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Housing Sales Price verses Market Value and the talk of Recovery

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.

For some, like the economists for vested interests like NAR or BIA, any positive news that can be spun to help their members do more business, is used with callous disregard to whatever the reality might be. Sometimes other boosters will write things that are simply absolutely silliness.

The job that I do daily requires measuring and monitoring what is happening in the Housing Market, with specific attention to the Inland Empire Region of CA, which is my primary market area. At the same time, attention is paid to the Case/Shiller Index, NAR, CAR, FATCOLA, Dataquick statistics, etc. These are examined from a macro to micro basis, that is, from a Metro to a Zip Code basis.

As with all Regions, there are many things happening in all the various Market Segments, regardless what the overall trends might show. As an example, in one city, we measured average price declines of 10% in one month last year, and in another Zip Code the same month, measured a stable market. What is happening in Desert Hot Springs, has no connection to Indian Wells, though they are both located in the same Valley. The differences may start with Household Income and Demographic differences that are huge, followed by things like Crime Rate statistics.

What I am seeing is that there are major variances the same month, each and every month, from one end or section of the Region to another.

As an example, in 2005 we had measured both a disconnect between Sales Prices and Incomes, and an Over Supply of Listings. And, we had observed that appraisers were being preyed upon to inflate the values overall, maybe only 5%, 10%, 15% per deal, but on deal after deal.  This “appraisal inflation” is called a fudge factor; it is not real value but paper value. The client pressures to inflate values and otherwise provide misleading appraisals was not new in 2005. I wrote an article on point for the Appraisal Journal in 2003, entitled “Predatory Lending, Client Pressures and Appraisal Frauds”, which tried to lay out reasons for the pressures on appraisers.

On the way up, the pressures were to inflate values to help make deals work, often with the appraisers client being the loan originator or the employer in the case of the bigger lenders. The overwhelming majority of appraisers have no academic education in the field of real estate finance or mortgage lending. There are not requirements that appraisers study these fields or the field of real estate for that matter, in order to get a license

Predatory Lending combined with hybrid loan programs that included zero down payment and no qualifier loans, allowed many people buy homes that were not qualified and could not afford a fully indexed loan payment at market rates.

 As with any product, a buyer can be sold an item for more than it is worth when the terms are easy.  Examples of consumer behavior are well documented on this point from buying diamond rings or sewing machines on credit, to cars. No one directly involved in a real estate sales transaction has any responsibility for the Market Value of the property being sold. Not the seller, not the agents operating under the Listing Agreement to earn their commission, not the lender originating the loan, not the escrow, title, or any other directly involved party.

A caveat federally insured or regulated financial institutions and agencies of the federal government, have Market Value definitions given to them or foisted upon them to be used in mortgage lending. In fact the federal bail out legislation, FIRREA, from the S&L Crisis of the 1980’s, not only has a definition, it has a new term never before published, Appraisal Fraud.  Bankers are admonished to turn in Suspicious Activity Reports when they spot Appraisal Fraud, which is an inflated or misleading report as per the definition. 

Unfortunately FIRREA was missing a critical sentence that allowed what happen, to happen.  Missing from the federal attempt to stop future financial crisis from happening was this simple sentence

“Do not pressure, allow your employees or agents to pressure appraisers into inflating property values to help make deals work”

It seems that lenders had blamed all their bad loans on inflated and misleading appraisals, so the SAR requirement made sense to Congress.  But, then, the testimony provided at the Congressional Hearings, which was published with the title “Impact of Faulty and Fraudulent Real Estate Appraisals on Federally Insured Financial Institutions and Agencies of the Federal Government”, a tome of some 2,000+pages, including the addenda.

During the S&L Crisis Hearings, when the appraiser’s organizations got their turn to talk, they reported that sometimes the client pressures came from the bank presidents themselves. In small markets, it only took a few lenders to actually put an appraiser out of business.

The firewall that FIRREA was to provide, requiring that appraisal and lending functions be separated in the regulated lender chain of command, was soon gotten around.  Many lenders created or participated in setting up their own Appraisal Management Companies.

FIRREA, like any important legislation, was a compromise with big interests getting some of what they wanted, from the ABA, MBAA, BIA, NAR and other State Realtor organizations. From an ease of entry in terms of a deminimus level of education, no degree in the field, any less course work than needed for either a massage or barber license; appraisal licensing became a law 20 years ago.

Thanks to many things, including the likes of Money Magazine reporting appraisal as one of the 10 best jobs, due to the high income level, freedom, and ease of entry; tens of thousands were attracted to a field they knew nothing about. Many came with keen business minds set up large networks.

In my State, there have been people who preyed upon the brand new licensee, with many different approaches, from loan originators hiring the newly licensed, and then telling them how to do appraisals that will go through the system, to individuals setting up trainees.

One of these types of shops was reported to have had 21 Trainees, all with his electronic signature. The way it worked was that they were responsible to go get the business, he showed them how to make a report look good enough to pass muster, and they did the work, signed his name and sent him 50% of the fee.

One woman Trainee who got busted in CA; admitted that she had four people working under her, two licensed and two unlicensed. She did the marketing and brought in the work, and handled the customer service and fees.  They did the work. Her share of the 50% fee split for 2005 was $350,000. That is a lot of volume at $300-$400 per report.

Also reported to me at that time, was that this type of operation, with large numbers of Trainees having the electronic signature and essentially doing business on their own, represented but one of over four dozen such operations that were known to State officials.  And, this represents the actions of an individual who figured out how to work the system, which is separate from the problems of client pressures that AMC’s eventually brought to bear on licensees.

All of this is but background for the problem, the system lacked any structural support for the truly skilled and ethical appraiser. Through Classic Conditioning, residential appraisers were being asked to take new assignments by checking first that they could “Hit the Sales Price” or “Help Make the Deal Work” in the case of a refinance.

Although Uniform Standards of Professional Appraisal Practice has an Ethics Rule that must be certified too, which includes not taking an assignment with a predetermined value, or sales price in mind; most appraisers do not understand what this means, or are blinded to it by their conditioning. Some started their first appraisal assignment shooting for the Sales Price. Tens of thousands have been Conditioned to do so.

Sales Price is a nominal number, whatever is agreed to, whether both parties are well informed or not, whether there is any terms or conditions that are propping up the price, or whether the transaction is a pure fraud deal.

Market Value is a federally defined term that requires the appraiser perform an acid test first with regard to the subject transaction and on every comparable sale relied upon to derive an indication of value.

Somehow, in the memorization of 50 test questions to become licensed, this important point has not gotten through to an army of licensees. It is an action step, not a passive one, and it requires true skills and understanding of the issues in order to be performed correctly.

Imagine, as an example, appraisals being written where the terms of the Subject transaction were ignored, along with those of the “Comps”, as well as the motivations of the parties, or whether the transaction was valid or a fraud, etc.

When, or if a residential appraiser fails to support the Sales Price, the entire system had been pressuring them to fix their report, bring the value up to hit the sales price. The HVCC that NY Attorney General Cuomo agreed to with FNMA, was intended to take this type of Client Pressure off of the appraiser, so they could tell the truth.  It sounded like a good idea, although the vast majority of residential appraisers have no idea about how to adjust for terms, motivations, concessions, and derive a Cash Equivalent value for a Subject of Comp.

Instead, unintended consequences have occurred since May when HVCC went into effect.  AMC’s have found local appraisers unwilling to work for the new low fees that they all of a sudden started to offer, about $200 for a URAR report. So, appraisers further and further away were hired and sent long distances to areas they were not familiar with and/or for which they may not have access to the data they need.

And, all of a sudden, appraisals started to come in lower than the Sales Price, and Realtors got up in arms, lenders too.

Still, I have many local appraiser friends who have no business, are essentially out of work or business over the last few months.

While all of this is going on in the background, or not going on, Builders began packing more concessions into deals to amp up volumes. A classic example came from a home I verified that had a Sales Price of $225,000, which included $10,000 in Buy Down fees so the buyer could qualify for the new FHA loan, $10,000 in Closing Costs paid for by the Seller, and $10,000 in Upgrades included in the terms.

The Concessions paid for by the Seller, amounted to $30,000. However, the Sale Price will be reported at $225,000. By subtraction, the Cash Equivalent Sales Price is $30,000. But, is this really the market value.

I pressed the sales agent if they had sold a home to a buyer who had a substantial cash down payment and was more concerned with value than terms. The answer resulted in a model match sale at $189,000, not $195,000.

The truth is each transaction can have a wide range of differing Terms or Concessions.  In the new home markets in my Region, Sales Prices are Propped Up By the Stilts of Concessions.

What gets picked up by those checking statistics for Housing Prices is the $225,000, and it looks like a Bottom has been reached.

As August comes to a close, we would presume that sales volumes and prices when the data is in will be higher than in July. All will rejoice, one more month of positive numbers. Wrong.

In many Regions, there is still a disconnect between Household Income and Housing Prices. Supportable Demand for Housing can be calculated down to the Zip Code level without having to pay for data, or down to the Census Block if one wants to buy data. No one researches or reports what Supportable Demand levels are, compared to Housing Prices, and in many instances, there is still a gap or disconnect.

As we head toward the Fall and then Winter seasons, sales volumes will decline, incentives will increase, and Market Values will be measured incorrectly.

Imagine that the whole mortgage lending world in terms of any issues involving the collateral value, is resting on the lowest bidder, traveling the longest distances to do a job that they really do not know how to do, but they do know how to make a report look good enough to go through the system.  

If every appraiser embraced and employed the process and procedures certified too, what is happening, could not happen.

With three Approaches to value, most appraisers use only the Market Data Approach.  The steps of the procedures to do it include:

  1. Gathering data from all the various sources and considering all of the data and what it is telling as a story about the local market. {this is time consuming and simply not done generally}
  2. Verifying the data selected for primary use as a direct comparison, to make sure it is arms length, or bonified, or a fraud. Major adjustments might need to be made for these factors, or the data simply eliminated.  Verifying Terms, Concessions, Buy Downs, Sweeteners, Incentives paid for by the seller
  3. Adjusting the primary market data buy a market derived method {this is time consuming and simply not done generally}
  4. Reconciling the adjusted data indicators
  5. Concluding to a market value estimate

When Steps 2 & 3 are eliminated, and part of Step 1, appraisals can be done much faster.  Starting an assignment with a Predetermined Value or Sales Price, takes a lot of time out of doing an appraisal. However, the results can be fraud, and the author may not even know.

Unfortunately, many buyers who check the Appraisal Contingency box on the Purchase Agreement assume that the appraiser is operating in their own best interest.  Not so, the appraiser works for those who hire them, and think about getting their current job done quickly and about little more than their next fee. 

The mortgage lending system is structurally flawed. And, while the appraiser may be blamed by the lenders in the end, they may never have been actually aware of the game that was being played and the role that they played.

There is little evidence of appraisal forgeries, though there are millions of examples of inflated or misleading reports.  There is little evidence of bribes or kickbacks being demanded or required by appraisers to Hit the Sales Price, most do it for free.

When it comes to statistics regarding Housing Prices, beware, that the numbers are propped up and those pundits who are trying to call the bottom may not have the resources or skills to ferret out the Concessions or Frauds included in the databases.

The new mortgage fraud volume is the FHA loan, not to dissimilar than in 1999 before the run up had started.