Hypothetical houses and hypothetical markets

Appraisers evaluate hypothetical houses every day - let me explain. Here are some of the examples:

1. New construction - we appraise what the home will be worth upon completion as if it was built at the time we write our report, using the data that is given to us. Without this valuable tool, banks wouldn’t be able to make informed investment decisions and homeowners would be left at the mercy of overpriced builders.

2. Exterior-only appraisals - everyday appraisers are on the streets inspecting properties from the street, or “Drive-bys” as their called for short. These are most often used by lenders considering foreclosure. They want to know if their asset is still in good shape and worth enough to cover the remaining loan. In this instance, the appraiser assumes that the interior of the home is in similar condition/quality to the exterior. We then use public records, prior multi-list data, and other sources to determine the value of the hypothetical house that all of that information tells us.

3. Regular appraisals - even when the appraiser has all the facts, and inspects the property themselves, there are things that the appraiser has to assume. We assume that the couch in the living room or the bedroom dresser isn’t hiding a gaping hole - we never move the furniture to check. We assume that what we see is consistent with what we can’t see.

All of these have their place, and are needed - but they also have a risk. An appraiser is always evaluating some degree of a “Hypothetical House,” the house that they can see, and assuming the rest. What if the assumption is wrong? Of the above, the most likely to be incorrect as to the real value of the “Real Home” is the drive by - the more assumptions that have to be employed, the more potential error is inserted into the system.

Appraisers play a part in the overall health of the real estate system.

1. Real estate agents - help to inform and educate buyers and sellers

2. Loan officers - help to ensure that the borrower is fit to secure a loan

3. Home inspectors - help to ensure that the property is safe and secure

4. Appraisers - help to ensure that the dwelling is fit to lien for the loan

Take any cog out of this machine, and the overall health suffers. But that is exactly what we see beginning to happen, and all in the name of making more money, faster.

The current trend is towards appraisers not inspecting the property at all. They are being given a report prepared by another party, without any necessary education on how to inspect a house. Appraisers are then expected to make value determinations based on that information. Can they produce credible results? Only as credible as the inspection, but yes. If this is the move that is coming to the real estate industry, then these inspectors need to be held to high standards. An appraiser trainee must train for a minimum of 300 hours and have 75 hours of education before they can inspect a home on their own, and only with the permission of their mentor. With this new move, a dangerous step is being taken back towards the early 2000’s where appraisers only had to inspect from the street… and this had a direct contribution to the housing collapse of 2008 (along with massive mortgage fraud on the part of the banks pushing for more money, faster… does anyone hear an echo?)

The further appraisals are removed from “Real Houses” and pushed towards valuing “Hypothetical Houses” the further we will move from actual “Real Estate Markets” and further towards “Hypothetical Real Estate Markets.” When these two collide, trillions of dollars go up in smoke in an instant.

Over listing your home will cost you money.

We see it everyday- a home is listed shooting for the moon, a price that will never see a contract- but who does it hurt? In the case of Indiana County, it’s hurt 50% of sellers.

Lets look at a hypothetical situation to better understand the issue:

1. A seller sits down with an agent to list their home. During the conversation, a listing price is agreed to that is 20% above the actual market value. This could happen for a few reasons:

   1. The seller has a mortgage that is far above the current market value and they are hopeful to get a sale price that covers the mortgage

   2. The seller has an expectation that is far above market value

   3. Complexity of the property made it difficult for the agent to analyze

   4. Inexperienced agents with a focus on commission rather than educating the seller regarding market trends

   5. In the case of a For Sale By Owner, the seller may lack the experience to price their home

2. The home is on the market, and buyers begin to search:

   1. Buyers who are in the price range to shop for the subject’s market value + 20%, look at the subject and see that it is far inferior to other properties, and walk away.

   2. Buyers who can afford the subject property at the market value may never look at it, because it is listed outside of their price range.

3. The home sits on the market. In the case of Indiana County and portions of Armstrong County where these trends have been seen, they sit for a long time. The normal 3 - 6 month marketing time passes and then 9 months and then 10 months. (Crickets)

4. The seller and agent get serious as the listing contract nears expiration. They begin/continue to drive the list price down. They finally get to the market value.

   1. Buyers who can afford the property finally see it within their search parameters.

   2. Buyers/Agents see the marketing time and price decrease history and assume there is something wrong with the property OR that the seller is desperate

5. Buyers, holding all the cards in the deal, finally make an offer.

Initially listing the home well above market value, often leads to the home selling below market value. In the case of Indiana County this, among other factors, has resulted in declining home prices in rural market areas.

How to prepare a GREAT CMA

We know that pricing properties in some markets can feel like grasping at straws. The more unique the property or the area, the more difficult this task becomes. We hope these steps that appraisers follow in the course of developing value opinions will be informative and helpful to you.

1. Determine your market area. Location, location, location. Depending on the property that you are representing, your market area could be a single street or an entire county. Major differences in marketability can be found by moving from one neighborhood to another, so when expanding outside of the immediate area ensure that your buyer pool would truly consider these expanded properties as well.

2. Look at the sales in the immediate market over the last 1-3 years. This will help to give an idea of what the immediate area can bear as far as values. If your price is above the 3 year high for the area, there should be a VERY good reason.

3. Narrow in on the types of properties over 1-3 years. Now that you have a general idea of the broad market, begin to refine your search. In some markets, you will have enough sales to only consider the last 6 months. With unique properties you may need to go further back in time. Consider the main factors in the buyer pool for your property. These include:

   1. Larger than typical acreage - If your subject has a city lot, stay away from the larger parcels. Sometimes appraisers, in order to bracket other amenities and due to lack of sales, may include such a property, but this requires expertise in vacant land sales to accomplish credible adjustments.

   2. Quality of the construction - If your subject is a standard 100 year old home, stay away from the custom built house with marble floors.

   3. Condition of the property - try to stay in the general age group of your subject, and consider recent renovations that have/haven’t been performed.

   4. Lower numbers of bedrooms and baths - the buyer pool for one bedroom homes with one bathroom won’t be looking at 5 bedroom homes with 4 bathrooms, and visa versa. Homes with 1 - 2 bedrooms have a drastically different marketability from even 3 bedroom homes that should be considered.

4. Pick your top sales. Bracket the amenities of the home you’re representing, selecting properties a little superior and inferior for each major marketable component (lot size, quality, condition, bedroom/bathroom count, etc). Look at the best sales you have over the last three years and look at the range that is indicated. Begin to “squeeze” in within that range considering which are superior and inferior to your subject, coming to a informed range that you can advise your buyer/seller with.

5. Only after the above consider listings. Everyone wants their house to sell for more than its worth, which makes listings fundamentally flawed for value determination. Until a property is sold, a listing price is only a representation of what a seller would like to get for the property, not what a buyer was willing to pay.

What NOT to do:

1. Don’t go 60+ miles away unless you’re representing a highly unique property.

2. Don’t take the sales of the area, and come up with the average.

3. Don’t compare a 2 bedroom home to only 4 bedroom homes.

4. Don’t simply search properties higher than what the seller wants and try to “make it work”

5. Don’t look at only listings and do the above

6. Don’t use Zillow. Don’t EVER use Zillow. By their own admission, 50% of their Zestimates nationwide are off by more than 5%. In other words, outside of highly homogeneous recent building plans, they’re numbers are worthless.

   For example, the owner of Zillow himself sold his home for 40% less than what Zillow estimated… https://www.inman.com/2016/05/18/zillow-ceo-spencer-rascoff-sold-home-for-much-less-than-zestimate/

   1. Lets look at another example from our area:

This is 162 Glade Run Road, Kittanning PA 16201. This .624 acre property for years was “Zestimated” at $112,350. On February 28, 2019 the property sold for $8,000… an error of 93%. BUT WAIT THERE’S MORE!! Once the property transferred, Zillow adjusted the new Zestimate.

Screenshot: 06/24/2019. Despite that selling price, it is still estimated to be worth $102,602. In short, Zillow can not even be trusted where there are recent sales. A drop of just 10%, when the data shows a drop of 93%.

Avoid these poor practices that will lead to a property expiring without a sale, drastically long marketing times or a price that won’t be supported and will “kill the deal.”

Under improvements / Over improvements

How much is the 4th pool worth on a property? How about the 29th bathroom? How about the 20th garage? These are absurd examples of “over improvements” in almost any market (unless your market included royal mansions), and present examples of how over improvements diminish in return as the number/quality of amenities increasingly exceed what is normal for a market area.

How do you value a home with one bedroom where 4 is typical? What about a 600 sq ft ranch in a neighborhood of 5,000 sq ft contemporary homes? What about a home with only a wood stove as a heat source? These are examples of under improvements and during valuation a key factor must be considered - “What portion of the market would be willing to purchase such a home?”

Decades of data, nationwide support the fact that buyers gravitate towards what is typical, and the buyer pool diminishes as you deviate from the mean in any particular amenity. Diminished buyer pools result in diminished demand, and therefore diminished value per unit. This is a principle across many economic fields and applies to real estate as well.

Another way of stating this is that “The more of something you have, the less each individual thing is worth,” and one of the easiest and most consistent ways of seeing this in the market is land.

Notice that as you increase the number of acres, the return divided by the total number of acres decreases. Some properties may have a better location in Armstrong County than others, and others may have sold above/below market value, but as a general rule, the trend is clear. Other amenities will have different shaped graphs - take pools for example. In the lower end of the market, pools offer no contributory value. The buyer pool in this range may not have the resources to maintain a pool, and therefore it is seen as a negative by part of the market, positive by some, and a net neutral overall. However, in the higher end of the market, this amenity can have a return (though nearly never higher than the cost of installation). However, imagine a buyers reaction to a second pool on a half acre lot. This would be seen as a liability that needs to be fixed not as an amenity, and therefore have a negative appeal. The second pool’s value on the graph would drop below zero, and so on.

When building/remodeling a home it is vital to consider, “What is normal for my market/buyer pool?” The wider of a divergence from “normal” will result in decreasing returns and difficult sales in the future.

Can we trust regression in amenity valuation?

Big data is the buzz word of the real estate industry right now. Multi-million dollar companies are popping into existence claiming to have the “right formula” for residential valuations - only to a few years later go bankrupt, (like Xiao which claimed to have the special sauce, only to re-brand as Clarocity which claimed the same, only to re-brand back to Xiao when their stock declined 98.5%, Or Housing Canary, or others). Fannie and Freddie claim to have the special sauce in the “Collateral Underwriter” but appraisers nationwide report that the output in all but the most uniform of areas is still just short of gibberish.

At the core of all of these algorithms is math, and much like stock market prediction, the math is complex, unproven and not for the faint of heart. Dr. Jason Osborne of NCSU gives 4 fundamental assumptions that must be true for multiple regression (the system at the core of these systems and most available to appraisers) to be reliable (read his paper here: https://pareonline.net/getvn.asp?v=8&n=2). These four assumptions are:

Homoscedasticity and Variables are normally distributed

This very large word means that the distribution falls evenly around the regression line. These both have to be tested on a case by case basis. However, since appraisers receive no mandatory college level statistical analysis, its too easy for appraisers to trust the tools that they are given that claim to be doing the analysis for them.

Variables are measured without error

At this point, most appraisers are laughing. Appraisers know that the data present in their local MLS has often been “fluffed,” (the word used in the real estate industry for what agents do to make a property look more appealing without outright lying). However, “fluffing” a 2 bedroom home with a windowless den in the basement into a 3 bedroom home is misleading at best. We also know that assessors are not always the most reliable home measures, sometimes including the below grade square footage with the above grade. The data sources that the regression here relies upon cannot be pushed through with out significant cleaning. This is why multiple companies over the last 10 years have been stealing this data from each other, because the raw data is worthless.

A linear relationship between independent and dependent variables

On this point, decades of real estate education again teaches us that regression in real estate fails this test. The “Law of Diminishing Returns,” bluntly states that the relationship of amenities to value is NOT linear, but rather a diminishing curve. Land is the easiest example to showcase because vacant land sales prove it time and time again.

From here we see that the price per acre (vertical) of land decreases as the number of acres (horizontal) increases. This is the “Law of Diminishing Returns” at work. This is true of all of the amenities in real estate (Square footage, bathrooms, pools, etc). As the number of amenities increase, the contribution to the overall value decreases.

However a quick thought experiment is also helpful. Imagine a market in which there are only 3 homes. All are identical, all have identical lots, square footage, bedrooms, quality, and condition. There is only 1 difference between the 3 homes, the number of bathrooms.

House #1 - has no bathroom, at all, anywhere

House #2 - has two full bathrooms

House #3 - has 35 bathrooms

Is the difference per bathroom between House #1 and #2 the same as between house #2 and #3. If you said no, congratulations, you understand the law of diminishing returns and that multiple regression CANNOT be trusted for real estate valuation. If you said yes, please contact me, I have a house to sell you.

In 2017, Town and Country Residential Appraisals reached out to the appraiser community online and asked appraisers to volunteer data from their various areas for us to examine (not to examine their appraisals, only the data that would typically be relied upon for regression). Appraisers from 6 different regions of the country responded. Aside from all 6 data sets failing tests 3 and 4 above, 5 of the 6 data sets additionally showed low levels of confidence in the data that they generated, some offering lower than 10% confidence that the data could be relied upon EVEN IF they had passed all four assumptions above. Please understand, this is not a critique of these appraisers. They delivered to us data that would be used in multi-linear regression. We performed no review of their appraisals or their interpretation of the data delivered (or if they use it at all).

Appraisers can not be complicit in handing over valuation to big data. This has already done damage to the American people and economy, and will only continue to.

Algorithms decide who gets a loan, who gets a job interview, who gets insurance and much more -- but they don't automatically make things fair. Mathematician and data scientist Cathy O'Neil coined a term for algorithms that are secret, important and harmful: "weapons of math destruction."

There is so much more to say on this subject ie. the importance of P and R squared values, sample sizes, confidence intervals, outliers, etc. However for more reading on this subject, please refer to the following for a primer on these subjects and why linear regression isn’t everything: http://resources.esri.com/help/9.3/arcgisengine/java/GP_ToolRef/Spatial_Statistics_toolbox/regression_analysis_basics.htm

In answer to common responses:

1. “I only use the data when it gives a logical result.” - This is called confirmation bias. If the confidence interval is low, but the data rendered “makes sense” to you, all you have done is confirmed your own opinion with data that is less accurate than a coin flip in determining contribution (500% less accurate in the case of confidence intervals below 10%.)

2. “R Squared values / Sample sizes don’t matter.” - I genuinely want to meet the person teaching people this, as I’ve heard it spouted enough with confidence that someone claiming mathematical competence must be teaching it. Simply, yes they do. I have yet to meet someone who can articulate a mathematical defense of this position, however I think they have the following assumption - “Since we have 100% of the sales data for an area, we have 100% of the sample and therefore, R-squared becomes obsolete.” 1) Unless you are also including all off market sales, not even that statement is correct. 2) ML Regression is not claiming to predict amenity contribution of only sold homes in a market but rather ALL homes, of which, typically, only small percentages sell, meaning that we very much need to consider the R-squared value and its effects on homoscedasticity and normalcy of distribution (tests 1 and 2 above) as well as the sample size and corresponding P value.

Market Data Analysis: Location, Location, Location

Some market areas are easier to analyze than others. A market area can be as small and contained as a single condominium plan. Other times, they have very irregular features. Today we’ll use the Freeport School District as an example, an area that covers areas in 2 counties, and at least 3 very distinct market areas. In addition to this being an analysis of a market area, this will also serve as a short example of some of the more simple steps that appraisers use in developing opinions of market areas, differing marketability, and comparable selection pools.

First we will start with a marked map of the school district.

Here we see the outline of the Freeport SD, with an approximate border of the Butler/Armstrong County line, with Butler County being to the left and Armstrong County being to the right.

This is a map of the sales in the Freeport School District over the last 3 years (from 04/30/2019). A quick glance shows that the supply and demand dynamics. There is a dramatic increase of sales in Butler County vs. Armstrong.

When we look at sales over all time, this trend becomes even more obvious.

If we apply a price limiter ($300,000+) to evaluate the marketability difference, we see an even more exaggerated difference. This shows that of the total 223 sales in all of the recorded MLS, 199 sales have been in the Butler County Area, while only 24 have been in the Armstrong County side (830% more). These kind of findings demand that we analyze if these two markets, serviced by the same school districts, are comparable.

Med Sale Price Med Taxes Med Tax Ratio Med Lot Med Year Built

Freeport Borough $60,000 $1,540 .026 City 1932

Armstrong County $139,900 $2,204 .016 1.66 1984

Butler County $183,500 $2,316 .013 .87 2001

Why are 400 homes scheduled to be constructed in Butler County when there are still unsold lots? Why have lots sat unsold in Armstrong County for a decade? The numbers tell us that there is a dramatic marketable difference between the two areas. Why do Freeport homes sell for so little? In part, because they are much older than the competing offerings and suffer a tax ratio of double that of the competition. The areas located in Butler County has easier access to the amenities of the 28 corridor leading in to Pittsburgh and Route 356 leading to Butler, lower relative taxes, the same great school system (ranked 79th in the state, and much higher than the neighboring districts) and buyers have been willing to pay a premium for this.

In addition to these basic tools, we also use pivot chart analysis, regression analysis and moving averages to determine if competing market areas are comparable, but that is for another time.

Are similar properties across this invisible county line comparable? Yes and no. They can be comparable, however, the market appeal of living in this superior market area of Butler County has to be reflected in the analysis in attempting to compare properties. Whenever comparable sales are available within the same area, it would be misleading to go into the adjoining area. We hope that this simple breakdown helps agents understand differences in market areas and how to better select comparable sales for their clients to consider.

How do I appeal my real estate taxes?

Before we discuss how to file a property tax appeal, lets first understand why this may be necessary. What is a “Property tax/County assessment?” An assessment is NOT:

1. An appraisal - it is at best a rough estimate, and lacks all of the precision of an appraisal.

2. Equal to the properties market value - many counties in the region we cover are working off assessments from pre-1990, and have little to no relationship with the market value of the homes they have assessed.

3. Performed by certified appraisers - while counties can, and often do hire organizations/individuals with this experience, there is no requirement for this to be the case.

These facts alone should cause anyone pause before trusting that their tax assessment is accurate. Further, these facts explain why so many county assessments differ wildly from the actual market value of the home. So how is an assessment performed, and where do the errors most commonly occur?

1. Data from across the region is compiled to estimate contribution of amenities.

   • In areas where data is abundant, this can result in reliable data. However, in rural areas, where data is limited, calculations based on limited data produces errant results. In the Indiana County reassessment of 2014-2015 this was the source of a great deal of error. Land values were miscalculated using non similar land sales and resulting in land assessments in rural parts of the county being assessed as if they were in the more developed areas where more land sales were available.

2. Inspectors review the outside of the dwellings, and take notes.

   • While the exterior is an important part of the home… its certainly not all of it. In the case of Indiana County, inspectors with no real estate experience were given a few hours training and sent out to inspect. This resulted in nearly every property in Indiana County with an unfinished attic above their garage being reported as having an “apartment.” This led to additional assessment to the property for nothing more than a storage space.

3. Assessors put this general data (with all of the errors that come from limited inspection) into a one size fits all algorithm that spits out a number.

   • Garbage In - Garbage Out. If any part of the information gathering process is in error then the algorithm will produce increasingly errant results. If the data on the specific property is in error, then the results will be errant. If BOTH are in error then the results will multiply the errors.

So, how can home owners who feel that this process has produced an inaccurate result appeal their assessment and therefore the taxes based on it?

1. Get a copy of your tax card. This is a public record that you can request and ask for someone to explain. If there are factual errors (garage apartments that aren’t there, too many bedrooms/baths, basement finish that doesn’t exist, etc), you can ask that they be corrected. In these cases the assessor may ask for photographic evidence.

2. Beyond this, if you feel that the final assessment value is inaccurate, it will require an appraisal to file an official tax appeal. Annual deadlines differ from county to county, so be sure to contact your assessment office and ask about the process/timeline. This will require that a professional, specific valuation of your property be provided as evidence that the non-specific, possibly non-professional assessment is in fact wrong.

Town and Country Residential Appraisals provides services for assessment appeal purposes for Indiana, Allegheny, Westmoreland, Armstrong, Butler, Cambria County, and would be glad to serve you.

FHA / USDA Financing

Over the course of the past 3 years, in the entire area that the West Penn Multi List covers, approximately 20% of all sales had FHA or USDA financing. In areas that are more rural in nature, this number bumps up slightly. However, when we look at these areas in the $100,000 and below range, that percentage jumps to 33%. All this to say, if you are a real estate agent servicing the market areas covered by the West Penn Multi List, FHA and USDA financing is unavoidable.

However, sadly, there are 0 hours of mandatory education to assist agents in understanding these products that buyers and sellers are agreeing to make contracts over. We hope that this short blog gives you some basic information necessary to help inform buyers and sellers so that they can make the most informed decision possible, and so that frustrations and misunderstandings are kept to a minimum.

FHA and USDA loan requirements are laid out in the HUD 4000.1 (available here: https://www.hud.gov/program_offices/housing/sfh/handbook_4000-1 | See sections: II.A.3.a,b - there are other pages, however this covers the highlights) This dictates to loan officers, investors, appraisers, underwriters and others involved in the loan process what conditions the loan/home/borrower must meet in order for the loan to be insured by one of these organization. In no uncertain terms, if any of those fail the requirements, the loan cannot be made. The loan underwriter has ultimate responsibility to ensure that these factors meet the minimum requirements. The appraiser in this scenario acts in a sense as the eyes, ears and sometimes nose of the underwriter in the home. Our report points out deficiencies in the property generally, as well as those that would disqualify the property from FHA/USDA financing.

The chipping and peeling paint that exposes the wood surfaces to the elements on homes of ANY age… will need to be painted per the HUD 4000.1 guidelines.

The leaking roof… it will need to be repaired.

The strong gas odor… will need to be inspected by a qualified professional.

We occasionally hear the complaint, “But the last appraiser didn’t make a big deal about it!?”

A couple of thoughts here:

1. Perhaps the last appraiser wasn’t performing a FHA/USDA appraisal. Perhaps it was a conventional loan?

2. Perhaps the issue wasn’t present at the last inspection?

3. Perhaps the appraiser missed it - in which case they could be liable for the error.

All of these aside however, for an appraiser to intentionally overlook a HUD 4000.1 deficiency just to “make the deal work,” is mortgage fraud. Period. Pressuring an appraiser to do so isn’t a great idea either.

There are some grey areas that require interpretation, and as often as possible we reach out to the appropriate body so that they will make a determination. The size of bedroom window egress is a great example. The HUD 4000.1 requires that a bedroom have direct exterior egress, however, it stops short of any specifics. What constitutes egress for a 6 foot tall man is not egress for a 4 year old girl? What size must the window be / how close does the window have to be to the floor? However, a window that is painted shut is not egress for anyone during a fire.

This gets to the point of all of these regulations. The Department of Housing and Urban Development composed the HUD 4000.1 to ensure that families buying homes with this financing would not only have a roof, but one that would last. Not just a house, but a safe home. As an agent (and as appraisers) we have close alignment in these hopes for the consumers that we come in contact with on a daily basis.

DOWNLOADABLE FILE OF THE HUD 4000.1

WE OFFER IN OFFICE TRAINING ON THESE TOPICS

What kills real estate deals? Part 2

Today we’ll take on the top 5 “deal killers,” and how real estate professionals can avoid these pitfalls.

Buyers and Sellers without professional help kill deals.

We see this on a regular basis, 1) sellers offer their property for sale without consulting a real estate agent, appraiser, or any other tool, 2) a buyer accepts the price, 3) everyone is baffled when the home’s value is much lower than the agree price. Do yourself a favor and call an agent or appraiser and get assistance on the single largest financial transaction you’ll ever make.

Hidden/non-disclosed defects kill deals.

“Disclose, disclose, disclose” - Its the partner in real estate to “Location, location, location.” Failure to disclose issues with the home could lead to a surprise on behalf of the buyer and underwriter - and neither typically react well to this. Further more, failure to disclose can result in legal troubles for the realtor that far exceed the state board’s punishments (As detailed in this article on legal ramifications: https://www.hg.org/legal-articles/violating-the-code-of-ethics-can-get-you-sued-26904). As an agent, if you know it, disclose it to all the parties. Inman lists failure to disclose as the #1 way that real estate agents get sued: https://www.inman.com/2015/08/25/10-most-common-ways-real-estate-agents-get-sued/

An agent can’t know everything, however, its your job to investigate, not overlook. Courts increasingly recognize the expertise that agents and brokers claim, and are holding them to that level of accountability.

Sales agreements above market values kill deals, and reputations.
Pricing properties takes years of experience. Sadly, this is not a skill that the current real estate education system emphasizes. A newly minted real estate agent has received 0 mandatory hours of education/experience in home valuation. Contrast that with a newly minted appraiser, who in Pennsylvania has a mandatory minimum of 200 hours of education plus a minimum of 1500 hours of experience in home valuation. We hope that in the future new agents will have many more opportunities opened up to them in this regard.

The CMA that an agent performs is vital in seeing a deal through to consummation and developing a good reputation. Priced too low and the property may sell, but you may have just guaranteed that no one in that family will ever use you again. Priced far too high, and the property may sit on the market for so long that the seller moves on to someone else. Three steps to a good CMA:

1. Use sales primarily over active listings. These tell you what the market has accepted - not just what sellers want. In the last three years in Indiana County 50% of listings expired without a sale - over that same time real estate prices were holding steady, but listing prices were being driven higher. Now, after three years of this trend, home values are falling in the more rural areas of the county. Chasing the latest listing prices will often result in a waste of your time at best, and at worst a deal that falls through because the market value doesn’t support the listing price.

2. Use the best sales available. Go back in time 3 years in the immediate neighborhood to find the perfect comparable, and allow that to inform your search for more recent sales. Find a few sales that are a little better/worse in every facet (size, lot, condition, quality, basement, parking, etc) and allow that to begin to form a range that your seller/buyer can fall in.

3. Get advice. Some properties are unique - we see them all of the time, and they are hard to value. First, use your brokers experience to help you - they’ve got the title for a reason. However, when in doubt, we have brokers and agents who call us for our expertise in these areas. While USPAP doesn’t allow us to discuss value with someone involved in a assignment we are working on, we can certainly give advice on everything else that we aren’t working on. Further, sometimes a restricted use appraisal, which is often cheaper and shorter than a full appraisal, may be called for to determine a list/offer price for particularly complex properties - saving you months of work/headaches for a small fee.

Uninformed buyers using the wrong financing kill deals.
In a world of 5 minute loan applications, sadly buyers think that’s all they need to know about the largest investment they’ll make in their entire life. The fine print in the loan may exclude manufactured homes, homes below a certain condition, homes near gas stations, etc. As the agent, you are the front lines to ask the question - “Will your bank write a loan on ____________?” and turn the buyer loose to do their homework. Recently we performed an appraisal for a lender who would not write a loan on manufactured homes - upon inspecting the home it was discovered to be a highly modified double wide - deal killed… by the appraiser? No, because the seller/agent did not know/disclose, and the buyer did not know, and the loan was therefore the wrong type. Anything else would have been mortgage fraud.

The agents are the experts and have the responsibility to investigate and inform. Here are a few thoughts:

1. Investigate the property - if something makes you wonder, order the tax card, or get a second opinion and find out what is going on. In the case above, ordering the tax card from the county would have saved weeks of headaches.

2. Know the basic mortgage products

   1. Portfolio - often the least strict lending terms. These loans are held by the bank for the lifetime of the loan, and never sold of the secondary market - therefore the property does not have to conform to Fannie Mae standards.

   2. Conventional - homes under these lending terms must adhere to the Fannie Mae selling guide, and all deficiencies of safety and structural integrity must be cured prior to closing. (https://www.fanniemae.com/content/guide/sel030619.pdf)

   3. FHA/USDA/VA - These loans are most strict, with a variety of additional requirements (all chipping and peeling paint cured, etc) Click here for our printable guides on these inspections. (HUD 4000.1 for USDA/FHA: https://www.hud.gov/program_offices/housing/sfh/handbook_4000-1) (VA MPR’s: https://www.benefits.va.gov/roanoke/rlc/forms/ci_guide_2005.pdf)

3. “As-Is” is a recipe for lower sales prices. The vast majority of sales in our area are Conventional or USDA/FHA/VA loans. If the seller refuses to consider repairs that would be required by these products, they are eliminating (in some cases) up to 80% of the buyers in a market. That can have a devastating effect on the final sales price of the home. There are more creative ways to address these issues that will result in higher sales prices (seller reduces price and buyer does repairs, etc).

Underwriters, who choose not to assume risky assets, kill deals.

Underwriters have a fiduciary trust to write loans that will be secure. When they don’t, we get 2008 all over again. Understand that the underwriter (and the appraiser by extension, working for the bank to investigate the property on their behalf) have this responsibility and take it seriously. Some properties are too risky, and in those cases, cash is the only option.

Can we trust the cost approach?

There are many things that people add to their homes that cost a great deal, yet add no value to a home. How well does the cost approach recognize and report this? Pools add no value (and sometimes subtract from value) in rural, low priced neighborhoods in the northern parts of the country, yet most cost manuals still report contribution. How do we square the cost approach with other data.

Among appraisers, this is a highly debated matter. Some swear by the cost approach, others swear it can’t work. Institutions like FHA/USDA require it 100% of the time, while the VA does not. Some lenders require it (though it would appear that this is possibly for insurance purposes more than valuation). This is an attempt to look at the strengths and weaknesses of the approach. First lets look at the underlying assumptions:

1. Cost (and income for that matter) approach is a derivative valuation methodology. Without the sales comparison approach, the cost approach can not exist. This is important to note, as this derivative data will be more prone to error the further it is removed from the primary data.

2. Cost approach assumes accurate builder costs. The collection of cost to construct data is a time consuming matter which is why appraisers often use cost guides like Marshall and Swift. There are a few areas of concern here. A) That the costs for the region are calculated accurately. In our rural areas, new construction is rare, with the cost of renovating a home being far below that of new construction. So, where does the data come from in these rural areas? B) That the equalization factors are accurate. In truth, THIS is how those regional costs are calculated - by taking state and national cost averages and multiplying them by a regional factor. However, again, with limited cost data, how can an accurate multiplier be calculated? C) That time factors are accurate. Again, this suffers the same issues as above - however, also suffering that data is always backwards looking in its accuracy - from 2016-2019 builder costs have spiked, in some cases materials have seen a 20% increase, and yet in our markets sales have remained flat. Finally, these errors multiply, seriously weakening the model.

3. Cost approach assumes accurate total economic life models. Marshall and Swift (a common cost estimator) gives no economic life above 65 years (Excellent quality, masonry home). Compare that to the dozen homes that are outside my window at this moment - homes of average quality, non-masonry (55 years by M&S) that have received only roofs, painting of the wood siding, and the bare minimum of updating to the interior in 1960 and yet have 30+ years of remaining economic life - yet are 114 years old. A polling of appraisers found realistic total economic lives of properties of this quality to range from 120-150 years. Yet M&S remains an industry standard? IF appraisers are to use the cost approach in a credible fashion, a radical divergence from the Marshall and Swift methodology is necessary.

4. Cost approach assumes accurate effective ages. This is a purely subjective opinion based on sensitivity analysis. While this is not uncommon in the appraisal profession, it is sometimes presented as far more black/white factual than it truly is. Given that depreciation is based solely on 1) accurate builder costs which we see issues with, 2) accurate economic life models which are notoriously inaccurate, and 3) accurate effective ages which are a subjective analysis, we see that depreciation is fraught with possible error.

This is a serious stack of possible compounding errors that strike directly at the overall validity of the cost approach. Add to this the possibility confirmation bias to simply confirm the sales comparison approach indication. So, what is the cost approach good for?

1. Contributory percentage to the whole. If we can validate the cost approaches relevance to market participants motivations, then the percentages of un-depreciated contribution of certain elements (bathrooms, below grade finish, overall quality, GLA) could theoretically be supported through this model without having to wade into the multiplying errors of points 3 and 4 above.

2. Affects of condition (effective age) on the whole. Again, if we isolate only this factor, without multiplying possible errors, we can see what effect 10 years of depreciation would have on the overall value of the home, and derive support for condition adjustments from this.

3. Age adjustments. If we can perform a series of cost approaches in a market vs. those same home sales, with an understanding that effective age is a factor of condition AND age, and find a way to tease these apart, then the result that would emerge would be the depreciation per year of the home. It should be noted however, that in teasing these two factors apart, a paired sales analysis would have to be performed in order to extract the condition adjustment before determining the depreciation per year.

Anytime that we use multiple parts of the cost approach however, we are introducing the possibility of error into the approach. However, that is true of ALL approaches to value. The more factors adjusted for in the Sales Comparison approach, the more possible errors- the strength of the sales comparison approach is bracketing. If all amenities are bracketed, we have greater confidence in the final range, with weighted analysis coming to a final conclusion. We have no such tool in the cost approach. Within the Income Approach, we become increasingly concerned with more and more adjustments (increasing gross percentages). If all factors are bracketed we have greater confidence in the output GRM range, with weighted analysis coming to a final conclusion. But with the cost approach, there is no bracketing, and therefore is the weakest of all of the approaches to value. It is very likely that in the future, this approach will be retired.

Of all of the approaches to value, the cost approach is probably the most open to error, confirmation bias and abuse. Even in new construction, the cost approach CAN NOT inform the appraiser of what the market is willing to pay apart from the sales comparison approach, and as a result serves a limited value. Cost approach serves a purpose in possibly extracting contributory value in difficult markets (though we have seen absurd data such as $3,000 contribution for a full bathroom in a $750,000 home, which the sales data and any real estate professional does not support). The cost approach is a severely limited tool, but good if used properly. A hammer is a very effective tool - just don’t use it the wrong way, you’ll just look silly.

What kills real estate deals? Part 1

There is a misconception among both real estate industry professionals and consumers that appraisers “kill the deal” with reports that either come in below the agreed upon sale price or truthfully disclose deficiencies pertaining to the property.  That could not be further from the truth.

I received a call recently that proves this point. The call was from an agent that had represented the buyer for a property that was an estate located in Westmoreland County, PA. This property had a number of issues including possible mold, water in the basement, torn and very worn carpeting, peeling wallpaper, a 75 year old kitchen, open knob and tube wiring, and duct tape on the bathroom floor holding loose vinyl tiles together. In addition to the condition issues, the bathroom was in a unique location and was only able to be accessed through one of the 2 bedrooms or through an exterior entrance located on the rear porch.  As would be suspected, the house was not under contract for a large amount, but nonetheless, there was a willing seller and a willing buyer.

When talking to this agent about a totally unrelated matter, she thanked me for the report on the above referenced property. Taken a little aback, I was not sure why she was thanking me. She explained that somehow the sale went through after the appraisal was completed with no glitches in the process. She had assumed that somehow I made the appraisal “look so good” that no one complained. There were no requests for clarifications and no request for endless repairs.  After realizing she thought that I had completed a report that overlooked all the issues, I reassured her that there was no lipstick applied to the pig. Our job as appraisers is to report true property conditions, warts and all. That is exactly what I had done with this property.

This opened up the opportunity to discuss that if we as appraisers supply a credible report that fully discloses the true condition of the property and its estimated market value in relation to those conditions, it does not have to kill the deal. However, more often than not, the lender sees the report and then decides that the property is not worth the risk or they refuse to lend unless repairs are made prior to the funding of the loan. In this case, the lender was a small local bank that offered portfolio loans- loans that are not underwritten by the GSE’s (Fannie Mae and Freddie Mac).  This bank chose to lend money on a property that was in overall fair to poor condition and where the appraisal report clearly disclosed all obvious deficiencies. Had this been through a different type of financing where the loan was underwritten by a GSE, it is certain that the loan would have not been approved unless some major repairs were made.

After having a great discussion on how lenders decide which properties and which borrowers they choose to lend to based on more than just the appraisal report, she stated that she would from now on educate other agents that I do not try to kill deals, I’m just doing my job.

Appraisers don’t kill deals.

Hidden/non-disclosed defects kill deals.
Sales agreements above the market value kill deals.
Uninformed buyers using the wrong financing kill deals.
Underwriters who choose not to assume risky assets kill deals.

If an agent is upfront and honest about the condition of the home, chooses appropriate properties for their CMA’s, and encourages the borrower to use the right financing - the appraisal most likely won’t be a problem. Being a great real estate agent takes a great deal of work and we applaud those who are constantly working hard to inform their buyers/sellers and improve themselves!

The real estate market works best when all parties (agents, brokers, loan officers, under writers, appraisers, buyers and sellers) are well educated, work hard, and are honest with each other. When any party fails in any of these regards, financial crisis is the the ultimate destination.

Series: How do I read an appraisal? Part 10

Today we finally arrive at the section of the appraisal that everyone jumps to first: The section that contains the opinion of value. You can find the full form here: https://www.fanniemae.com/content/guide_form/1004.pdf

Before we get to how the opinion of value is determined, lets address a few different conditions that the appraisal could be made according to, at the lenders request or per certain standards. A report can be made:

1. “As Is” - this means the property is appraised as it is, on the day of inspection. While sellers may put “As is” in their listing, IF they accept an FHA/VA/USDA or Fannie Mae backed conventional loan as part of an offer, they are accepting that the property MUST meet the minimum standards required to qualify for these loans. The appraiser must complete the appraisal per the standards and guidelines that the client/lender/government impose and in some instances, cannot be completed “as-is”.

2. Subject to completion per plans - these are common among new construction, where the appraiser values the property as if it were built on the day of inspection of the land per builder specifications. The appraiser must have those plans and the materials list in order to value the property credibly.

3. Subject to repairs - If a deficiency is noted in the report that does not allow the home to secure a loan (chipping paint on older homes for FHA/USDA/VA, exposed wiring on any government backed loan or conventional, leaking roof, etc) then the report will be made subject to those repairs being completed. That is to say, as if the repairs had already been made the day of inspection. (FHA/USDA minimum property requirements are located in section II.D.3.a-q of the HUD 4000.1 available here: https://www.hud.gov/program_offices/housing/sfh/handbook_4000-1)

4. Subject to inspections - while appraisers can identify many issues that would raise red flags in the loan process, there are many areas of expertise that we do not have. A horizontal crack in a basement wall can be a sign of settlement and future problems, however, the cause, severity and cure are not within the appraisers expertise. An appraiser can note a ceiling that appears to have water damage, but the cause and cure are the expertise of a plumber or roofer. These items are called out for inspection by a qualified professional. The professional then gives their opinion to the lender as to any future need of repair, and the lender has the choice as to how to proceed.

Reconciliation/Opinion of value

After all of this data gathering, and data analysis, and dozens of items that haven’t been addressed here (Highest and best use analysis, comparable selection, statistical analysis, sensitivity analysis, survey analysis, depreciated cost analysis, etc), the appraiser has a group of numbers that they have to make sense of.

In an ideal world, the comparables would all adjust to the same number, and the cost and income approaches would all present the same number… but that never happens. For the sales comparison grid, weight is given to each sale as to the relevance of those sales in determining sales comparison approach to value. This weight is given based on a variety of factors, but most typically are based on the overall similarity of appeal of a comparable to the subject, similar locations, similar amenities, or close groupings of value indicators.

Finally, we have three numbers - The Sales Comparison Indicator, Cost Approach Indicator and Income Approach Indicator. If the appraiser feels in their analysis that one approach does not produce a credible result in this instance, that approach can be excluded and explained as to why. The appraiser then weights these approaches to value in determining the final opinion of value, giving weight to the indicators that they feel are most credible.

Some say, “An appraisal is just an Opinion of value.” However, after this 10 part series we hope that you see that the opinion of value that is developed is more like a Doctor’s opinion of your illness than just something plucked out of the air. No other party in the real estate transaction is held to such a high standard as the appraiser when it comes to their “opinion.” No other party has as much education in valuation, or required experience necessary to be licensed to develop these opinions. In fact, it is illegal for anyone other than a Licensed Appraiser to use the words, “Market value” in connection with their opinion of value.

A closing thought

Appraisal standards (USPAP) require that we communicate only with our client, and the client is the party that engages us for the appraisal. So, in most cases, neither the homeowner OR the lender is our client - but rather a third party. If you have questions for the appraiser in these cases, the ONLY thing they can tell you is, “Please pass your question along to your lender and they will pass it along to me.”

This can feel like the “run around,” and many appraisers don’t like it, but sadly, it is currently what we must do. PLEASE, if you have a question during the loan process, talk to your loan officer. This person is there for that reason, and can answer many questions, and if not they can pass your question along to the appropriate parties, including the appraiser.

Series: How do I read an appraisal? Part 9

We’ll come back to the bottom of page two of the URAR 1004 (found here: https://bit.ly/2IkOwqn) next week, but first we need to address the other two approaches to value. In the prior weeks we’ve looked at the top of page two which addresses the Sales Comparison Approach. Today we tackle the Cost Approach and Income Approach.

Cost Approach

A common error in the sales comparison approach is “A house is worth whatever someone is willing to pay.” A similar error might be, “A house is worth whatever it costs to build.” So many more factors affect value than this. Right now (Winter 2019) builder costs are quickly outpacing the market value of homes in our coverage area. Market values, over time, are affected by the cost of construction, but the cost of construction is far more volatile than market values.

For this approach, cost manuals are consulted to determine cost to construct new, and then depreciation (physical, functional and external) are subtracted, arriving at a estimated replacement cost of the home. Among newer homes the cost approach can be very helpful, however, Town and Country has regularly seen that the older the home, the less effective this tool becomes. It is interesting that some many lenders do not require this approach to be developed at all.

However, the cost approach, even when not as reliable of a market value indicator, can assist in determining other adjustments used elsewhere in the appraisal analysis.

Income Approach

This tends to only be developed with the subject property is an income producing property or is in an area where it highest and best use would be that of an income producing property.

This area is very small on the form, however it is deceptive. The analysis and work file required to perform this analysis properly does not fit in such a small space, and usually requires 2-3 more pages to be added to the report. However, in brief, the following is performed:

1. The estimated rent that the property could produce is developed from numerous comparable rentals.

2. The Gross Rent Multiplier (GRM) is calculated from comparable rental sales by dividing the sale price by the monthly gross rent. Example: a property that is similar to the subject sold for $50,000, and its monthly rent was $1,000 per month. The GRM would be 50. This is performed with multiple properties.

3. Multiply the estimate rent for the subject by the GRM to arrive at the income approach indication of value..

This is very simplified, but a basic overview to understand the methodology behind the numbers in this section.

Series: How do I read an appraisal? Part 8

Next up in our review of the URAR 1004 (found here: https://bit.ly/2IkOwqn)

Gross Living Area is the heated, finished, living area that is totally above the grade of the soil.
Gross living area is NOT unfinished areas, unheated areas such as enclosed porch, or areas that have ANY portion below the grade of the soil. Heated garages are not living area. Heated pool houses are not living area. Unheated half finished attics are not living area and basements are not part of the GLA of the home. These are the Fannie Mae standards that appraisers must follow when performing appraisals that will be sold on the secondary market.

This is why the finished areas are divided into the “Above Grade” and “Basement” levels in the grid above. Many counties may tax you as though the finished basement level is the same as the above grade, however, Fannie Mae recognizes that the actual real estate market does not.

Functional Utility is the ability of the home to provide for its intended purpose. Examples of problems of functional utility are:

1. Captive bedrooms - having to walk through someone’s bedroom in the middle of the night in order to get to your own bedroom is not the typical intended purpose of a bedroom.

2. Having the only full bathroom be in the unfinished basement is not what the market expects from a bathroom.

3. Having a half bathroom in the back of the home and another half in the front of the home, with no full bathroom, is not typical.

4. Having the home’s water well be in a hole in the living room floor… is not typical.

5. Having a 3000 sf 1 bedroom home is not a typical function of a home

6. Having the holding tank of the septic tank be within the walls of the home, is not typical.

   Town and Country has appraised ALL of the above.

Functional utility is often those items that make you say “Wow!” or “Why?!” An appraisers job is to recognize those items and collect data to determine the impact on appeal because of those items. Sometimes these items can be cured (the cost of fixing the issue is less than the value increase) and sometimes they are incurable (the cost of fixing the issue is more than the value increase).

Series: How do I read an appraisal? Part 7

As we move down the URAR 1004 (found here: https://bit.ly/2IkOwqn) we come to a few areas that can be confused for each other. Here we’ll separate them into parts and explain how each factor separately affects value.

Site / Location / View

On their surface these three seem to be inseparable. The location of the site changes the site’s value. As does the view… how can these be three separate analysis. For this, lets address some real life examples in our coverage area.

How much does a nuclear clean up site, that has no guarantee of disclosure until 2030, affect value?

This is an external influence on the properties near the Kiskimere site in Parks Township, Armstrong County. This would be an example of a factor of location. We’ve performed repeated paired sales analysis to extract the difference in appeal from here to just a few miles away.

What happens when you have riverfront property, but don’t own the rights to use the river front?

This is the case along the Allegheny River in Armstrong County, where one side of the river owns the rights to the river front, but homeowners on the other side don’t. Each have the same view, but the location of the other side has a higher appeal.

What happens when your land is shaped like a triangle and/or is located on a cliff?

This affects the price per square foot of the subject acreage, because the utility of the land is diminished. We perform vacant land sales analysis on properties with similar characteristics in the market to determine the reduction in value to the site.

What happens if your house is built under an overpass and next to high tension wires?

Once again, we came across this in Armstrong County (do you see a trend). These are largely factors of the view. In order to analyze the influence in this case, other properties that have sold within view/hearing of these places are examined to extract impact on appeal. Other examples would be railroad tracks, locations on heavily traveled roadways, etc.

Quality / Condition

These factors are easy to confuse, so lenders have largely adopted a coding system:

Quality ratings range from Q1 - Q6

At the high end of the scale is Q1 - picture the white house. Custom everything, best materials for everything. These homes are very rare because the people with the skills needed are rare. On the other end of the spectrum is Q6 - picture a hunting shack. It barely qualifies as a home, and for part of the year might not be habitable. Most homes in our area fit into the Q4 rating, which Fannie Mae Defines as:

Dwellings with this quality rating meet or exceed the requirements of applicable building codes. Standard or modified standard building plans are utilized and the design includes adequate fenestration and some exterior ornamentation and interior refinements. Materials, workmanship, finish, and equipment are of stock or builder grade and may feature some upgrades.

Condition ratings range from C1 - C6

At the high end of the scale is C1 - brand new, never lived in. On the other end of the spectrum is C6 - this has condition issues so great that the house can no longer function as a home, holes in the floors, roof, missing water lines, no electricity, etc. Most homes in our area fall into the definition of a C4 range:

The improvements feature some minor deferred maintenance and physical deterioration due to normal wear and tear. The dwelling has been adequately maintained and requires only minimal repairs to building components/mechanical systems and cosmetic repairs. All major building components have been adequately maintained and are functionally adequate.

So, a home can be a Q1 quality while in C6 condition (in fact the White House during the War of 1812 was this when it was burnt down) - and you can have a brand new hunting cabin (Q6 quality in C1 condition).

Series: How do I read an appraisal? Part 6

Today we move to page 2 of the URAR 1004 form, and the sales comparison approach.

We’ll point out a few areas that can be confusing or unclear:

1. Number of comparable sales and listings.

   Located on the top two lines of the page: This is not the number of comparables used in the report (but it could be). This is the total number of comparables that the appraiser felt were sufficiently comparable to the subject that sold in the last 12 months that were analyzed. These homes may have a wider range of values than the buyer actually considered - however, these sales have factors that were necessary to analyze in order to develop a credible analysis. The more homogeneous the neighborhood of the subject, the more similar the comparables will be and often resulting in a tighter range. The more variable and rural the area is, the wider the range of comparables will be.

2. Sales price/Gross living area line

   This line is often misused by those who don’t understand it and is most useful in areas where homes and lots are all nearly identical. Otherwise there is wide variation and it causes confusion unless you know how to read it. This line only takes the sales price and divides it by the Gross Living Area (we’ll cover this later) - with no consideration of the number of bedrooms, bathrooms, condition, quality or ACREAGE. In other words, a 100 sf cabin on 5 acres that sold for $10,000 and a 1,000 sf ranch on a city lot that sold for $100,000 would both have the same “Price/Sq ft:” $100. Using this line alone to judge how “comparable” two properties are would be a gross error. Picking comparables is a far more complicated task than applying a single arbitrary metric.

3. Financing and Concessions

   If my home is listed for $100,000 and the buyer offers me $100,000 but asks for $5,000 back to cover their closing costs, how much is the home itself worth?

   This is a commonly confusing area of the form, but a simple example may give clarity.

   You walk into your local grocery store in search of an Apple. The apple costs $.95. You tender $1.00 to the cashier and they hand you back $.05. How much did you pay for the apple?

   Simple, right. Even though you handed over $1.00, you only paid $.95, and the grocer only received $.95. How you spend the $.05 is up to you.

   The hand in the back is raised, “But the contract price of this sale includes the concessions?”

   And here is the difference in our scenario:

   1. The bank is making a decision to determine if the value of the home is enough to cover the loan amount, NOT the market value of the home.

   2. The appraiser is determining the market value of the home - not the loan decision. We have two very different and important tasks.

      It can be confusing, but once you focus in on the buyer/seller motivations (which is what market value is based on) and not on lender banking decisions, the issue becomes more simple. Additionally, the data available would appear to support that the only valid adjustment to be made here is a dollar for dollar adjustment in the market areas that we cover (Westmoreland, Butler, Armstrong, Indiana, Cambria, and some parts of Allegheny County).

Series: How do I read an appraisal? Part 5

The improvements to the property include all of the structures added to the site. This section breaks the dwelling into a variety of sections for recording:

1. This describes the units construction and style. Effective Age is number given to the home based on the overall condition of the dwelling.

2. Simply describes the attic space and what access or finish is located there.

3. Gives data on areas of the home that are located below the grade of the soil. This includes finished and unfinished portions, and any of the common deficiencies found there. Its important to note that for lending purposes, the finished area below the grade of the soil is treated differently than what is located above grade.

4. Describes the heating and cooling of the home.

5. Describes the outer construction of the home and the condition of those elements.

6. Describes the inner construction of the home and the condition of those elements.

7. Gives a record of any amenities that may/may not be found in typical homes.

8. Describes the car storage on the site.

This portion of the form is rather self explanatory, its a simple reporting of the facts with little analysis. Sections 9 and 10 represent a more subjective portion of process.

Section 9: Asks the appraiser to describe the home’s improvements/special features/deterioration. This section is supplemented by the photograph addendum. The deficiencies we are asked to look for fall into 3 categories:

1. Safety - any deficiencies that could pose a safety concern to the occupant. These could include, a) lack of handrail/railings, b) exposed/unsafe wiring, c) tripping hazards in carpet, d) missing extension pipes on pressure relief valves on water heaters, etc.

2. Structural Integrity - we are asked to look for elements of the home’s construction that could threaten the improvement’s long term existence. Things like a) shifting foundations, b) leaking roofs, etc. The appraiser must determine that the home has a minimum 30 years remaining economic life.

3. Security - this refers to the subject’s ability to secure a loan. When it comes to loans that are backed by or underwritten for FHA/VA/USDA, additional regulations apply. For example, FHA/VA/USDA require that in homes built prior to 1978, ALL chipping and peeling paint be removed and painted on the basis of the possible existence of lead based paint. Standing water in basements automatically trigger the appraiser to require an inspection by a qualified professional. If this isn’t done, those loans can not be written for the subject.

These issues must be corrected BEFORE a loan can be made on the subject property.

Section 10 asks two questions:

1. Do any deficiencies rise to the level of affecting the livability, soundness or structural integrity of the home? This goes along with the above.

2. Does the property conform to the market area? If the market expects…

   1. 4 bedroom 2,000 sq ft homes and the subject is a 1 bedroom 700 sq ft home - it doesn’t conform

   2. Homes with a roof in proper condition and the subject has an “unplanned skylight” - does not conform

   3. Ranch homes on 3 acres and the subject is a town house with shared party wall and no yard - does not conform.

Market conformance is a subjective analysis based on data from the area and observations by the appraiser. The information reported to the lender is used to make determinations on whether to write a loan or not. The appraiser doesn’t have the final word - they merely observe and report the information available in all of the above areas.

Series: How do I read an appraisal? Part 4

How much is an acre worth? Well, it depends…

1. Is it river front or next to a nuclear waste site?

2. Is it one parcel or divided by power lines/major highway?

3. Is it sloped like a cliff or is it flat?

4. Is it a normal shaped lot or is it a foot wide and two hundred feet deep?

   (Town and Country has appraised all of the above, sometimes multiple at once)

The location of the subject specifically is addressed in the site section. This includes not only the lot size, but the other factors that can make much more impact. One of the greatest impacts on value is the Zoning. If the subject is a 2 acre parcel with a multifamily dwelling and zoning only allows single family dwellings, there is a huge problem (we have come across this scenario as well).

The appraisal process in this section requires familiarity/research of the area’s external factors, municipal utilities, zoning, topography, flood zones, and any covenants and restrictions that may limit the usage of the property - none of which are as easy as merely checking boxes.

Highest and Best Use Analysis

A property must be appraised in terms of its highest and best use. There are four tests that must be applied to a property, in order:

1. Legal permissibility

2. Physical possibility

3. Financial feasibility

4. Highest profitability

Steps three and four cannot be determined until the first two steps are analyzed. Most of the time legal permissibility and physical possibility are easy questions of zoning and building requirements, however, when they are not, they can slow the appraisal process down considerably. Sadly, sometimes an appraiser can wait for weeks for the local code enforcement officer to inform them of the legal permissibility of the subject under consideration. When homes are built that fail tests one and two, huge problems can occur.

In this case (http://massrealestatelawblog.com/2012/02/21/a-different-type-of-tear-down-court-orders-million-dollar-marlblehead-manse-demolished-for-zoning-violation/) the failure of the home to pass the first two tests cost millions of dollars and 16 years of legal problems. This is why appraisers in every appraisal must begin the process with step 1 and 2 of the HBU analysis and not proceed until they are confident that these criteria are met. It may slow the appraisal process down, but its better than a lawsuit against the appraiser and real estate agents for not disclosing this information to the buyer years down the road.

These two short lines in the Site Section of the report reflect a great deal of analysis behind the scenes, as is the case with so much on the URAR 1004. When you read through these reports, reflect on the fact that you are being given a 15 minute read through of analysis that took hours to develop, and something that can’t be merely replaced by an algorithm.

Real estate valuation is not a “by the numbers” only process. This is the fatal flaw in the current move towards algorithms.

Series: How do I read an appraisal? Part 3

Location… location… location. The three “L’s” of real estate. Location gets two sections of the first page because of this importance. The first is the neighborhood, the macro look, and the second is a look at the individual location of the subject within the neighborhood.

Depending on where the subject is located, the neighborhood may be a small development or an entire township as in the case of rural properties. Without getting too complicated, the neighborhood of the subject is the area in which the typical buyer pool for the subject property might also look for a home. Some neighborhoods are directly comparable to each other - one end of the same school district might have the same overall appeal as the opposite end, even though the distance is quite far. However, sometimes moving just a half mile in a built up area over a school district line can have a large impact on appeal. Distance isn’t everything.

The rest of the data here asks the appraiser to analyze the overall market conditions in the market. Are home prices increasing/declining? Is there an over/under supply of homes for sale? At Town and Country we analyze the prior 3 years of sales in an area to derive our opinion. If there are more homes in the market than sold in the last 2 years combined and the days on market are creeping towards 9 months, these factors may indicate a softening market area.

This section serves as a snap shot of the market area of the subject at the time of the inspection, a look back at how the market has performed in the past, and based on current supply of homes, how the market is performing currently. It also begins to provide data on the predominate trend of homes in the area and whether the subject conforms to the market… but we’ll cover that in weeks to come.

Series: How do I read an appraisal? Part 2

USPAP (the standards that govern the appraisal profession states the following:

Standards Rule 1-5
When the value opinion to be developed is market value, an appraiser must, if such information is available to the appraiser in the normal course of business:

(a) analyze all agreements of sale. options, and listings of the subject property current as of the effective date of the appraisal; and

(b) analyze all sales of the subject property that occurred within the three (3) years prior to the effective date of the appraisal.

The appraiser MUST analyze the contract, and listing history of the subject property IF available. Analysis of these factors include:

1. What the agreed upon purchase price is

2. Monetary/Personal property concessions

3. Contingencies

4. Listing history of the property

5. The above factors, and their affect on market value, if any.

There is a common question, “How can the appraiser’s opinion of value be impartial if they know the contract price?” The data shows that this question could be valid.

While most valuations fall into a bell curve around market value (which would be expected if purchase prices are to be trusted at all, the drop at just below contract prices and spike at/slightly above contract price would indicate that this does possibly skew opinions.

The Bad: Appraisers can get sucked into “hitting the number.” The bell curve in the above graph actually peaks approximately 3% lower than contract (a very interesting percentage given typical concessions) if the spike at contract price is ignored. Inside of a real estate transaction, there is only one party that is not financially compensated based on a closed sale/higher price and that is the appraiser. If this data is skewing opinions upward, then there is a possible long term problem. Agents seek higher commissions, banks want higher payments and the market begins to spiral upwards away from fair market value… and as we learned in 2008, prices can violently correct.

The Good: Good appraisers know their job and this risk. A good appraiser only addresses the contract price at the end of their analysis, not the beginning. Also, the meeting of the minds between the buyer/seller is a data point, one of many, but a data point that deserves to be analyzed and reconciled with the rest of the market. In an ideal world, a knowledgeable/informed seller prices their home reasonably, and a knowledgeable buyer makes a reasonable offer. Real Estate Agents have a huge responsibility in this - to set aside their own personal gains and inform their buyers/sellers (for more on this topic, watch economist Steven Levit’s warning: https://www.youtube.com/watch?v=pbFkw_roJqI).

Another question often asked is, “Isn’t market value just what someone is willing to pay?” After the long process of coming to an agreed upon purchase price, having an appraiser come in with a different market value opinion can be frustrating. Why would the two be different? A simple story may help us tease the two apart:

Imagine a small village within a large desert, with a faithful well at the center. Everyday the well produces enough water for the town's people, without fail. Each day a young man pulls up gallons of water and sells the gallons for $1 each. Each person in town has enough for the day, the man is compensated for his efforts and everyone is satisfied.

Now, on a certain day, a man struggles across the desert after a long journey, nearly dying. He is an adventurer, who has just found the greatest treasure known. He knows that when he gets back to civilization he will be rich beyond words. A young boy wanders out of town and finds the man. The man offers 1 million dollars for the water sack that the boy carries, and the boy gladly complies.

A couple of questions at this point:

1) What is the water worth to the boy?
2) What is the water worth to the man?
3) What would happen if the boy began demanding 1 million dollars per gallon in town?

Its a simple and almost silly story, but it gives us a simple example. To the boy, the water is still only worth $1. To the rich man who doesn't know the value of the water, its worth his very life. To the town, once the man has drank his fill, its still worth $1.

The price in one moment doesn't change the value. An uninformed buyer doesn't set the market. Just because a house is listed for 1 billion dollars doesn't mean that its worth it. Markets are made over hundreds of transactions, between informed buyers and sellers over the course of time.

The selling season sees more listings and sometimes pricing becomes more aggressive than the market can bear. Be sure to have an accurate home valuation before listing, as it can often save you time, frustration and disappointment.

Appraisals remain the most unbiased and reliable method of valuation, but the process and standards can always be improved upon. Algorithms are being tested, but are still decades away from reliability in anywhere other than homogeneous suburban areas. Town and Country takes our job seriously to “promote and maintain a high level of public trust in appraisal practice” (Preamble to USPAP) not merely “make the deal work.”