Lawrence Yun of NAR is complaining that appraisals are preventing legitimate real estate transactions from occurring. Because of the way appraisers sometimes choose comparables, I have some sympathy for this view. And as I noted in an earlier post, Rhonda Porter says the Home Value Code of Conduct is nothing more than a way to line the pockets of Appraisal Management Companies. I have some sympathy for this view as well.
But we should not go back to the days when appraisers were basically paid to stay out of the way of the consummation of a deal. So let me suggest two proposals:
(1) Appraisers should not be allowed to see the offer price of a house. This is the only way their valuation will be truly independent.
(2) Appraisers should use valuation techniques that allow them to report a standard deviation of their estimate. Subdivision tract houses will have small standard deviations; architect designed villas will have large standard deviations.
We could then move to a pricing rule where Mortgage Insurance will be required if (1) the LTV based on appraised value is greater than 80 percent or (2) there is a greater than five percent chance that the true value of the house implies an LTV of 95 percent.
Step (1) would be easy to implement, and I think would help a lot. Step (2) will require lots of training (and perhaps different parameters from those that I am suggesting).
We need to stop kidding ourselves that we can measure house prices precisely. We need to start measuring the level of imprecision.
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13 comments:
Appraisers estimate price primarily by comparing the prices of comparable nearby properties. Using this method, it is entirely possible to completely miss the fact that the entire market is in a bubble.
Other factors such as median income and national rate of real price appreciation would have to be factored in to protect the system as a whole.
I agree that changes need to be made in the appraisal process for underwriting. Though I doubt most of the current stock of appraisers would have any clue how to generate a standard deviation for an estimate. But the generation of more model based estimates with the aid of a computer and an appraiser's inspection would likely lead to more consistent and reliable results. In all likelihood that would have curbed some of the mortgage fraud during the bubble.
But I'd second the above commenter's suggestion that the underwriting process needs to include other valuation measures beyond comparable sales. Gross rent multipliers a certain level over the long term average for the area, for example, should trigger a need for mortgage insurance.
I have a paper that looks at the predictive power of confidence scores (akin to standard errors) in Automated Valuation Models (AVMs). While get statistically significant results, the practical effects are smaller than my priors. A one sigma change in the AVM Confidence Index has about the same kick on claims as a 2 or 3 percentage point change in LTV in this sample of high LTV (FHA) borrowers. That's the national sample - the effect in the Atlanta MSA sample is even smaller, so it may be picking up easy vs. hard to value regions, more so than properties.
"Appraisals, Automated Valuation Models, and Mortgage Default"
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=895232
Good ideas. I can tell you from personal experience rely heavily on the contract price as an anchor point, and we all know that is a source of errors.
You might be interested in Elena Panaritis' post at FT.com today (link below). She suggests value uncertainty is an underlying cause of the crisis. She seems to think there's a way to reduce the uncertainty - I think your approach of reporting it is much more realistic.
http://blogs.ft.com/maverecon/2009/07/the-real-estate-roots-of-the-crisis-in-the-us/
Sorry, that second sentence should be "I can tell you from personal experience that appraisers rely heavily on the contract price as an anchor point, and we all know that is a source of errors."
Richard, currently with HVCC most of the appraisal management companies have ownership interest by the very banks who are ordering the appraisals or funding the loans. Is this not a conflict?
Originally, the code would not allow this, however they were modified in Fannie Mae's annoucement 09-01 on 1/7/2009:
"Appraisal management companies: The lender's ownership of or affliation with an appraisal management company is no longer restricted...."
Lenders should not have any ownership interest in an AMC.
We could then move to a pricing rule where Mortgage Insurance will be required if
(1) the LTV based on appraised value is greater than 80 percent or
(2) there is a greater than five percent chance that the true value of the house implies an LTV of 95 percent.
Residential appraisal companies owned by mortgage companies are under scrutiny for over inflating U.S. home values during the refinance boom
A new reform, headed by Andrew Cuomo, Attorney General of New York, is aimed at easing the pressure on appraisers so they can do their job accurately.
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Fannie Mae and Freddie Mac said that they would only buy mortgages from lenders who use an independent appraisal company.
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Wow what a idea. You suggest very usefull ideas. Thats great keep it up ma. I like your efforts. For the more information visit www(dot)onthemarkmortgage(dot)com.
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