We have all heard complaints concerning appraised values being lower than selling prices in today’s recessionary environment. The buyer wants to buy a property and the lender wants to make a loan, but the appraisal stands in the way. There are a lot of possible reasons for this, and not all situations are the same.
My experience has taught me that, in many such situations, the sales contract is higher than the value of the property; however, this is not always the case. The appraiser can be wrong and, in this challenging market, it is not always an easy task to separate out the meaningful data from the not so meaningful. This is especially true for the appraiser who is relatively new to the business and does not yet have a recession under his or her belt. It is further complicated by the fact that some appraisers have become more cautious, given the many criticisms they, as a group, have faced as a result of the many bank failures, due in part to underwater loans.
In considering the legitimate challenges of appraising property in the current market, there are a number of issues that should be addressed and understood by the appraiser, as well as the lender and the property owner.
First, we have markets with little or no sales. Does this mean that properties do not have value? Does it mean that values are simply less? If so, how much less? What data can, and should, be used, and how should it be used to determine value under these circumstances? It is hardly a project that should be undertaken at home by armchair critics and property owners. Under the best of circumstances, the appraiser will find themselves making value judgments with far less than perfect data. Of the many variables complicating the landscape and muddying the waters, that of the foreclosed property can be the elephant in the living room.
Consider the following hypothetical example. Properties comparable to the subject in the same subdivision sold before the recession for around $400,000. Since the economy tanked, one quarter of the neighboring properties are for sale and none are moving. The least expensive of those for sale is listed for $300,000, and it is getting only a few lookers. There have been only two sales within the past year, and they were both foreclosures that sold at the courthouse steps … one for $200,000 and the other for $250,000. Finally, a buyer takes the bold step of moving back into the conventional market by signing a purchase contract for a home at a price of $300,000. The appraiser appraises the home for $225,000, arguing that the market only supports this value. Is it appropriate to use only the foreclosed properties as the basis for the evaluation?
If this example sounds farfetched; it is not. There are many communities in the United States currently experiencing similar circumstances. Sellers, buyers, brokers, lenders and appraisers are all challenged by this difficult and complex market. Of all those with an involvement in this transaction, the appraiser is likely the most challenged. He or she is confronted with the responsibility of rendering a fair and unbiased opinion of value, and there is very little relevant data from which to base a professional opinion.
For those who say that foreclosures should not be considered, this is simply not true. This data is oftentimes among the only indicators available to the appraiser.
For those who take the position that foreclosures are always comps with equal weight as sales, occurring within the conventional market, they are wrong, too. In this case, the appraisers only data lies within the old comparables at $400,000, current listings as low as $300,000, a sales contract of $300,000 and two foreclosures averaging $225,000. The answer lies somewhere in between the $225,000 and the $400,000, and it is up to the appraiser to determine where the value lies within this range of central tendency.
Just how accurate are foreclosure comparables, and how much weight must they carry? While we will not attempt to resolve the dilemma of placing a value on the hypothetical property, we will attempt to lay to rest the part a foreclosure should play in a value decision by an appraiser.
First, foreclosure properties are often very comparable to many subject properties being sold and requiring appraisals. The appraiser not only is able to use them in determining a value if they are comparables which have sold within a market, he or she has a responsibility to report them and to consider their effect on value.
Second, many foreclosed properties simply do not provide unadjusted value indications that are consistent with the relevant market for subject properties. They are not consistent with market values, and while the appraiser is bound by Uniform Standards of Professional Appraisal Practice (USPAP) to report and consider them, they must be adjusted appropriately, if, and when, used as comparable sales.
When considering foreclosures as comparables within a market, the appraiser must consider how the properties were sold. Were they sold at auction at the courthouse steps, as in the example? Was the buyer able to gain access to the property in an effort to perform a physical inspection? Were they sold by a realtor, representing a bank, after the properties have already passed through to the bank through the auction process? If sold by a realtor for a bank, was adequate time given for normal marketing or did the bank want to sell the properties quick to get them off its books? Also, what was the physical condition of the comparable foreclosures? Were they damaged; had they been repaired; had they been remodeled? Did the buyer have adequate time to obtain financing to support the purchase?
Finally, foreclosure properties are very similar to any other property considered as a comparable. If there were circumstances, such as poor physical condition, lack of inspection access, inadequate loan application time or a compulsion to sell quickly, allowances must be made for these differences. In some cases, the differences may be so significant that the comparable is rendered useless or of little value. In such cases, the sale should be reported, but not included or given weight as a comparable sale.
In other cases, only slight adjustments or no adjustments may be required. Whatever the case, the appraiser is required to consider all comparable sales, occurring around the time the property is sold. Whether the comparable is a foreclosure or a more traditional sale, the appraiser is required to give consideration to the data it provides and use the information appropriately.
If the appraiser uses a foreclosure as a comparable sale, this does not mean that he or she is wrong. It may mean that he or she is just doing his or her job. It may have qualified as a comparable, and may have been the only relevant data from which to render an objective opinion of value.
Charlie W. Elliott Jr., MAI, SRA, is president of Elliott & Company Appraisers, a national real estate appraisal company.