When something bad happens, we want someone to blame. Yesterday I dropped my husband’s wedding ring into my favorite crystal glass for safekeeping while he was doing handy work, and the glass broke under the weight of the ring. Frustrated and heart broken, I wanted to blame the jewelry shop for selling us such a heavy ring… (senseless, I know, but I was upset) but I couldn’t. There was no one to blame, just an unfortunate event. (I’m going somewhere with this – I promise.)

On a similar note, and forgive me in advance for bringing up a rather sensitive topic here, but I have to ask…

Why do homeowners blame mortgage companies for low appraisals?

Why (oh why)? I understand we’re all upset that home values are devastatingly low. I get it – we’re all plagued with the same nausea-inducing housing market here. And having an appraisal come in too low to move forward with refinancing can be absolutely arresting – especially if it means tighter budgets, financial turmoil or even foreclosure. But what I’d like to address here is to make sure we aren’t blaming the wrong people.

The reason I bring it up: I can’t tell you the (exponentially growing) number of times I’ve heard the blame of a shallow appraisal wrongfully fall on the shoulders of the mortgage company, or better still, the loan officer/mortgage banker. NOT the downward-spiraling housing market that’s been media blasted for the past… oh say… year and some months now (goodness gracious no!), but… the mortgage company. And if not the mortgage company, the appraiser or the title company who hires the appraiser (neither of whom should bear the blame either).

From casual conversations to online complaints, I’ve seen and heard bitter homeowners with low appraisals tear all these guys a proverbial ‘new one’ for failing to recognize the value of surround sound and pedestal sinks. Misdirected? I think so.

Don’t we realize that if anyone wants to help get us the loan we need, it’s the mortgage company, the title company, and the mortgage banker? Unless there’s some crazy new business model I’m unaware of that allows these guys to make money without closing loans… um, maybe we need to find someone else to blame. (Just going out on a limb here.)

Let’s examine the loan officer: Here’s Gary the Mortgage Guy praying to the Mayan suns (I don’t know… maybe he’s running out of idols) that – for the love – THIS deal will go through. THIS phone call won’t end with a tearful homeowner on the other end. Wouldn’t he be on the side of the homeowner? True, I’m not a mortgage banker, but I can tell you that I feel pretty comfortable making the assumption that this guy wants your home value to be in great shape so he can help you out.

Let’s consider the mortgage company. For starters, it’s my guess that any mortgage company left on the map at this stage in the game wants nothing more than to help homeowners. And frankly, Gary the Mortgage Guy nor his company can be successful until the homeowner’s home value is approved for a loan. So by default, mortgage companies are a poor scapegoat as well.

So who’s left… How about the title company? Quick disclaimer here: I don’t know a lot about title so it’s tough for me to confirm. But I *think* that in addition to appraisal services they offer title insurance, closing and escrow services among other things. All which require (drum roll…) closing a loan! Wouldn’t make a lot of sense for these guys to purposely stiff their partner’s clients on an appraisal, right? Right.

And the appraiser? I don’t think this guy is trying to deliberately underestimate home values. I once heard that dentists and psychologists held the most general contempt for their daily grind… but I wouldn’t be surprised if that’s all changed this year to stock brokers, investment bankers and appraisers. I can only imagine: There you are, trying to do your job efficiently and you have Hulkomania Homeowner behind you pointing out built-in microwaves and garage door openers that aren’t yet notated on your legal pad. (Zoinks, Scooby.)

So here’s the thing. When we’re so mad, so frustrated and choked up about a low appraisal, it has nothing to do with the mortgage company or the mortgage banker. They truly have no control over how the appraisal comes in and you can bet that if anyone’s on your side, they are.

Appraisals are actually based on a pretty standard equation that doesn’t leave anything up to opinion. (You can find more information on appraisals including a live walk-through with an inspector here…)

Unfortunately, the only blamable item here is the market itself. (I know, I sound like my mother when my dog ate my ice cream cone out of my helpless five-year-old hand.) No one’s questioning whether we’ve poured our Home Depot hearts and souls into our homes except the housing trend and the economy. So let’s muster up the right-mindedness in the event of a low valuation, take a deep breath and find respite in the fact that the mortgage/title/appraisal world isn’t targeting us in a ploy to destroy our hopes and dreams. They’re on our side… we just have to wait for the rest of the housing market to join them.

Photo Credit: ILoveButter

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Tags: appraisal, appraisals, appraiser, property values, valuation

Commentators speak of numerous broad housing indicators and indexes tracking property values across the nation.  However, Real Estate, unlike Stocks and Bonds, are not fungible.  Properties are non-homogenous and are affected by both broad economic macro and local micro factors.  Due to market inefficiencies, the usefulness of data derived from these broad indicators is limited.

Constant Quality vs Traditional Valuation Measures

In compiling housing stats, people typically look at several factors including overall volume, average price, number of bedrooms and baths, and price per sq ft, while adjusting for seasonality.  Data from all homes within a certain property type or market area are included.  Issues arise when homes of greater/lesser quality, size, or type are sold within a given period of time.  The average price of a typical four bedroom home might appear to rise when in reality, the houses sold in the past year were significantly newer/renovated or of higher quality.

Constant quality indexes have been used to measure the change in prices of the same house over a period of time.  Certain steps are taken to minimize the effect of sales of improved homes and homes sold between relatives.  While this appears to give more accurate results, several issues remain.  The role of new construction within a market area and buyer migration can skew results.

OFHEO and the S&P Case/Shiller Index provide quality control data

The Office of Federal Housing Enterprise Oversight compiles data on conventional conforming mortgage transactions from the Federal Home Loan Mortgage Corporation (Freddie Mac) and the Federal National Mortgage Association (Fannie Mae).  The House Price Index (HPI) utilizes a modified version of the weighted repeat sales methodology proposed by Case and Shiller.  The benefits of OFHEO’s HPI are that the data utilized encompasses a broad stream of data and includes additional areas that the S&P Case/Shiller Index leaves out.

The data source for the Case/Shiller Index is derived from Public Records while the HPI utilizes data from single family residential property with at least 2 mortgages originated and subsequently purchased by either Freddie Mac or Fannie Mae since Jan 1975.  It is important to keep in mind that data on multi unit, attached properties, government insured loans, and property exceeding conforming loan limits are excluded.  This index is updated quarterly.

It would be prudent to look at broad market indicators and statistics published by the S&P, OFHEO, and the National Association of Realtors, understand the different methodologies in which they analyze their figures, and then investigate the myriad of factors that influence a property both from a macro and micro level.

Tags: home value, house values, housing, valuation

The news has been saturated with reports about the financial bailout, the Secondary Mortgage Market, Securities and Derivatives. In these troubled times, it is important to understand the fundamentals of Real Estate analysis. There are a variety of models and tools that can help us better understand changes in market conditions and can even simulate probable ranges of value under different economic scenarios. I will be exploring how capitalization and yield rates provide the backbone of analysis in more detail in later posts. All investors, in one way or another, must incorporate the following four steps in their decision making process.

1. ESTIMATE THE STREAM OF EXPECTED BENEFITS.

Expected benefits include cash in the form of rent, depreciation, possible tax savings on other income, proceeds from the sale of the property (reversion), as well as other ancillary benefits. Make sure you project yearly changes in potential gross income, expenses, vacancies, capital growth and taxes using either a reconstructed operating statement or a pro-forma.

2. ADJUST FOR THE TIMING OF THESE BENEFITS.

$1000 received today is worth much more than $1000 received 10 years from now. Adjust for the timing of these benefits by using a process called discounting. If your time horizon is 10 years and you have purchased property solely for capital growth, then you had better be highly confident that the return you will receive through appreciation will be worth the wait and exposure to increased solvency risk.

3. ADJUST FOR DIFFERENCES IN PERCEIVED RISKS.

Real Estate is exposed to various forms of risk from issues in liquidity, interest rates, inflation, and economic growth, among others. However, Discounted Cash Flow models, sensitivity analysis, and simulation can give investors a handle on probable ranges in which an investment might fall in forms of risk management.

4. RANK ALTERNATIVES.

Different properties (or investments) should be ranked on perceived risk-return combinations. Additional financial returns should be rewarded for any added risk undertaken. Net Present Value can give us an indication of the total return of an investment in absolute terms while use of a Profitability Index can help analyst rank investments that differ greatly in overall cost and value.

Tags: money, present value, real estate, real estate evaluation, valuation