Today's real estate marketplace is challenging some well-seasoned perceptions. Think about one of the cliche's you grew up with ... "beauty is in the eye of the beholder". Actually, from a real estate perspective the phrase is more aptly put "value is in the eye of the beholder". Over the years you've probably seen some very clever "Your House as Seen By" messages. They might have left you with an impression something like:
Here's Your House as Seen By .....
The Tax Assessor
Today, however, it's getting harder and harder for the "beholder" to have even the foggiest clue as to what real value is. Market value used to generally mean "what a ready, willing and able buyer, being under no undue pressure, is willing to pay, to a ready, willing, and able seller, under no undue pressure to sell." And loosely, of course, if there is a mortgage involved, it also depends on what the buyer's lender's appraiser confirms it's worth. With current market conditions being so volatile in so many areas, "value" is now considered a "moving target". To some degree, that's always been the case. Today, however, that's particularly true.
Amidst claims of undue pressure placed on appraisers to determine "value" to meet or exceed a particular price, there are efforts under way to decontaminate the appraisal process. In a recent post by Regina Brown, she explores how a New APPRAISAL law will affect every Realtor and Lender by May 1st!. This new regulation approved by the Federal Housing Financing Committee (FHFC) outlines the Home Valuation Code of Conduct which defines what lenders, processors, underwriters, agents, and others can and cannot do relative to the appraisal process.
Despite the measures outlined in this action, however, it's important to understand that the appraisal process itself, though well intentioned, is inherantly flawed. Though the appraiser (as well as the underwriter for the buyer's lender) has a critical level of influence over whether a loan is ultimately approved or not, we must not lose sight of the factors that color the appraiser's perceptions. For example:
Though the appraiser does view the interior and exterior of the property being appraised, and takes measurements, photos, and notes about that property, that appraiser does not see the interior of the properties s/he uses as "comparables" in determining value. Generally a "drive by" of the comparables is done with an exterior photo and observation of the comparable's "location", but they will not be able to observe the condition or floorplan of the comparable. Even if they were to get inside those homes, however, they would not be observing it as it stood at its time of sale.
Square footage is only part of the story. Two homes could have identical square footage, but with one home being "functionally obsolete" because of its layout, while the other of the same size has broad, flexible appeal. This can make a huge difference in the buyers' perception of value...after all, they're the ones who have to "live in the house"
There are factors that can make a huge difference on the salability of property that are often overlooked in appraisals. For example, were there strong odors (cigarette smoke, pet urine odors, strong cooking odors, etc). What about evidence of mold, damaged or stained flooring, severely uneven flooring? These are the types of things that appraisers are not privy to ... and they can dramatically impact the sale prices of those comparable properties.
Particularly in a slower market, when there are vary few "good comparables" because few homes are selling, appraisers are forced to either draw comparables from outside the preferred target area or to take comparables that had sold much longer ago than desired. The further away the property in time or distance, the more "ajustments" the appraiser must make to arrive at a value. The more adjustments, the more room for error.
The appraiser generally will use comparables that are most similar in terms of size, type of layout (single story vs 2 story, for example) and also the type of sale ("normal" arms length transactions vs "distressed" sales such as foreclsores, short sales, etc). Traditionally, when there are very few of these distressed sales, appraisers can bypass a "similar" property which was a distressed transaction because they have other comparables from which to draw. However, when the market has large numbers of such distressed transactions, appraisers may be forced into including those properties in their evaluations, which can have a significant negative impact on the value of the subject property. This calls into question the validity of comparing the motivation behind a transaction rather than simply the physical characteristics of the properties involved.
When the appraiser does his work, he begins with a copy of the sales contract on the subject property. In other words, he beings with the end in mind! He knows the contract price as well as any concessions being made by the seller. If an appraisal were really to be totally objective and unbiased, the contract price and terms would be irrelevant. Since, however, the appraiser knows what the buyer felt the property was worth, his job is more or less to "confirm" or not the buyer's determination.
Many appraisers operate in very large geographic areas. As such, they are very often quite unfamiliar with the nuances between neighborhoods that often determine why a buyer might select one area over another, even if the selected area is more expensive. A "similarly sized' property in the less desirable area would then have a negative impact on the appraiser's perception of the value of the subject property. In other words, sometimes they simply do not know what they do not know!
The appraisal process, in reality, is much more an "art" than a science (though appraisals by and large are weighted in the loan process as though they were, in fact, reliable science). It's important to also understand that an appraisl is done to protect the lender's interest in the transacton. After all, when a buyer invests 5% of a purchase price as his down payment, that means the lender/s risk is the other 95%. Though in many parts of the country real estate contracts do not provide for specific action if the appraisal comes in lower than contract price, particularly in today's precarious markets, it's prudent to include some condition to the sales contract stipulating that the property must appraise at or above contract price. This at least to some extent would open the door to some recourse in the event the appraisal came in low.
It's also important to remember that, regardless of what value is attached to a property today, it's a safe bet that the value may well be something different 6 months from now. It may be higher, it may be lower. But whatever "number" is attached to a property, it's real value to the owner has other measures. It's "home"; it's pride of ownership; it's a part of our American Dream. And particularly now it's good to remember that real estate has historically been a wonderful long-term investment as well.