Up close with Jonathan Miller on the decreasing quality of appraisals today

With the front and center impact of appraisals on the sales market, we had a theory that we wanted to test with Jonathan Miller, blogger and appraiser extraordinaire as President and CEO of Miller Samuel.    Our thesis was that, in markets with upward momentum, appraisals will always under-estimate home values based on the reliance on the past 6 months’ of closed sales data, all of which would therefore be valued lower than comps of the improving present time. Conversely, in markets with downward momentum, appraisals will tend to overestimate apartment values based on “peak” valuations.  Yes, there are time adjustments made in the process, but we thought this might be an interesting angle for buyers, who can arguably leverage such artificially low appraisal values in their seller negotiations and achieve “below market” pricing.

Very quickly, however, Jonathan highlighted the over-simplicity of this theory and instead took us down the rabbit hole of the state of today’s appraisal industry.   Here is the synopsis of this journey.

Back in the boom days, appraisers were under massive pressure:  they either “hit the number” (i.e. matched or beat the contract signed price of the home) or went broke.  Values during these chipper times were therefore biased high, to be sure.  Now, values are biased low, all based on HVCC (the Home Valuation Code of Conduct), borne out of Cuomo’s good intention to relieve the pressure off of appraisers and inject objectivity into the system. During this time, 2/3 of the banks’ loan origination volume came from mortgage brokers (versus direct), all of whom were paid via commissions if the deal closed.  (This structure outlines the built-in-bias to make the numbers work, of course.)   Understandably, therefore, considering such tremendous loan volume, national retail banks closed their in-house appraisal departments (seen as cost centers) and, in the process, stripped themselves of all in-house valuation expertise, relying on the third party (read: mortgage brokers) ordering of appraisals. This move allowed the banks and mortgage brokers to grow quickly and generate significant volume.

Along comes the HVCC in May 2009.  It does not allow mortgage professionals to order appraisals, lest they are willing to have that paper not be purchased by Fannie.  As 2/3 of loan volume (and therefore appraisals) came via mortgage brokers, what were banks to do? They had already closed their in-house departments, they’d probably gone through several mergers … how were they supposed to manage the appraisal process?   They therefore turned to unlicensed and unregulated AMCs (appraisal management companies), institutional middle-men who handle all of this for the banks. Just call an 800 number and you can order an appraisal in Nevada, one in California and another in NY all in one shot … easy breezy.

Now, the appraisal fee being paid by the bank has not changed, but AMCs are incentivized to find appraisers who will work for ½ the fee, and they keep the other half.  Such appraisals usually have a 24-48 hr turnaround, when a normal appraisal takes 5 days or so to conduct quality research.  What you therefore have is “an army of form fillers” coming from out of market, driving from many miles away to do 12 appraisals in 24-48 hours in Manhattan then heading back home.  90% of retail bank appraisal volume now comes from AMCs, employing people willing to work for ½ the market rate. They usually come from lower priced housing markets, have no local contacts and limited local experience.  The only qualification seems to be that they are licensed appraisers in the state.  That’s like saying having a driver’s license makes you a good driver.  However, because lenders are so afraid of the market, they reward these appraisers by giving them more work, reinforcing this behavior.  This is why so many horror stories are popping up about appraisers lacking local market knowledge.

“I am more profitable than I’ve been in years because we’ve parted ways with national retail banks and only work with regional or private bank groups who care about what the actual value of a property is,” Jonathan notes.  “In 2005, 75% of my work came from the large banks and 25% from private individuals, co-op boards, law firms and other non-bank entities.  Now it’s flip-flopped, enabling me to give greater attention to clients who actually want accurate valuations.”

One horror story that particularly struck us regarded a listing that had been on the market for 3 months.  The property went into contract and its appraiser drove from 3 hours away only to inspect the wrong apartment.  (The listed property was a 2-bedroom and the appraised property was a 1-bedroom in the same building.)  Of course, this killed the deal.  Shockingly, even though the broker realized this and complained to the bank, the bank stood by the appraisal.  “This tells me that banks don’t want to lend – they’re afraid of their own shadow,” notes Jonathan. “This is what happens:  the bank offloads appraisal management services to a 3rd party who picks the appraiser, who then screws up the report, then the AMC does a review of the person they hired and stands by them, while the bank doesn’t know what’s going on.  They are missing very real opportunities for legitimate transactions.”

What is a buyer to do?  If you’re already in a transaction in which the lender won’t exclude the original low appraisal, don’t bother ordering your own appraisal, as the lender can’t use it.  Your best bet is to go to another bank and hope you have better luck.

Remember, lenders are looking at all loans:  commercial, auto, etc.  Their balance sheets are under duress and they’re trying to make sure everything is AAA, plain vanilla, with no questions. “Feedback that the mortgage industry is loosening up is absolutely not true,” Jonathan concludes.  “The only shift is that some professionals are becoming more adept at dealing with lenders.”

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