Appraisals are here to stay.
Everyone in the world has heard that shady real estate deals, often with phony “juiced up” appraisals, were at the epicenter of the 2008 US Great Recession. And of course we were blamed as the catalyst for the entire world going into economic free fall. It was a lot of blame for one industry to shoulder. Sweeping policy changes and new standards of practice were implemented, aimed at preventing any future sculduggery. Many focus on the appraisal process itself.
Appraisals are essential to verify the value of collateral for mortgage loans. Until Artificial Intelligence becomes sophisticated enough to negate the need for human evaluations, we’ll continue to need licensed experts to render “opinions of value”. However, lenders are now required to place a “firewall” between themselves and appraisers. There can be no opportunity for complicity.
To ensure this compliance, banks typically place appraisal requests through third party Appraisal Management Companies or AMC’s. The AMC assigns the appraisal orders through a blind lottery-style system to prescreened, licensed appraisers. The AMC reviews the appraisal reports when complete, ensuring they comply with USPAP before sending them on to the bank.
There are rules.
Appraisers are required to use standardized forms and to make standard adjustments which they know will be reviewed by someone else. Adjustments for the size of the home, the number of rooms and the lot size are all pretty formulaic. It is predictable. And since lenders are an appraiser’s primary food source, they are extremely concerned about making any missteps and being removed from a bank’s list of approved appraisers. That would be professional suicide. So they play it pretty safe.
Appraisers are expected to use one of three methods to determine a property’s value: Sales Comparison Approach, Cost Approach or Income Approach. The Sales Comparison Approach is far most commonly used. This is when comparable homes (AKA “comps”) recently sold are used to determine the subject property’s “fair market value”.
Appraisers MUST use the most recent sales which are physically nearest to the subject property. Optimally, they will identify 6-8 comparable sold properties from the most recent 6 month period and within 1/2 mile radius. If 3 neighbors within the same builder tract sold within the most recent 3 months, you can expect those to show up in an appraisal – even if they are different floor plans and in different condition. Period. End of story. So your neighbor’s messy divorce that resulted in them fire selling their home will impact your home’s valuation.
Sadly, most upgrades as well as tragic choices, do not impact property value as much as you might expect. The greatest determinant of value is what other buyers recently paid for similar properties. So no, that little condo in Anaheim with $150,000 worth of Italian marble won’t appraise for $150,000 more than a recently sold model match. It was an unfortunate design decision by the seller.
Age matters. When appraising a vintage home, it doesn’t make senses to use newer homes as comps, unless you have absolutely no choice. Thankfully this is seldom the case in Orange County. And if a seller wants to claim that his beautifully updated Eichler home built in 1961 is worth more than a newer homage to mid century architecture, he’s probably going to be disappointed. 60 year old plumbing and electrical systems certainly don’t meet current green standards and are also likely to be near the end of their functional lifespans. Newer has greater value in terms of continued utility.
An appraisal and a home inspection are essentially the same thing. Absolutely not! Appraisers are only tasked with determining the market value of real estate. Appraisers do verify that a few items required for federally insured loans are in place. These include smoke and carbon detectors, a furnace, a cooktop and water source in the kitchen and at least one toilet. If there is grossly conspicuous disrepair, like a sagging ceiling, they’ll make note of it. Conversely, a home inspector will take hours inspecting every aspect of a home for it’s proper operation, safety and adherence to current building codes. So while an appraiser verifies that a furnace is there, the inspector will document if it is actually working properly. Massive difference.
Appraised values will be the same no matter why an appraisal was requested. Nope. An appraisal determines if the contracted price in a resale makes sense. If the appraiser deems a home to be within a few thousand dollars of a contracted purchase price, they’ll typically state the contract price as the value. Seldom will an appraiser document that a home is worth more than a buyer has offered to pay. This is begging for unwanted extra scrutiny by the bank, which is avoided at all costs.
When appraising for a refinance loan, they’re more concerned about what the worst case value would be in the event the borrower defaults on the new loan. What a bank could sell a home for tomorrow if they had to foreclose, is not equal to what a buyer has promised to pay for it today. Refinance appraisals commonly reflect lower values than purchase loan appraisals will for the same exact property.
If my home is the only one for sale, it’ll set the market value. Possibly not. You may need to be patient and wait for your neighbors to sell if you live in a unique and higher value neighborhood. It happens. When there are simply no recent sales truly similar to the subject of an appraisal, we’re all guessing about how to adjust value for different property characteristics when comparing the home to those that are different. Buyers are fickle and unpredictable. What they value today may change tomorrow.
Believe me, debating property values is something I do every single day. This is why appraisers will often say that “boots on the ground” agents can have a more precise understanding of a home’s value. I have been asked on several occasions to assist lending institutions with challenging appraisals where something was missed, often with great success.
Unseen issues can be terribly important. Knowing that one neighborhood has stable soil while another, outwardly identical and just a few blocks away, has significant issues with soil liquefaction is a valid explanation for lower sales prices for homes in that adjacent area. An appraiser may not know this, when an agent who has sold many nearby homes will. Some knowledge only comes with time.
I’ve seen unexpected landmines ranging from unstable soil (Costa Mesa), rampant foundation efflorescence (Huntington Beach) and seasonal noxious landfill odor (Covenant Hills – Ladera Ranch) greatly impact property values after a contract has been signed. What a buyer thinks he knows before property investigation can be unknown in pretty short order. Working with a seasoned real estate pro who has seen years worth of resales is more important that many understand.
As always, I am happy to help you navigate this complex, fascinating market. Real estate is my passion.