Steven R. Smith's  Instablog

This week my local Redlands Daily Facts newspaper had a front page article indicating "Office Vacancy Rate 43 Percent". The local broker they quoted is Rick Lazar who has worked here his entire career.

Lazar indicated that last year the vacancy rate was 25% and two years ago it was 15%.  This story is not isolated to one town in one region, it may be being played out across the country.

Four years ago there was ample money for new construction of projects of all types. Construction projects were being approved and funded by commercial lenders of all sizes and types.

No one was requiring any Market Analysis or requiring that supportable demand or absorption studies be conducted.  Every new project sold or rented before completion.

In early 2007 vacancy rates were in the 7%+ range in the local retail, office and industrial markets.

By the 3rd Quarter 2007, with more new buildings being completed each month, the vacancy was moving past 15%.

Many of the projects built in 2007 have never sold or been occupied, most have been foreclosed on.

Why? In August of 2008 Commercial Mortgage Backed Securities markets essentially closed.

Loans for buyers dried up, so did refinance funds. Sales came to a standstill, even as more projects were being completed.

Had construction been halted in 2007, the current over supply would not have been created, or at least it would be a minimal one, not the huge problem it is today.

Business growth has come to a standstill, with many small and even chain operations going out of business or closing stores, or filing bankruptcy.

According to Lazar, the current inventory and absorption rate means that there is a four year supply of  vacant commercial properties in this local market area. Is that a lot, Yes.

The overall regional Inland Empire vacancy rate is about 23% according to regional economist John Husing.

At 43% with prices down and soft, now might be the time for locals to plan their purchasing.

In Managerial Accounting and Managerial Finances courses budgeting and planning for future growth requires cash investments now. Maybe now is the time for companies that want to grow, to invest in real estate in depressed markets.

Why now, because prices are already down, and the new owners {the lenders or their investors} are likely to make deals to get rid of their inventory.

This week there have been many articles on the problems with the FHA reserve fund.

In recent years in my Region, as prices came down, the FHA loan became an ever larger part of the housing market sales.  More so since the $8,000 credits became available.

This program allows many people who cannot qualify to own a home, to be able to buy one.  That sounds great on the surface, but in fact it is bad when you realize what happens to them. They become preyed upon.

Typical transactions have nothing to do with the Market Value of a property, only in the structure of the deal, which, when all worked out, results in an agree upon Sales Price.

All is well for all who are involved from the sales or lending side, escrow and title too. Except, and unless, the appraiser assigned to the case figures out that the property is not worth the Sales Price. 

Since the S&L Crisis of the 1980's after which appraisers were licensed for the Public Good, one might expect that the appraiser would be the best friend of a buyer who is otherwise being preyed upon.

That might be the case if there were any structural support for the honest appraisers. There isn't. Instead, there has been a continual conditioning of the appraiser by the client, to hit the Sales Price and call it Market Value regardless.

Those appraisers  who would not play this dishonest game, were routinely not used.

No wonder now, that the loan losses are mounting, that the insurance fund reserves are being eaten up at an alarming rate. Not to mention the fact that Congress has been plundering them.

How will FHA survive? They will have to sue the appraisers and recover their losses on the Errors and Omissions Insurance policies.

This should be kept a secret, or it might scare the tens of thousands of accommodating appraisers who make a living hitting the Sales Prices.

The sadest thing is that there is no support or reward for the honest and competent appraiser. No one involved in selling or lending on real estate wants them.

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With an uptick in sales volumes and price statistics, many are trying to call a bottom to the markets. The motivations can vary, from selfish, self interests, to simply writers who are not really real estate oriented and do not understand normal housing market cycles.

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There have been millions of words written since the national Housing Market began to suddenly downturn over three years ago.

It came all of a sudden, after five years of frenzied run up that was totally irrational, yet whose flames were fanned by the largest trade organizations in the world of real estate, the building industry and mortgage lending.

The assortment of loan programs that made it possible for those without any financial skills or discipline to be able to buy homes without having to prove they could pay for them; fueled the entire run up.

Helped along was an army of residential appraisers willing to Hit the Sales Prices on ever increasing squirrely deals packed with more and more Incentives.

Lending organizations rewarded their CFO's with big bonuses for helping them do record level volumes. Countrywide paid their CFO a $17,000,000 bonus for his contribution in 2005 of all the hybrid loan programs he came out with.

Along the way, the licensed appraiser pushed to try and help the hand that fed them make their deals. 5% here, 10% there, maybe 15% upward pushes on Market Value estimates, over a five year period; resulted in a database populated with false or artificial prices.

Particularly targeted by the Players whose livelyhood came from preying on low equity, low income or buyers with blemished credit, was the FHA deal.

This worked well in the early years, until the price level to homes so far beyo9nd the loan limit, that new Conventional loan products had to be invented, and the GSE's raised their loan limits to accomodate the continued flow of loan products.

During this time period, Mortgage Backed Securities were pushed by Wall Street and their rating agencies, as if they were no risk investments.

Still, it came as a surprise to the whole financial world, even the regulated banks, and the regulators themselves; when the artificial Sales Prices began to crumble.

Calculating Supportable Demand for Housing is not a big mystery, not beyond the mental faculty of the Economists with Phd's, or the Financial Analysts with their MBS's. But, then, if these groups pander to the hand that feeds them, what they have to say, is in no way objective.

A 10th Grader can be trained in about 20 minutes, if they know how to use a calculator or spreadsheet, to determine Supportable Demand for Housing in any Zip Code where Household Income levels are availableand where the average house price is available.

It is simple really, starting with the interest rate, and normal underwriting guidelines.  Say we used a 30% factor allowable for housing, and multiplied that by the Household Income for an area. It would give us an amount that could be spend on the mortgage. We could divide that amount by the Loan Constant and derive the Loan Amount that would be supportable. Then, by adding a Down Payment, the Supportable Demand level for Housing in that particular area is clear.

When there is a disconnect between House Price Levels and Supportable Demand Levels, prices will ultimately have to reverse and go downward. And this did happen, but for some reason, no one could believe it. Many denied it for 6-9 months, some appraisers denied it for more than a year until forced to deal with it.

At the smae time if Sweeteners are added to the pot on the majority of deals, like free money, or Seller Paid Costs, or Cash Back to the Buyer, or Silent Seconds, or New Cars; Sales Prices can be Propped Up by the Stilts of Concesisons.

Market Value for lending purposes was defined by Congress in 1989 in the FIRREA legislation desinged after the S&L Crisis was identified and investigated.

Market Value is different than Sales Price by definition. Sales Price is simply a nominal number that has been agreed to by the parties to the transaction, with the help of the profesisonals who are assisting them for a comission. 

The Sales Price can include the fact that sometimes Buyers are not all that well informed, or that they are not operating in their own best interest. They may be in a situation where sales techniques have been used to push their Hot Buttons. They could be from out of town, or new to town, etc. 

What if the Sales Price includes a free car? Could the home be sold again to another buyer at the same price with out such an incentive? Probably not.

Cash back to the buyer or seller paid costs, free upgrades; are all Concesions that are designed to induce buyers to buy but do not have anything to do with Market Value as defined.

Essentially, Market Value is the net number, that is measurable from sales, net of their Concessions and Incentives, abnormal Motivations, etc.

The issue has become pronounced as prices have come down and more and more buyers are using FHA loans. Here is but one example from a new tract of homes in suburban Southern California. These are the Sales Price and Terms that I verified with the sales office on one of their deals:

• Sales Price $225,000
• Interest Rate Buy Down Costs -$10,000
• Seller Paid Closing Costs -10,000
• Builder Upgrade Allowance -$10,000
• Net Price = $195,000.

 In this case, the Cash Equivalency net price is $30,000 less than the Sales Price. Is this $195,000 price, Market Value? We could test it, which I did.

What we did was ask the sales office if they had ever sold the same model home to someone who did not need help with their down payment or care about incentive, but were most concerned about Price or Value. The anwwer was yes, but the Price was $189,000 to a buyer who did not need down payment assistance or help with their Closing Costs, etc.

In this example the Cash Equivalent Sales Price of the $225,000 Sale, is $189,000 for Market Value purpose. The differential is huge in terms of dollars and percentages, much more than appraisers recognize, 16.4%.

Most FHA appraisers will not adjust more than 3% for Concessions, so their Adjustments look OK. But, what if the real adjustment should be -16% on a deal they are relying upon as a "Comp"? Then, their conclusion of Market Value will not be a Cash Equivalent one, but a false one, though it will be closer to the Sales Price.

It is not as if the stuation was bad enough, the Home Valuation Code of Conduct agreet to by NY Attorney General Cuomo and FHLMC/FNMA, requires that loan originators use Appraisal Management Companies to order appraisals as of May 1, 2009.

There were lender owned AMC's as well as independent ones, but there is also now a whole new plethorea of new ones that sprung up.

From the appraisers side of the phone, the AMC is simply looking for the fastest and cheapest appraisers, and skimming fees off their backs, with the blessings of the parties to the HVCC. It is the wild west in this regard.

Local appraisers who refuse to work for fees equivalent to working  for 1979 wages, are seeing jobs go to outside firms willing to travel long distances, even sending unlicensed people to do the inspections. 

Even a brain surgeon working too fast, will have to cut corners. Appraisers are a whole lot less eduated then surgeons, but much more willing to go fast. There could be a link that says education, real education would be better for the appraiser than speed. 

But, then, Congress in response to the lobbysts of the day, made ease of entry the primary feature of the enabling legislation that required appraisal licensing.  It seems NAR and the Lenders and Builders, were terribly worried there would not be enough appraisers if they had to actually obtain an education. 

Instead of a college degree in their field or so little as having to complete a college major in their field, as long as a person was not a felon and could pass a prep school course and momorize 50 test answers, they could get their license.  Actually, you could be a felon too, as long as the felony was not financial related.

East of entry attracted an army of functinally illeterate people into the field of real estate appraisal 20 years ago, and continued to do so until recent years.

Imagine keen minds with no real regard for the Public Good, Fiduaiary Duty, Tort Law or any sort of consequences; being told they could do 3-5 reports per day and get rich as an appraiser.

Uniform Standards of Professional Appraisal Practice {USPAP} when it as first agreed to by the joint powers that created it, was 89 pages in 1989. In 2009 it is 370 pages but the qualtity of the appraisal went down.

If you do not believe it, ask a dozen appraisers how to calculate a Cash Equivalent Sales Price and see if they can explain it. 

Or, ask them what the Supportable Demand for Housing in Your Zip Code is, as if it were an important thing for you to know in regard to your real estate decisions, or theirs.  

There was never any structural support in the FIRRA legislation that was going to cause better quality appraising. License Boards have proven that they are largely impotent, some claiming a lack of funds, others without the will, others with Employee Unions that protect the unmotivated from having to do their jobs, etc.

Whle FIRREA was supposed to put a fire wall between loan origination and appraisal, the smart minds in the banking world found ways around the problem.

Appraisal Fraud in simple terms is the inflated or misleading report. FIRREA admonishes regulated lendert to turn in Suspicious Activity Reports if they spot Appraisal Fraud, but does not tell the banker not to pressure the appraiser or allow their authorized agents to do so. HVCC was intended to fix that problem. 

Instead, it created a bigger problem. Appraisal Fraud is rampant, and there is no one with the will or desire to stop it. Besides, there are too many commisions at stake. If appraisers knew how to do their jobs right actually did, Sales Prices would be shown to be disconnected from Market Value by the Stilts of Concessions.

God forbid that a lowly appraiser making $200 be the one to stop an industry that makes 6-12% per deal off of each house sale. 

It is my belief that the Public Good that the law states was the reason the appraiser was licensed; is the buyer in real estate transaction, and the investor and mortgage insurer of a real estate loan.

The truth is, that there is little thought on the part of the appraiser woking for the lowest fee, promising the fastest deliver times; with regard to anyone or entity that might rely upon their appraisal report.

Did Cuomo and FNMA/FHLMC have any idea what would happen as a result of the HVCC? Probably not.  Are things better now? Certrainly not.

Is it possible that appraisers have been Conditioned to shoot for the Sales Price to help make deals work? Absolutely.

Does it matter if a particular Housing Market is disconnected from Supportable Demand? Not as long as there are government programs that will bail out the Buyers, protect them.

This whole thing seems really transparent, but only if you think about it. Who are the winners in this game, those who make commissions on sales and loans?