What happened? Everything was going right. 

In the midst of this run for profits a hyper market surge of prices was seen in many markets and this was with borrowed money, not cash. People committed to buy new and resale housing often with low-down or no-down money at any cost. That fueled/caused the run up in prices. It was an investor driven run-up in prices and not a conventional market increase. Problems associated with such demand include:

·          Fast reselling of properties (includes flipping)

·          Speculative buyer thinking; novice investor buyers

·          Limited or no real analysis of future value trends or market trends

·          Lender underwriting problems

The 2007 subprime market crisis is an easy proof of these factors and resulted in the U.S. House Committee on Financial Services: Subcommittee on Financial Institutions and Consumer Credit - government hearings on the subprime market crisis this spring. Financially distressed owners with little or no equity now (or negative equity) are facing the disaster of losing their house and any future credit hope.

Buyers and refinance borrowers are victims of poor judgment on both sides. They often cashed out (with money at closing) maximizing their loans with discounted rates, increasing loan amounts and escalating monthly obligations. With a pullback in real estate prices,  and little ability to make ends meet, these losses were inevitable.

“Risky products: 2/28 Exploding ARMS (are a result of) loose qualifying standards and business standards” and are not responsible, says Michael Calhoun, President of the Center for Responsible Lending, a consumer advocacy group. http://www.responsiblelending.org/pdfs/House-Calhoun-Mar27-final.pdf

These "loose standards" are not just in subprime lending.

“Now, about one in eight adjustable-rate loans (a quarter of which are subprime)...are in foreclosure. If lenders exercised poor underwriting in the subprime market, it’s likely their judgment in their Alt A and prime lending operations wasn’t much better.”  David Lereah, Chief Economist for the National Association of Realtors, REALTOR Magazine, May 2007.

75% of foreclosures are not subprime loans.

This post 9/11 real estate lending period was an unusually busy few years with increasing values commonplace and celebrated. But what aided these increases? Easy access to cheap loans and people tapped into that. Hook, line and sinker.

But can the value of these loans remain stable now? How really secure and solid is the value of my property? Can the decline be minimal?

Unfortunately, no, in my opinion.

Irresponsibility and poor judgement in real estate sales, lending, inspections and appraising have been prevalent in many areas for some time. The result is unusually high amounts of foreclosures, pre-foreclosures, significant drops in listing prices, oversupplies of existing inventories (1-2 years of inventory in many market segments) and very few buyers in 2007 support this. 

Values are coming down fast, no matter what some appraisals you have in hand may say. Ask yourself:

·          Are there the same number of buyers and the same type of buyers presently in the market?

·          Has the new construction market come to a halt? What is the health of the market?

·          Are the resale market neighborhoods also being affected?

·          How are inventories in your market? Why are foreclosure numbers growing and is it significant?

WhaRelationships between lenders, appraisers and all real estate players are seeing problems

      What is the hard cost of building materials and land now compared to 2004-2005?  If demand is slow now, the prices must be too high. What are the builders doing? Are they being creative? Are they showing integrity in their sluggish selling? Are they showing false value in their sales? Watch the tendancies of the builder sales offices to guide the selection of comparable sales appraisers use. They can limit access or steer appraisers to sales they want you to know about. Few appraisers will work hard enough to require signed HUD Settlement Statements, full copies of sales contracts for comparables and interview the agents correctly to get the real transaction information.

6% Seller paid financial concessions to a Buyer's closing costs are readily acceptable in underwriting these days. A $295,000 sale price with the Sellers paying 6% to the Buyers ($17,700) is a net sale price of $277,300, something an appraiser has to consider. http://oceanus.occompt.com/wb_or1/details.asp?doc_id=28629608&file_num=20070022715&doc_status=V

      One Florida real estate company recieved a 26% real estate commission in a 08/2006 condo conversion sale with a price of $190,000 (if the developer's HUD Statement sent was correct). A well known federal bank underwrote the mortgage. Where did the commission really go to? http://oceanus.occompt.com/wb_or1/details.asp?doc_id=28320001&file_num=20060574732&doc_status=V

Creative lending practices are commonplace.

Lenders & mortgage brokers hire appraisers. Appraisers need to work and lender sources are usually the majority of their business volume. Appraisers are required by federal appraisal laws to conform to USPAP, the Uniform Standards of Professional Appraisal Practices. Most mortgage brokers and lenders think 'an appraisal is an appraisal'. If an appraiser 'certifies' a value opinion and it can pass underwriting requirements needed to fund and close the loan, it doesn't matter really how accurate the appraisal value is to many. Or does it matter? 

In a competitive marketplace, the higher the value of the appraisal, the better lending options are available. Higher values serve lending needs better. Higher values allow more money to be available for borrowing. This increases better lending options for a borrower. Lenders need to close more and more loans to be profitable. That's business.

But this can pose challenges. Look at the following questions a lender is required to think about. See how they might be tempted to favor one appraiser over another. 

• How can I get a higher percentage of loans closed each month? 
• Can appraisers help me close more loans? 
• What appraisers do I consider to be reliable? 
• Do they hit the targets I need, more often than others?  

How is this a problem?

Loan officers, even those you think may think they have good character, will call up to 4 appraisers for every loan they are doing, and ask the appraiser what value range might be realistic. A mortgage broker told me directly, "The appraiser who gives me the highest value, gets the assignment." This is done in many different ways. I regularly hear, "We don't want to waste the customer’s money by paying for an appraisal..." "If the value is not there..." or "if the loan is not possible..." That means they can't get this customer to commit to use them exclusively, unless there is a guarantee of a specific loan, rate and terms. The borrowers are shopping around too. That's good shopping practice, right? It’s good to shop around for the best deal. But are potential problems existent in this method? Definitely yes.

The market is flooded with lending choices for borrowers and the lender doesn't get paid unless a loan closes. So they are motivated to keep the client satisfied. That's essential in business. But this trend makes integrity practically impossible or difficult for the lending industry. An appraiser who does not 'play by the rules' and give 'value conclusions' that they want, is likely not going to get future appraisal assignments. The appraiser can therefore be tempted to give an appraisal report and/or value conclusion that is favorable to the lender in many situations, one which is not an accurate value estimate and is rather inflated or too high. An appraiser who is thought of as 'conservative' or a 'stickler' is not going to get the regular volume of orders that others might.

Why call an appraiser who seems to give lower value estimates or is critical? What is the immediate financial incentive to do so?

Unfortunately, lenders and agents generally hate appraisals being low in value. Why? Are they interested in objective expertise? Not necessarily. Are they concerned for one party over another? Yes. They are interested in their own personal interest first & closing a sale. 

This just came in from a mortgage broker I've known for years. Lender: “This is from my current appraiser FYI - He does have a point.” Lender's Appraiser: “Local lenders do not typically allow time and/or market adjustments. If we were to do appraisals correctly, they would never get through underwriting, and you sure as heck wouldn't be getting any kind of fast turn-around.”

Are Federal Banks excluded from this problem?

Let me ask you a question. How can a loan officer for a federal banking institution compete at an acceptable business level of volume, unless the appraisals help meet their margins? How can a loan officer make sure their volume is met each month & keep their job secure? How can they add lending revenue to the books? They need appraisal values to help in this & higher appraisal values allow them to be able to make more money. Or at least it used to.

A federal banking branch down the street from my house supports the 'high value is always good' thinking. My wife & I signed up for a checking account in 2006 and the loan officer asked if we needed a home equity line. When I said I was an appraiser who lives in the neighborhood, the loan officer immediately asked me if I give ''good values''. She said their appraisers have been too low in their values and she promised me assignments if I could help her. I told her I admire and respect appraisers who are willing to tell the truth; they have my respect. That bank is a top five federal banking participant in this region.

I understand her challenge though. She is trying to close deals and satisfy her required numbers of closings per month, but she apparently was willing to jettison 'honorable' appraisers for anyone who walks in the door who will give her consistently high appraisal values. My wife was stunned a federal banking officer said this to us. Many federal banking officers I know do the same thing. They need to make loans. 

Mortgage Brokers

Some former associates referred a mortgage broker to me in 03/2007 since they were not on the FHA approved. The broker said they had a conventional appraisal done, but their sub-prime lender closed operations before funding. Here's the email: 

"The appraisal I need was done by __ for conventional loan, but the only lender who approve my client close operations before we close. That’s why we move to FHA option. You want me to send you this appraisal or you have to due a new one? If yes please I need this appraisal on ASAP basis, the closing must be next Monday. is 1 of the 2 new one I’m going to summit to you today."

The property was listed at $169,900 and the pending contract was $169,000, per conventional appraisal 02/28/2007 and concluded a value of $200,000.  The appraisal stated the house was ''listed for $190,000 on 09/28/2006'', but did not state the changes in list price from 09/2006-02/2007 or the final list price at the time of appraisal. 

What happened?

Limited analysis resulted in error of valuation. Didn't they consider the listing history? Why did they not comment on this in the report to help support their value conclusion? 

They used comparables that closed in 12/2006, 11/2006 & 09/2006. They stated that Property Values were 'stable' & that Demand/Supply was 'in balance' in the Neighborhood section (but said inventories were rising in the addendum). That market area has been seeing falling prices, due to high oversupplies. There were more recent selling indicators in my opinion, both pending and closed sales.  An analysis of active listings and pending sales were not referenced in the appraisal which could help provide better support for their conclusions.

Why look at such things as active listing prices, price changes and pending sales information?

To avoid error.

In our example, the Sales Comparison Approach stated 'None Noted' for each sale regarding sales concessions. No evidence was given that sales were verified. So how does one know if it really was verified? 

A local MAI said they don't verify sales concessions in their residential appraisals. "How do you kake money verifying sales?" Another local MAI said in a public appraisal meeting, "We don't verify sales in our residential reports." I applaude his honesty before his peers. But does his statement show proper 'due diligence'?

What are other appraisers doing? Are they in violation of state and federal law? 

Yes. Whether they get caught or not.

Proper verification and disclosure is required for all appraisals. Ask the State Appraisal Board about their position on this if you do not agree. An appraiser can state for example, "List Agent - John Doe" to show you have confirmed the sale. 

I would encourage any reader of an appraisal report to assume no verification from sales was made, unless a specific person is noted in the report for each sale. Stating 'tax records' and 'MLS' info is not enough verification. How else will you know if a financial concession is made?

A developer friend of mine told me he would never use me professionally again, after I disclosed a settlement problem in the foundation of a house he was buying. The cracks in the exterior and interior were up to 3/4'' thick. He said do me a favor. Don't put that in the report. The room was a couple inches below the rest of the grade. I would not do what he asked. I was fired thereafter from any referrals and future business with this customer and the lending participant involved, because I ''cost'' him money and he can't afford to hear what my appraisals will reveal. He can shop around and get another 'certified appraiser' to give him what he needs. He said, "We'll still be friends."

So what are the solutions? Accountability thru Procedures & System Oversight Changes

Appraisers and loan officers are not perfect. But systems and procedures can be set up to help appraisers succeed, thrive and show excellence in their work, rather than worrying about meeting a value target. My staff has always performed well in their quality, because they were supported and trusted to give their best view of an accurate value estimation. I stand by any appraiser who is willing to tell the truth and do the hard work of analyzing real market factors. Appraisers should never have to worry about a value outcome. Their job is to be unbiased and accurate.

Appraisal peer review equals accountability. Appraisal reviews guarantee better appraisal quality. This is commonly done for atypical borrowers or property types. But that doesn't help enough. Error in value estimating requires more accountability and a more specific system can improve this significantly, besides AVMs and credit ratio factors. 

If wholesale and retail lenders of FNMA & portfolio products would require the use of an appraisal industry rating system for all appraisals, that would provide an ongoing ratings or grades for specific appraisal companies and each appraiser. Relocation companies have this in place. This may be being done or is in varying stages presently, but must be implimented for future lending. Ratings for specific loan officers, underwriters, mortgage companies, title companies, tile company reps by name also should be monitored. In such a system, there would be a sharp decline in the ratio of bad loans to total loans in portfolios. Is this being done sufficiently? Revenue losses can come in a very few poor performing loans or in loan types (condo conversions, rapid price increasing markets, etc.). Requirements for systems in these areas could easily be set up.

Market participants (vendors) who show high marks would be rewarded by more assignments, not less. And it would help monitor appraisal quality more than government oversight does which does not really work adequately. Vendors must be able to see their performance levels and ongoing recommendations to increase their ratings. Easy access to this information will improve performance of individuals and companies. Competition for true high ratings will be sought after.

Trustworthy defined means ‘worthy of trust’. People want to have high work quailty. But if the system rewards poor quality, dishonesty and lazy work, then nonperforming loans will increase, as evidenced in the rise of subprime loan problems, foreclosures and conventional loan problems. Better management systems when properly implimented will increase performing loans. Technology continues to help provide changes to old systems and procedures, which continue to allow loan underperformance and which fail to hinder fraudulent lending practices. Better systems will encourage quality reporting and accountability to all factors of loan underwriting.

Commitment to these changes are a win, win.

Alistair Beggs, in his book Pathway to Freedom, (pg 173) says that "honest endeavor" is to be rewarded. Automated rating systems that will encourage excellence and dissuade participants who are "increasingly adept at building rationales" which are erroneous and costly, should be applauded.

Our free enterprise system needs to be free from the old ill practices, so that new growth and 'untapped opportunities' can emerge. The present lending underwriting systems have the right foundations. They just need to be advanced more. This will bring better performance. It won't hinder performance. The foreclosure and subprime market messes are the evidence of what defines real performance and confirm the changes needed.