It seems that the opinions of those in the lending community, involving the different methods, procedures and practices pertaining to the evaluation of collateral, vary. Most of us have grown accustomed to appraisals; however, there are other methods being used that many of us never have had reason to become aware of.
In today's evaluation environment, we have many so-called appraisal techniques, that the scope of this article cannot contain all of them. Recent technological advances in computers and the Internet have been a game-changer in the property evaluation arena. There is a much broader array of products than there has been in the past. This can be a good thing, but it is not necessarily good. Each product has its strengths and shortcomings.
This discussion may not have been as necessary as it is if we hadn't had the recent economic crisis and mortgage meltdown. Over the decades, we have had other economic downturns, and with each downturn has come a review of why there were so many bank failures, foreclosures and other financial setbacks. With all of the safety nets, just what is it in our system that seems to make the banking industry so vulnerable to risk and loss? In most every occasion of this type, the microscope is placed upon appraisers. Even though I am an appraiser, I admit that this is a perfectly legitimate area to explore. Having said that, the industry is filled with those who suggest that collateral should be evaluated in some other way than the traditional appraisal. Issues, such as turnaround time, cost and trust, are always touted as areas where the traditional appraisal comes up short.
Among the smorgasbord of evaluation techniques available, there are three that seem to be talked about the most, and which are probably used the most. They are as follows, and included is a brief statement as to their strengths, weaknesses and primary uses.
1. The traditional appraisal
Strengths: Highly accurate, uses human judgment and thorough.
Weaknesses: Higher cost and slower turnaround time.
Use: First mortgage originations and many other alternative uses.
2. The broker price opinion (BPO)
Strengths: Moderately accurate and uses human judgment.
Weaknesses: Less detail, slow turnaround time.
Use: Mostly used in cases of loss mediation and foreclosure.
3. The automated valuation model (AVM)
Strengths: Very fast and economical.
Weakness: No human inspection or judgment and less certainty.
Use: Secondary or support to appraisal or BPO.
The traditional appraisal is the most thorough and arguably the most accurate. It is generally used when it is important to get the most accurate evaluation, such as in the origination of a loan. It is the most expensive of the three methods and takes much longer to obtain than an AVM, which is available almost instantly. Most, but not all, appraisals are prepared after a thorough interior inspection. Appraisers are not expected to have any interest in the property and must conform to Uniform Standards of Professional Appraisal Practice (USPAP).
The BPO is prepared by a real estate broker who has less evaluation training than an appraiser. It is usually prepared after an exterior-only or drive-by inspection. It is not subject to USPAP and is most often prepared by a broker with an interest in listing the property for sale. BPOs are not normally accepted by secondary market entities, such as Fannie Mae, Freddie Mac and the Federal Housing Administration (FHA) when they buy paper.
The AVM has been more widely used lately, given the availability of more comparable data. It uses zero human judgment, rather a series of formulas that compare the subject to other sales of properties. There are no property inspections, and usually it is not proven that the property actually exists. If there has been a fire that burned the home down or if there has been a mistake in the address, it is possible that there is minimal property value. The AVM is used mostly to support or to provide additional data when other collateral assessment techniques are employed as a second opinion.
Sound confusing? What does all this mean to the lender making a decision relative to a mortgage loan?
First, it is no more confusing than we as people make it. If it is necessary to obtain a value indication immediately at little cost, then the AVM may be the best alternative. This should only be tried provided that the decision does not require verification of the existence of the property, an evaluation of the condition of the property or human judgment relative to the comparing property to comparable sales.
It may also be appropriate to purchase and use a BPO in evaluating a property under some circumstances. If the property is subject to foreclosure, then a broker, taking a look at it and rendering an opinion as to its market value and what price range the property will likely fall into, may be appropriate. The BPO can serve as support to an appraisal or an AVM can also serve as support to a BPO. In some cases, all three may be appropriate.
Finally, if it is important to get the best and most accurate opinion of value for a property, choose an appraisal by a licensed appraiser. The appraiser is trained for the task, verifies the existence of the property, typically performs a thorough inspection of a property, has access to all of the most recent comparable data, has been trained to offer superior judgment about a property, prepares a product that is USPAP compliant and should be an unbiased party with no interest in the property. Appraisers are people, and they are not perfect. They can make mistakes and they sometimes do. Other evaluation methods have their place, depending upon their intended purpose, but should not be considered an alternative to an appraisal when it is critical to get the most professional and accurate opinion relative to a property.
If you, like I, want to help prevent another mortgage meltdown, support the use of a thorough appraisal by a licensed appraiser on all purchase and refinance transactions.
Charlie W. Elliott Jr., MAI, SRA, is president of Elliott & Company Appraisers, a national real estate appraisal company. He can be reached at (800) 854-5889, e-mail [email protected]