone who does this should go to jail.

What I am suggesting is that appraisers pay attention while they conduct research, and target properties that are good investments. Put to use the knowledge that each of us has acquired and begin to profit from our skills instead of only telling others what something is worth.

This is my two cents for today! Now go and find a few “rotten apples“!  With the right management and care, who knows what kinds of  “orchards” your future generations can enjoy.

See you around the water cooler!!

Uncle Zev