Last month, the Appraisal Institute released “Guide Note 12: Analyzing Market Trends,” a resource designed to give AI members an analytical framework for studying market trends while developing a market value opinion on a property. The Guide Note is particularly concerned with challenges faced by appraisers when market conditions are rapidly changing, as demonstrated by recent boom and bust cycles of the U.S. housing market. In slower markets like today’s, the Guide Note recognizes that a lack of market data is often challenging to appraisers attempting to make market value adjustments.
Based on the latest information contained in a large sample of purchase-mortgage appraisals completed in June, FNC conducted an analysis to examine how appraisal valuations respond to local market conditions – particularly when conditions are prone to produce less efficient transaction prices. It is well known that buyer-seller-negotiated prices can deviate from a property’s underlying value due to various inefficiencies that exist in real estate transactions. In today’s market environment, the problem is likely compounded by distressed conditions that characterize many housing markets across the country. Unlike in a typical arms-length transaction involving two households─homeowners and homebuyers, the parties to distressed properties are typically unique and the properties are often sold at a significant price discount which may or may not represent underlying market trends. Likewise, fewer home sales make it more difficult to observe relevant price information and market trends and thus more likely to produce inefficient prices.
The analysis shows that appraised value can differ quite significantly from contract price despite the fact that nearly one in three pre-closing sales transactions are appraised at exactly the contract price. Of a sample of purchase-mortgage appraisals on single-family homes and condos completed between January and June 2012, nearly 25% are appraised above contract by 3.0% or more. Combined with another 8-9% appraised at below contract by 3% or more, a third of the purchase-loan appraisals contain a market value opinion differing at least 3% in value from the contracts.
More importantly, the analysis shows that appraisal valuation appears to be performing the important risk management function it is designated to do for lenders’ mortgage transactions: helping to ascertain the market value of the underlying collateral. The analysis finds a strong positive correlation between indications of market inefficiency and appraised value’s tendency to move away from a contract price. In other words, there is a greater chance that appraised value will be different from the contract price when underlying market conditions are more inclined to produce less efficient transaction prices. Overall, the evidence suggests appraiser due diligence in the process of developing a market value opinion on the underlying collateral.
• More active markets – defined in the analysis as having at least 10 non-distressed sales in a prior month – are associated with lower probability of observing significantly different appraisal valuation. A more active market makes gleaning information more efficient. A significantly different appraisal valuation is defined as one in which appraised value falls below or above contract by at least 3% of contract price.
• Greater market distress – measured by the proportion of distressed properties in total homes sales in the prior three months – is associated with a higher probability that a significantly different appraised value will be observed. More specifically, market distress increases the probability of appraised value falling significantly below the contract price.
• REO or short sale properties are more likely to be appraised at higher value than the contract price. Sellers of such properties are driven to make a quick sale and are typically willing to ask a price significantly below the property’s market value in exchange for liquidity.
• Low-tier properties – contract price below $250,000 – are more likely appraised above the contract price. In contrast, high-tier properties (those with a contract price at $1 million or more) are less likely to receive a higher valuation. Since the subprime mortgage crisis is concentrated among low-tier properties, distressed sales are more likely to occur among these properties as their owners fall into financial distress. Since the appraisal data often have missing information regarding a property’s distressed sale status (short sale, REO, or other forms of distress), it is suspected that the low-tier property indicator picks up such impact on appraisal valuation.
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*According to a newly released report from the General Accounting Office, “Residential Appraisals: Regulators Should Take Actions to Strengthen Appraisal Oversight,” the nation’s five largest lenders obtained appraisals for 98% of home purchase mortgages sold to the GSEs or insured by the FHA.
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