As you all know, I am not one who has a vested interest in inflating property values. Matter of fact, I was sounding the alarms when I saw bogus "name your price appraisals" come across my desk whenst I was in the banking industry.
However, today the pendulum has swung to the other side and not just the other side, but to just as much of the extreme as when prices were outrageously high. For when I had my house appraised recently, not only did it come in below what I was expecting, but so low that I literally laughed at it. Not only because I would never sell it for that, not only because the LAND alone (in my humble opinion) was worth more, but because the rental income I generate alone would be 50% MORE than what a mortgage would be to finance it 100% for that price.
So let me explain to you what is going on.
First of all you must understand that the appraising industry which is a VITAL part of this economy (as it conveys price information to the market about the largest single asset people own - THEIR HOMES) is occupied by nothing more than 100%, grade A, morons.
First they would whore themselves out to whoever would pay them the most to "deliver" the price the borrower or the bank needed for the deal to go through back during the bubble days.
Now they're just engaging in CYA.
So you're not dealing with brilliant people, you're just dealing with people who go where the money is.
Second, because of their stupidity the problem is that they're not doing their job and that is ACCURATELY APPRAISING PROPERTY. The problem this presents is that it stunts or at least mutes part of the "stimulus" plan in that while (presumably) all this TARP money and bailout money was to be used to help provide low interest rate loans so the masses could refinance at lower rates and thus improve their personal finances, it's never loaned out because why????
Oops! Sorry, your house appraisal came in too low. We can't refinance.
(Never mind that in some cases if the banks don't refinance they'll end up foreclosing and repossessing a house that is less than what is owed to them and it would be in their best interest to refinance, but, eh, banks are even more moronic than the appraisers)
Regardless, the whole point is that while people would like to refinance, they would like to save money, and we would like to get this economy back on the road again, the appraisers effectively prevent this with their insanely low appraisals.
Now I know why this is happening, for whilst my days as a credit analyst, part of my job was to audit these appraisals. And to understand why your house is "worth" only 50% of what it was before and why you were shot down for the loan and the bank is now going to repossess a presumably worthless property, you must understand the three appraisal techniques.
First there is the cost approach. This basically states the value of the home is the amount it costs to build it.
Then there is the income approach. This is like a "discounted cash flow" approach to valuing property. It theorizes if it was rented out what kind of value would those cash flows give the property.
Then there is the all important "sales comparison" approach. This takes sales of similar properties in similar areas and then applies similar prices to your property.
And that is the approach where the problem lies.
For you see, appraisers take RECENT sales. The problem this presents is that "What if you were in a bubble?" Or conversely, "What if you were in the worst housing market ever?" When housing, and the mortgages used to finance it, are presumably long term assets.
Understand the problem this presents when trying to value properties.
If you valued on property based on the sales approach 3 years ago, it would be overvalued.
If you valued it today (I'm getting the feeling) it would be undervalued due to the majority of sales being foreclosures.
But the bank has typically a 30 year mortgage on it, and you would plan to live in the home for more than 5 years.
This means the value of a home shouldn't be based on the current, minute to minute market fluctuations in home prices, but rather a long term rolling average.
But, of course, again, try to tell that to appraisers or explain that to banks. And you'll see why we have to bail out the banking industry and while the appraisal industry, vital as it may be to our entire financial system and economy, is nothing but a bunch of lemmings.
11 comments:
Finished your book yesterday. Thanks for a very informative read, one of the only books with economic charts, etc that has actually managed to be interesting and compelling. Learned a lot about banking asides from the reasons for the crash.
Cap -
As a 30-year+ real estate professional (closing attorney, mortgage broker, and real estate agent), I frequently have to remind people:
What is "fair market value"? It is what a willing buyer will pay a willing seller - TODAY. Not yesterday, not tomorrow. Not 9/10/01, not 9/12/01. TODAY.
I have never understood the overwhelming preference for the comparable sales approach to appraisal, particularly for investment property. The capitalization rate of rental property is a much better indicator, in my view, of the value of the property, particularly when considered over the long term. If current local rental rates for property similar to yours will support or exceed the mortgage payment, the proposed mortgage amount is reasonable.
Your thoughts?
Oh Captain. While I can understand your frustration, you know the value of anything is only what you can get for it (or from it). Enjoyment, rent or a sale in the current market. If a bank tried to value property based upon what it thinks the long-term value would be, how well do you think they would do? They would probably crumble faster than the current system.
Now honestly, would you loan someone $300k for a house where you believed it would be worth that amount sometime in the next 5 - 10 years but you could only expect to sell it for $200k today? If yes, I would like to apply.
Every house I ever bought or refinanced always appraised withing one or two percent of the sale price. Did not take a genius to figure out why. The appraisers would not make a lot of money of the loans don't go through.
Hi Anon,
I agree, the market is what it is. When the Dow Jones was at 14,000 I said it was overvalued, but I was "wrong" because people WERE paying 14,000 for the DJIA. That was the reality.
however, this gets back to my point. An asset financed with long term financing should take a long term view as to the value of the collateral that insures against the loan over the lifetime of that loan. If a bank could face the possibility of repossessing an asset over the course of 30 years, then what would be the "rolling average" value of that collateral?
This would have prevented the previous bubble from forming as banks would look at housing prices 5 years ago and not lent out as much on overinflated houses, as well as not be shooting themselves in the foot today not loaning out money on properties REALLY SMART people are buying now (especially given the positive cash flows and CAP rates some of these rental properties are generating).
My larger point is that the appraising industry needs more scrutiny and scathing just as much as the banking industry does if it's going to sit perched in one of the more important functions of the economy yet have such idiotic people working in that industry.
My neighbor is an appraiser. And he is not particularly bright.
He spends a lot of time complaining that the banks are pressuring him to arrive at a much higher value than the appraised home is worth, while trying to pay him less than half of what he used to make (pre-2005).
I have little sympathy for the banks or for the appraisers.
But it's clear that in FL, banks are sitting on abandoned/foreclosed properties because they don't want to write down the values. They are not refinancing. They're not doing anything. But the bad thing is that in FL, an abandoned home quickly rots in the humidity, losing much more value than an abandoned home would in, say, Colorado. Some gated communities have started bulldozing empty houses and invoicing the bank for the cost of the demolition. That's amusing to watch.
I have been in the real estate industry for 15+ years.
I have seen all sorts of quirky things with appraisals.
This market has been the most shocking to me. Houses that could realistically fetch $200k to $220k are getting appraisals in for $150k. Certain markets, localities, are "deemed: Declining Markets". So the appraisals are marking the value further down, thus contributing to further decline.
It is a mess out there... Thanks Barney Franks!
About 6 years ago, we decided to refinance our house - we wanted a shorter mortgage so that the house would be pain for before we retired.
We refinanced with a large east coast mega bank. The load balance was for around $60K.
First appraiser came out and appraised it at $275K. We were a bit surprised - we expected it to be in the low 200's.
Even if the appraisal was off by say 50%, the property would still secure the loan, we were surprised that the bank hired a second appraiser for a second opinion.
The second appraisal, done completely independently and unknowing of who did the first appraisal and the amount they determined, matched the first appraisal.
The bank then told us they thought both were high, but since the principal was so far less than the appraisals, they approved the loan.
I never thought one could get two appraisers to agree. ;-)
What I don't quite understand is how homes can be evaluated based on comparable sales when in a rural area like mine where the number of sales in a given year are very low (1-2 properties total). It would seem to be that the sample size of recently sold properties would be insufficient to be statistically valid. I would think the fewer number of similar properties, the more inaccurate an appraisal would be.
We recently had an appraisal done.
It was so low we laughed at the appraiser.
Texas is not a bad market right now and the appraisal came in at 65% of the appraisal done in 2000 AND at 75% of the Tax District value.
"you know the value of anything is only what you can get for it (or from it)."
I've always taken issue with this tenet.
Value is what something is worth to ME. No more, no less.
Two children trading marbles in a playground with equal prices in the store next door both come away richer...
Captain Capitalism,
The appraisal needs to be based on the current SALE market value of a property because it is the collateral for the bank, and the bank is not going to rent out the property if you default: they are going to sell it. This is because they are not in the business of renting out properties, so they do not care what the long-term fundamental value is.
Fundamentally, lenders are not equity, so they do not care about upside based on the fundamental value. They just care what happens if they need to sell the collateral.
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