You... might not be closing.

Jeff Foxworthy mastered the “You might be a redneck…” joke format, and has used it for decades. Today we take some inspiration from his format and apply it with some levity to the real estate market.

If your buyer is using FHA/USDA financing and your house is shedding paint faster than a Husky in Houston… You might not be closing. FHA/USDA/VA have strict rules on peeling paint - even if you have a newer home. If exterior wood surfaces should have covering to protect them, they’ll need to be scraped and painted to pass these minimum standards.

If your buyer is financing their loan, but the foundation is shakier than Evander Holyfield getting an ear exam from Mike Tyson…. You might not be closing. Banks want to know that the collateral (your home) will have at least 30 years of life left.

If your home has unfinished construction/remodeling that even the Clampetts would turn up their noses… you might not be closing. We get it, your home is going to be amazing… once it has a floor and working plumbing. Appraisers are skilled in the art of seeing what isn’t there yet (we have to do it all the time for new construction loans) but many lenders get worried about lending 100% of the money on 50% of a house.

If you priced your 1 bedroom shack based on the mansion down the street because “location, location, location,” … you might not be closing. Location is important, but so is looking at a home like a buyer.

If you did all of the work yourself… without pulling any permits… you might not be closing. If construction has been performed that requires permits by your local municipality, many lenders will have a lot of extra questions.

If you dug for oil but hit the septic tank… you might not be closing. Active environmental hazards need to be addressed before the lender will write a loan.

NEVER refinance your home this way!

In the lending/appraisal world there is something called a “Drive-by” or “exterior only” appraisal. These are performed on a 2055 FNMA form and have a scope of work that is limited to an inspection “from the street” only. According to the scope of work, the appraiser then assumes that the interior is consistent with the exterior of the home (in condition and quality).

There are times where these are needed - pre-foreclosure is the most common need. The bank can’t gain access to the home, but needs to know the value of the home to make financial decisions.

“REFINANCE, much less a FULL REFINANCE should NEVER be performed based on an exterior-only report. You are asking to go under water if you allow your bank to do this to save $100.”

We can not say this strongly enough. Please, ask your bank what kind of appraisal they are ordering, and demand a full appraisal to save yourself thousands. We ran across a case recently that illustrates the dangers of using the wrong type of appraisal:

1. In 2016 we performed an exterior-only appraisal for a lender. The home had been fully updated on the exterior. We were asked to not contact the homeowner in the engagement letter. Therefore we complied with the required scope of work and appraised the home under the hypothetical condition that the interior matched the exterior. The final opinion of value was $105,000.

2. The bank then made a loan on the property based on a 90% loan to value ratio: $94,500.

3. Now in 2019, we were asked to perform a full appraisal on the home. The exterior is still in very good shape… but stepping through the front door is a journey back in time. Well maintained, but nothing updated since the 1970s. The value of the home now: $85,000. After three years of mortgage payments, the homeowner is now $3,000 in the hole.

How did this happen, did we perform a bad report? We immediately double-checked our work and found that the report was a credible appraisal of what we were asked to appraise. However, the lender should NEVER have been allowed to write that loan based on that appraisal (that’s a FNMA, federal lending regulations issue).

We close this blog with a warning from the past about the cost of liberty. We might insert the phrase “financial liberty,” here to emphasize our point. The borrower must educate themselves about the loan process in order to not be taken advantage of by those whose financial interest is not concerned in the slightest with their own. We write these blogs for anyone involved in real estate in hopes that a more educated populace with lead to a more financially free populace.

Lead Based Paint

The classic cracking/scaling pattern of lead based paint. If you see this, there is a high likelihood that your home/structure has lead based paint.

Since the ongoing crisis in the Flint Michigan water supply, lead has been in the news nationwide. Lead is one of the most destructive substances to childhood development as it attacks the brain and central nervous system, and at highest levels can cause coma, convulsions, and death.

“At lower levels of exposure that cause no obvious symptoms lead is now known to produce a spectrum of injury across multiple body systems. In particular lead can affect children’s brain development resulting in reduced intelligence quotient (IQ), behavioural changes such as reduced attention span and increased antisocial behavior, and reduced educational attainment. Lead exposure also causes anaemia, hypertension, renal impairment, immunotoxicity and toxicity to the reproductive organs. The neurological and behavioural effects of lead are believed to be irreversible.”

— World Health Organization

With such horrifying effects, it is no wonder why the FHA / USDA and VA will not underwrite a loan unless Lead Based paint is properly treated. Today we will tackle some in-home investigating and treatments that you can perform to keep your family safe:

Investigating Lead Paint - excerpts taken from House Logic

The EPA has recognized the following in-home tests for discovering if your home has lead paint present:

For wood and metal surfaces: https://leadpaintepasupplies.com/lead-test-kits/

For wood, metal, drywall and plaster surfaces: https://www.esca-tech.com/ProductDetail.php?category=2700&productnum=LPTK

These tests work in a similar fashion, in which a swab of the surface is taken and a chemical reaction takes place in the presence of lead in order to reveal a color indicator.

Please note: While these tests may give you peace of mind, they will not suffice to exclude your home from needing larger remediation in the case of FHA/USDA/VA financing for a loan. The level of testing that would be required by federal guidelines is usually far higher than the cost to encapsulate any supposed lead paint.

Remediating Suspected Lead Based Paint

HUD/EPA’s policy infers that there is a high likelihood that any home built prior to 1978 has had lead-based paint at some point, and so all homes built before this date MUST have all chipping and peeling paint remediated by the following methods:

1. The surface must be scraped to remove all loose and peeling paint. Those chips can not be left on the ground however, as this is a risk to the ground and water being contaminated with lead.

2. The surface must then be painted to encapsulate the remaining surface.

Dust is the primary means that lead can enter the body, so this process should be performed carefully. HUD provides extensive guidelines for the entire process, available here.

Information

https://www.who.int/news-room/fact-sheets/detail/lead-poisoning-and-health

https://www.hud.gov/program_offices/healthy_homes/healthyhomes/lead

https://www.epa.gov/lead/protect-your-family-exposures-lead

https://www.webmd.com/women/lead-paint#1

Treatment

https://www.health.ny.gov/environmental/lead/renovation_repair_painting/encapsulants.htm

Market Data Analysis: Declining Markets

Telling someone that their house has lost value won’t make many friends, but it will distinguish you as a real estate professional if you can analyze a market and be honest. The national news has talked about housing prices increasing yearly for nearly a decade now, and some areas of greater Pittsburgh has matched those trends at some times, others have remained flat, and others have declined. Today we look at some declining markets, and how to use simple tools to visually determine if there is a decline, and at what rate.

The above is the national median sales price trend since 1990 vs. the builder cost trend. We can see the slow down in real estate around 1990, the decline of 2008 some possible trends emerging now. However, the first thing that we should note is that VERY FEW areas in the greater Pittsburgh area have seen increases this aggressive. SO, before any seller says, “I bought my house 3 years ago, and houses have gone up nationwide by 3% per year… so my house is worth 9% more?”

The above are homes that are from across Indiana County that are of a higher quality construction. This is not merely a limit of, for example $200,000 and above (limiting a data search by a hard number like that will skew the results of the analysis). In appraisal language, these properties are all Q2-3 homes (For the definition: http://www.bradfordsoftware.com/uad/UAD_Glossary.pdf)).

Over the last 3 years (after a reassessment in Indiana County that sparked a spike in selling, and reduction in property values) the above data points represent the higher quality sales across the county. Once selected, these sales (with sale date, sale price, and original sales price) were placed in an Excel Spreadsheet. The data points were then graphed and a trend line calculated for each using the tools within Excel. We observe a few things above:

1. There is a clear convergence of the scatter plot around a downward trend (with the exception of a few recent sales. Those two sales were some of the largest properties in the analysis, and one of them sold 23% below the original list price and stayed on the market for 2 years).

2. The trend line indicates a median decline of $19.45 per day. When calculated with the median sales price of $325,500 this comes out to an annual decline of 2.18% per year among these homes. This is then a starting point from which we can refine the decline - however, this is a great starting point from which to make sure we’re taking a possible declining market into consideration.

3. From other analysis of Indiana County as a whole, we’ve seen that some of the hardest-hit areas “may” be finding a bottom. There is the possibility that those recent high sales will result in a similar possible turn OR those recent lower sales would indicate that the decline continues. In six months, we’ll know for sure what is happening right now.

That is perhaps the most frustrating part of market analysis. Its always rear looking. While our “gut” might tell us that the market is “hot,” data is needed to be a professional. Look at the above graph one last time. The original list price trend is falling at 3.98%, 180% faster than sales prices. Why? Because sellers and their agents were way off 3 years ago, and are only recently starting to get to close to realistic sales prices. Our gut is susceptible to “confirmation bias,” in this case, the desire to see a stronger market than what really exists.

Do yourself a favor,

1. Run the data on your market areas on at least an annual basis to stay on top of what the markets are really doing.

2. Read our county reports that we distribute throughout the year for wider trends.

3. Stay abreast of the national market data, but don’t put too much weight on it.

CMA Toolkit: Test your list price.

When preparing your CMA, one of the best steps you can take is to test your list price. The process is pretty simple but easy to skip. Let’s go through the basics of a great CMA.

1. Look at the history of the market area of your property. This will give you an idea of the high-low range that the area can handle. Three years is a good time-frame to look at.

2. Narrow in on properties characteristics like yours. Now that you have the broad range, begin to narrow in on property characteristics that matter. If your property is a 4 bedroom home, eliminate the 2 bedroom sales. If your property has 1 bathroom, throw out everything above 2 baths. If your property has been recently updated, throw out the REO. Now you have a much smaller indicated range.

3. Get picky. Now that you’ve trimmed from possibly 100’s down to 20, select those 3-5 properties most like yours. This will give you a much tighter range within which to advise your buyer/seller.

4. Test your price. The steps so far should get you in the ballpark, but “confirmation bias” can be sneaky. Its time to see if you were truly objective. Take the price that you’ve come to and do a search in your market area of a (for starters, it may need to be tighter or wider) 10% plus/minus. Start looking at your property list and ask yourself the question, if I had $(Price) to spend, would I buy the house I’m looking at or this house.

   In appraiser speak, this is called sensitivity analysis: The ability to look at two things and determine which is superior. As you move through the list of properties you should find the space where your property falls, the sweet spot, and that should inform the price that you place on the property.

   If cheaper homes are better than yours - your price is too high. If higher-priced homes aren’t as nice as yours - your price is too low.

Home valuation is tough - that’s why appraisers have 300 hours of education and 1500 hours of experience before they can sit for their license. If you ever need advice, don’t hesitate to call. We also offer in-office training for free for real estate agents on a variety of real estate topics, including FHA/USDA/VA financing, CMA preparation, and others.

I'm sorry Chip and Joanna Gaines lied to you.

We love Chip and Joanna Gaines - they’re cute, spunky, hard working folks. They’re an adorable couple, but sometimes we cringe at the real estate statements that come out of their mouths - and they are some of the better ones on HGTV. Chip and Joanna claim to “take the worst house in the best neighborhood, and turn it into our clients dream home,” and on its face, this sounds pretty good. In home valuation language they are trying to buy under improvements for the neighborhood, which are usually a good deal, and below market value, but then there is the second half. A “dream home'“ is often code for “over improvement for the neighborhood,” and typically see lower market values compared to their costs. With that said, lets look at some of the half truths and hidden land mines that you want to avoid if you’re following Chip and Joanna’s example.

1. “Fixer-uppers” don’t usually qualify for financing.

   Its a rude awakening when you find your dream “fixer upper,” place your offer and then the bank comes back and informs you that the condition of the home won’t qualify for your loan. Lenders have minimum property requirements that a home must meet in order to secure financing. The short thing to remember here is: Is the home 1) Safe - are there obvious safety concerns that endanger inhabitants of the home, 2) Structurally Sound - is the home going to stick around for 30 years, or does it need a major structural overhaul, and 3) Can the property qualify for the particular type of loan you need (chipping and peeling paint will hold up a FHA/USDA/VA loan, etc). There are loans that can be used for fixer-uppers, but you need to know to ask for them: FHA 203k / FNMA/VA Renovation loans. These loans allow you to obtain quotes from contractors and take out a loan for the final total cost versus the final market value of the home once renovated.

2. Cost does not equal value.

   “I’m going to buy a $20,000 home in a $30,000 neighborhood and put $50,000 into it! So, Chip and Joanna taught me that will add $50,000-$100,000 dollars, right?!

   No. That’s not how any of this works.

   You’ve priced your property out of the market, and unless a very foolish person comes in with $100,000 cash, you’ve probably thrown away nearly $40,000. The mantra that every renovator needs to memorize is “Cost does not equal value.” Its a simple and silly illustration, but it works: how much does a fourth full size pool add to value. Anyone can see that cost doesn’t equal value in this case, but it holds true across the board. In any renovation, you must keep in mind a few things to see the largest return on your investment:

   1. What is the high end of our market?

      This should help you set your maximum budget. If you bought your home for $50,000 and the highest sale in the last 3 years was $70,000, spending anything more than $20,000, even in all the right areas, is probably throwing money away.

   2. What is typical for my market?

      If your market expects 2 bathrooms, and you only have 1, then its probably wise to add a 2nd from a return on investment perspective. However, in the same neighborhood, its probably foolish to add a 4th. This is true of materials to, if the market expects laminate flooring, don’t expect a large return for marble.

3. Fixing up a home is romantic - but where is the baby going to sleep?

   Drywall dust is a horrible thing for babies. Take into consideration what your life is going to be like during your dream renovation to ensure it doesn’t become a nightmare. Get a realistic plan and budget before you embark on the journey and then be prepared for adjustments. A contractor can help a great deal to tell you how much your dream project will cost - but an appraiser can tell you how much that dream will be worth, so it doesn’t become a nightmare.

4. “Fixer-uppers” can quickly become “over-improvements.”

   As noted in this Realtor’s opinion of the market area of Waco Texas, these big beautiful homes that Chip and Joanne build have a hard time being sold for what they cost to build.

   https://www.yahoo.com/lifestyle/waco-realtor-reveals-big-problem-194513387.html

   Builders don’t make markets, buyers do. If there is no one willing to buy a home in a market for more than $250,000, then it doesn’t matter if you put $2,000,000 into it - the ceiling is $250,000. Barring a cash buyer with no knowledge of the area, you’re going to be eating crow and Ramen Noodles for a while.

5. The Shotgun House

   This episode is so jam packed full of very bizarre real estate decisions/statements, that we need to comment. Lets walk down the list:

   1. They find a home that they are given… that doesn’t usually happen. Further, they are offered reclaimed materials for free… this doesn’t usually happen either.

   2. They move the home to a lot they’ve already purchased. This will make anything but a cash deal nearly impossible.

   3. The home they are given is 1 of 2 left in the city. In a city with a population of approximately 130,000, to have 1 of 2 of something is either very good, or very bad, and in the case of this one bed room home, its not looking good. In home valuation language this home “does not conform to the market” which would exclude it from some financing (even in perfect condition).

   4. At the end of the show they do some funny math, the cost of the lot + the cost of renovation = the value. We’re sure that Chip and Joanna didn’t mean to commit a violation of Texas Appraisal Procedures that could result in a fine, but when they used the word value, they did. Furthermore, this simplistic game of addition, is misleading to the buyer and the viewer. To put it simply, cost does not equal value.

   So what happened then? After a short time the owners, who were told that the house was worth approximately $140,000 attempted to sell it for $950,000, and it sat, and never sold.

   Shocker.

   However, we do want to bring in another interesting point. Zillow claims to have accurate home valuation tools (verbiage that they have been sued over), when you look at the numbers, you see is really more a shell game. In this case, they were consistent with that strategy. A look at the Zestimate history above reveals that Zillow grossly over estimated the land value by 250%. Then when the county assessed the home at approximately the cost of the purchase plus improvements, it simply mirrored the assessment (assessments are not appraisals, and are not good indicators of market value, but they have more credibility than Zillow). Then, when the house was listed for $950,000, the Zestimate shot up to $750,000, before retreating slowly over a year to a level 5-8% higher than before the listing.

   That is how Zillow claims “accuracy.” Their algorithm weights listings heavily assuming that agents have properly informed sellers, and then if the sale closes near that price, Zillow can claim accuracy. However, if the price is way off base and never closes, Zillow moves back to their old math and no comparison of accuracy can be made. So their data on their accuracy is incredibly skewed to act as if they are credible, when in fact, they are just piggy backing on agent’s accuracy (which is FAR better than Zillow).

A few closing thoughts:

1. HGTV can give you some neat ideas to spruce up your home, but get a professional opinion on the big financial decisions. Builders don’t operate in the world of “value” but rather “cost.”

2. Neither Chip or Joanna Gaines are licenced appraisers (per TALCB https://www.talcb.texas.gov/), yet they regularly offer the “market value” of the properties both before and after repairs. Per USPAP, this constitutes an appraisal. Per Texas TALCB rules, only an appraiser can perform an appraisal and performing an appraisal without a license can result in a fine of $1,500-$5,000 per time. Over 5 seasons, that brings their total potential liability to the Texas Appraiser Licensing and Certification Board to between $237,000-$790,000.

3. Never, ever trust Zillow. https://sacramentoappraisalblog.com/2019/05/01/two-things-to-understand-about-zillows-accuracy-rate/

For more on this topic, read below:

https://www.fatherly.com/play/chip-and-joanna-gaines-use-hgtv-to-lie-to-middle-class-homebuyers/

https://birminghamappraisalblog.com/appraisal-tips/an-appraisers-take-on-the-fixer-upper-craze/

https://www.realtor.com/advice/home-improvement/lessons-i-learned-fixing-up-my-outdated-fixer-upper/

Market Data Analysis: Location Part 2

Today we turn our attention to high value homes and a factor that affects market value. For this we will take a birds eye view of an area. This is a look at two school districts’ sales over the past 10 years at the $400,000+ price range. If you had to draw a line dividing the two school districts, without any other help, where would you draw it?

Zooming in on the southern end of the map we see the density remain in the south west portion, and drastically become more spread out to the east and north.

Using the above school district maps we see that the density of $400,000+ sales over ten years highly corresponds to these maps. In the same way that you might draw a line with a pen on the maps above, for ten years buyers have been drawing the line with the wallets.

But why? Franklin Regional is closer to the metro area and its amenities, but the sharp line indicates that this is not the only story. If we look at homes of $400,000+ in the Kiski School District over that same time (32 vs. the 305 in Franklin Regional), we see a median sale price of $442,500 (vs $553,827 in Franklin Regional) and a median acreage of 8.73 acres (vs 1.55 acres in Franklin Regional).

Buyers and sellers are sending a clear message - these two markets are not comparable. If you ever represent a property on the border of a school district, before you assume that you can use sales from across the border, make sure that the market data supports that assumption.

For more on this: https://www.housingwire.com/articles/49830-half-of-homebuyers-with-kids-base-purchase-on-school-district?fbclid=IwAR33nnrqBUS-MEkKBiP8nq6lvwiEnb1RGQbyHcLwjkLZKOzQm0jdfZhe-sc

Single wide, double wide, manufactured... Oh my!

You find your dream ranch styled home, obtain financing, make an offer, and then the appraisal comes back saying the home is a double wide?! How did no one say anything! We’ve seen this scenario where a deal is progressing and then the bank pulls back because they will not lend on a “manufactured home.” In some situations, they can be hard to spot, but it can mean the difference between being able to purchase a home or not. So today we want to equip you with some tools for the field on how to spot a manufactured home, and what issues may need to be overcome.

First lets clear up some terminology:

1. Manufactured Home - refers to a home that is constructed to meet HUD guidelines, built off site, delivered to the property in portions and then connected. “Single-wides” and “Double-wides” and “Triple-wides” are manufactured homes.

2. Modular Home - refers to a home that is constructed to meet building code and it is also built off site and delivered to the property in portions and then connected.

The real difference is the quality of the craftsmanship and the minimum requirements of construction. Manufactured homes are built to HUD standards and modular homes are built to IBC (International Building Code) standards.

Here are a few easy steps to determine if the property is a manufactured home:

1. Order the county record. Most counties will note if the structure is a manufactured home and in some cases regardless of how many sections, call it a trailer.

2. Look for the HUD Tag located on the corners of the home

3. Look for the HUD data plate or certification, which is a piece of paper glued to some surface of the home (under the kitchen sink, in a closet and near the electrical panel are most common)

4. Look at the bottom of the structure. If you see a steal under carriage this is a sure sign (but some manufactured homes have wood under carriages) then this is a manufactured home not a modular.

Why is this important:

1. Manufactured homes built prior to June 30, 1976 can not obtain typical financing. This makes finding the HUD Tag and Data Plate very important. We’ve recently seen a manufactured home built in 1970 sell with conventional financing in the MLS - sadly this person (and the appraiser who signed off on it) will be in for a rude awakening when they attempt to sell.

2. Manufactured homes have a very different marketability than modular or other stick built construction. This is represented in the fact that FNMA requires these to be performed on a different forms with different analysis.

3. Remember, once a manufactured home, always a manufactured home- no matter the modifications. We’ve run across manufactured homes with extensive additions and/or remodeling rendering them very similar to a typical stick built structure. However, for lending purposes, it will always be treated as if it is a manufactured home, no matter the modifications.

Some common questions:

1. What if my home sits on a permanent foundation and/or was recently converted to real estate?
   Once a manufactured home, always a manufactured home. That’s the answer, basically. Converting your home to ‘real estate’, or placing your manufactured home on a concrete block foundation, for instance, will not change the fact that it is manufactured. It will still be appraised the same way and will have the same marketability as before.

   • But what if I changed/updated/upgraded almost everything?

     If any part of the original manufactured home remains, FNMA requires that the property be analyzed as a manufactured home.

   • But it doesn’t even look like one anymore?!

     See above.

2. My manufactured home has vinyl skirting. Will it qualify for FHA financing?
   Not without backing. FHA states that “if the perimeter enclosure is non-load bearing skirting comprised of lightweight material, there must be adequate backing (such as: concrete, masonry, or treated wood) to permanently attach and support or reinforce the skirting” This means that your vinyl skirting will need to be reinforced with backing. It’s been our experience that treated wood is the cheapest and quickest fix.

3. I can’t find my HUD Data Plate / Compliance Certificate in my house. Is that going to be a problem when I sell? It depends. Don’t you love that answer? It really comes down to the lender. When needed, your lender will be able to guide you through this process. But to get you started, you can check out this helpful link by HUD: https://www.hud.gov/program_offices/housing/rmra/mhs/mhslabels

Whether you’re buying or selling, knowing the difference between a manufactured and modular home could mean the difference between making and breaking the sale. Make sure you advertise your home for sale correctly and make sure if you are a buyer that you do your homework to make sure the home is what the seller says it is.

Market Data Analysis: Odd Properties

Odd balls: Geodesic domes, underground dwellings, and those homes that make you ask, “Why?” These are atypical for our market area, but they exist and they sell, so there is supply and demand and therefore a market. If there is a real estate market, then there is a market area. In the past 10 years there have been 11 sales of geodesic domes in the entire West Penn Multi List. So if someone wants a home of this style, where are they willing to consider - in other words, what are the boundaries of the market? An entire region. The more unique a property the wider the market boundaries and the need to expand.

For a less extreme look, lets consider log homes. These are not typical for the market, but certainly more common than domes. In the past 3 years there have been 11 log homes sold in Armstrong County. If a buyer is committed to this style of home, where will they consider? Given the relatively low supply, they would like consider the whole county. They might also consider looking in neighboring counties as well. They might also consider constructing their own. So, with such low supply why aren’t there log cabin sales people on every corner? Due to the equally low demand. Low supply and Low demand = stable markets.

Take away:

1. When a property is typical for a market, your market area can be as small as a single street.

2. However, when the property is unusual, the market area will expand quickly. Imagine for a moment being asked to sell 1600 Pennsylvania Ave NW, Washington, DC 20500. The White House. How would you determine a fair price? What would your comparables be? Aside from “priceless,” if we had to place a dollar amount, our comparable search would be global in scope, including historic homes from various countries and cultures.

When pricing a property consider the buyer motivations at work. Get in the head of the buyer pool and ask the questions they’re asking. Its the tough assignments that make you grow.

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.