Appraisal crisis redux.

Appraisal crisis redux.

Since June I've been obsessing about what might at first glance seem a thoroughly uninteresting, if thoroughly welcome, piece of regulation, the new Home Valuation Code of Conduct.

The HVCC is an appraisal-generating system, effective May 1, 2009, drafted by one state's Attorney General's office and accepted by one Federal agency but with a huge impact on the national real estate market. It's ostensibly designed to eliminate pressure on residential appraisers to "make the price"—validate a home's market value as whatever number the buyer put on the purchase contract—but in practice has led to a multitude of unintended consequences not only for the real estate industry but for the consumers the HVCC allegedly protects.

In Changing the rules in the middle of the game, we saw how the Home Valuation Code of Conduct has affected the Las Vegas market, with local agents and mortgage brokers claiming that low-ball appraisals made by incompetent or inexperienced appraisers, under-paid, overworked and often from out of the area, hired by third-party appraisal management companies (AMCs) paying far less than the usual pre-HVCC fees but charging consumers far more, were scuttling legitimate transactions and threatening the recovery of that badly battered market. What the appraisal crisis really means looked at the HVCC's apparently similar effect on our own market. This week we'll take a broader view, following the national debate as well as one local story.

First, why should you care whether appraisers are pressured by agents, loan reps and consumers to appraise homes at or above the contract price? Because, according to popular belief, "inflated" appraisals were either a) entirely, or b) almost entirely to blame for the rapid and, in many areas, unsustainable rise in home prices during the boom. This single-minded focus on appraisals stems from the fact that whenever anything complicated like, say, a market, goes wrong, most observers find it helpful to blame just one aspect of the system, not realizing that a) systemic failures are always a team effort, and b) the alleged culprit or culprits are usually just a handy smokescreen for the real culprit or culprits. But the advantage of focusing on the easy target is that a) it makes the media's job a lot easier (or, to be more accurate, makes the job easy enough for the media to do), and b) it's far more satisfying to the observers, since it gives them a clear-cut villain to boo and hiss.

Second, why should you care if there's an appraisal crisis, even if you're not an agent, buyer, seller or homeowner? Because sucking the professionalism out of residential appraisals in the holy name of reform undercuts the recovery not just of the real estate market, but of local, state and national economies, the global economy and maybe even the galactic economy. Tired of worrying about getting laid off? Wondering when your stock portfolio will be worth what it was back in 2007? Feeling you've deferred that big-ticket purchase or expensive vacation too long? Then start rooting for a stable real estate market, which among other things means one with as few appraisal-related "quirks" as possible.

And third, why should you care about an arcane piece of regulation with the innocuous title Home Valuation Code of Conduct? Because the HVCC's design, implementation and nasty consequences give us an object lesson not only in regulation done hastily to advance careers, sweep inconvenient truths under the rug and please the peanut gallery, but in how such regulation is defended in the face of those consequences. It's also a nice example of that popular morality play featuring "the forces of reaction" (the industry affected by ham-fisted regulation) battling "the forces of progress" (the consumer advocacy groups, regulators and politicians who rammed through the ham-fisted regulation). Have this happen to your own industry and you may find yourself inadvertently empathizing, if not actively sympathizing, with the next allegedly rapacious industry whining about government intervention.

How did it come to this? Rhetorical question alert: How does it usually come to this? In their rush to judgment, everyone in charge ignored a few critical but inconveniently complicated ideas, among them the fact that:

appraisals are done not to protect the interests of the home buyer in particular and society in general or to ensure the sanctity of the marketplace but to raise the comfort level of the lender, an entirely different function (as events since 2005 have shown) and a situation the HVCC does nothing to change
no dispassionate observer of the appraisal industry could doubt its motivation to keep its largest customer, the mortgage banking industry, happy by issuing optimistic appraisals when lenders are feeling optimistic and want to lend, and by issuing conservative appraisals when lenders are hunkered down and hate to lend, a situation the HVCC also does nothing to change
determining the value of a home is far less scientific and far more subjective than the public seems to think and the appraisal industry seems prepared to admit, a situation the HVCC again does nothing to change and in fact may indirectly worsen by eroding appraisal standards
booms and busts are a fact of markets, and the fact that the fallout is worse this time may have more to do with the peculiarities of this particular boom, including aggressive subprime lending and mortgage securitization, than to opportunistic appraisers taking the well-worn path of least resistance

So now we have the Home Valuation Code of Conduct to make everything right, except that the lenders are still calling the shots, something that got us into this mess and something an expedient Band-Aid fix is almost guaranteed to worsen. Which is exactly what it's done, according to a National Association of Realtors® survey of approximately 30,000 members including agents and appraisers. The survey shows that:

"Approximately 76 percent of Realtors representing buyers or sellers indicated that the time to obtain a completed appraisal increased after May 1", the date HVCC went into effect, with 69 percent of those reporting "an increase of over 8 days"
37 percent reported lost sales due to appraisal problems
70 percent reported "an increased use of out-of-area appraisers" unfamiliar with local neighborhood differences, home prices and trends
"The number of NAR appraiser members reporting that they obtain over 50% of their assignments from AMCs increased from 14 percent to 39 percent after May 1"
"Approximately half of NAR appraiser members reported a reduction in fees received by them, and 70 percent of NAR appraiser members reported that consumers were paying higher fees"
71 percent of NAR appraiser members reported that "time for an appraiser to submit an appraisal to the AMC decreased"
"Approximately 85 percent of NAR appraiser members reported a perceived decrease in appraisal quality"
"Among Realtor respondents obtaining an appraisal for a client, 55 percent reported a perceived decrease in appraisal quality"
"NAR appraiser members reported a significant number of assignments in unfamiliar geographic areas"

Now, if you're the kind of person who reflexively doubts anything the National Association of Realtors says because you equate "NAR" with "sleazeball small 'r' realtor", realize that a) not every NAR member is a small "r" "realtor" (I was a member well before I started selling homes), and b) there's little love lost between small "r" "realtors" and appraisers, as the acrimonious postings on NAR's HVCC blog confirm, even if they all happen to be Realtors®. (Many of the appraisers who posted seem to think that agents are sloppy, greedy, overbearing knuckleheads. I don't know how this rumor got started.) So you can put aside your conspiracy theories for a moment, unless you feel awkward without them, and believe that since the HVCC was implemented May 1:

Appraisals suddenly take longer
Appraisals have suddenly become a major reason why home sales fall apart
Appraisers are increasingly straying outside the neighborhoods and cities, even counties, they know
Appraisal management companies have suddenly become much bigger players
Appraisers are suddenly getting paid less, while consumers are suddenly paying more
AMCs have suddenly given appraisers less time to do their jobs (yet note that appraisals are suddenly taking longer, which confirms that suddenly a small group of appraisers is getting most of the jobs)
Even appraisers are suddenly seeing a decrease in appraisal quality

Kind of a textbook example of the Law of Unintended Consequences, para. 1b(iii) Poorly Drafted Regulations, yet it's all good if you're the Federal Housing Finance Agency, the outfit that set this train wreck in motion by agreeing to adopt the HVCC for all Fannie Mae- and Freddie Mac-purchased loans, which account for about two-thirds of all home loans. According to its July 22 notice, Strengthening Appraiser Independence and Improving the Valuation Process and Standing Up For Motherhood (I'm kidding about the motherhood part—barely) where there's smoke there's no fire. Here's a sampling of the agency's response:

"Contrary to some suggestions, the Code provides for communications with appraisers about errors, additional needed information and unprofessional conduct" except that by then it's too late, according to an appraiser who posted on the NAR blog I mentioned, because an appraiser who agrees to change his report after it's submitted to the lender runs the risk of having all his previous reports audited and consequently getting black-listed
"...the Code does not lower appraisals..." per se, although that's one of its unintended consequences and, given lenders' reluctance to make loans these days, you have to wonder how unintended that consequence was
"...the Code does not favor the use of AMCs over independent or in-house appraisers"; true, it doesn't mandate AMCs, just makes it more likely that lenders will prefer AMCs to independent or in-house appraisers
"The Uniform Standards of Professional Appraisal Practice...requires that an appraiser be competent and knowledgeable of the local market..." Question: How many desperate appraisers are going to let some industry code of practice keep them from working in areas they don't know? Answer: So far, not enough.
"Closing costs have risen in some instances, but that has not been a function of the Code. Lenders have tightened underwriting standards", yes, since 2007, and we didn't have problems of this magnitude until after May 1, 2009.
"The Code may initially have slowed appraisal time...(but) as the market adjusts...more efficiency will reduce turnaround times." "More efficiency"? You mean appraisers will finally stop getting lost trying to find those faraway neighborhoods they've never worked in? You mean they'll strap booster jets to their Kias so they can knock out a few more homes?

Which ties in nicely with a local story, sent to me by a client, about a San Jose home sale temporarily tripped up by the HVCC. According to a San Jose Mercury story posted July 23, the sellers received two offers the first week their home was on the market, indicating it was attractively priced, and the first appraisal confirmed the purchase price of $560,000. "But just days before the sale was to close, an appraisal required by a new federal code [HVCC] came in $100,000 below the sales price". An early and welcome instance of the HVCC saving a buyer from himself? "The second appraiser, based in Oakland and sent by an appraisal management company, told the [sellers' agent] he had never worked in San Jose." Which meant that he probably knew less about the San Jose market than the buyers, who "had spent months looking for the perfect house, walking through at least 40 and viewing hundreds more online".

"I'm an educated person," said one of the buyers, a Palo Alto attorney. "I've lived in the Bay Area my whole life. I had no question it was worth $560,000-plus. Neither did my agent or the mortgage broker or the first appraiser who approved it." A third appraiser, sent out after the buyers' agent "insisted the management company send someone with a 408-area code", valued the home at the purchase price and, "after weeks of hand-wringing, the deal closed."

And, by the way, none of those three appraisals were free. Just the kind of additional cost and all-around excitement the real estate market needs these days.

The Mercury story has another interesting quote, from a Santa Cruz appraiser "who used to have about 10 jobs a month [and] says she is now lucky to get just one, as the management companies change the way work is doled out. And instead of being paid between $350 and $500, she might get just $200. The management company pockets the difference."

At least someone's getting something out of this. Somehow someone always does.

"I'm sure there were a lot of crooked appraisals," she adds, "but to put every appraiser basically out of business is not OK. After having my business for 20 years, I'm about to lose my house."

I wonder if Attorney General Cuomo would appreciate the irony in this.

Finally, I'll quote someone who could never be accused of being a shill for the real estate industry, Wharton finance professor emeritus Jack Guttentag, the Mortgage Professor, who writes regularly on lending issues. In his July 27 column for Inman News, "Appraisal rules backfire in down market", he confirms that "to protect themselves from liability, most lenders are ordering appraisals from appraisal management companies." What's the problem with this? "Because AMCs operate nationally but do not have appraisers everywhere, more appraisals are being done by appraisers who are not familiar with the local market. Appraisers working for AMCs are also paid less per appraisal than independents, which may induce them to invest less time. Less knowledge by appraisers means more scope for bias [or just plain error], and in a declining market, the prevailing bias is toward lower values."

So this "prevailing bias" (otherwise known as "everyone knows") among appraisers perpetuates lower values and delays the market's recovery, even as the recent influx of investors and first-time buyers would ordinarily stabilize values. But as the more obtuse posts on the NAR's HVCC blog confirm, there seems to be a sizeable contingent of appraisers who feel that prices will recover when and if they say they've recovered, not when know-nothing buyers say they've recovered and certainly not when sleazeball small "r" realtors say they've recovered. Which makes you wonder if we've accidentally stumbled across a lonely outpost of Soviet-style command economy in a forest of free-market demand economy, with prices set not by consumers but by the best in low-level bureaucratic-style thinking.

And, no, I don't listen to Rush Limbaugh.

"In sum," says Guttentag, a vocal exponent of borrower protections, "the HVCC 'cure' for the appraisal problem of overvaluation has been implemented in a market where the problem has become undervaluation, and HVCC is making that problem much worse. It should be scrapped. When normal markets reemerge [there] will be time enough to reconsider how appraisals can be made independent without disrupting relationships that have served borrowers well."

For once, the Mortgage Professor and NAR are on the same page.