This one is long, and boring, and important. I’ve had yet one more borrower hurt by a broken system, and really want to find a solution to this.
You may not know that I used to be an appraiser. In fact, I founded what eventually became one of the largest real estate appraisal firms in the Bay Area, with three offices and 25 appraisers at our peak. We handled about 30,000 appraisals over 14 years, and I trained over 100 very competent, ethical appraisers over that time.
I was certified with the highest-level designation in the state, and I was recognized as an expert witness to testify in court cases by the municipal court system, superior court system, and federal bankruptcy court.
Back then most lenders allowed their loan officers to choose the appraiser. The system had a huge built-in flaw: if the appraiser didn’t give the originator the value needed to make a loan work, he didn’t get any more business. Consequently, we (my particular company) built our business working for larger firms who only allowed their QC department to choose appraisers, so we weren’t under that pressure as much as others.
But most of the work in the industry wasn’t done that way, and appraisers were regularly pressured to inflate values.
The natural consequence was that a large percentage of the appraisals were grossly inflated, and lenders didn’t have the security that they thought they did on paper. This worked out OK as long as real estate continued to appreciate, as the appreciation covered up the bad appraisal work.
Fast forward to changes in the law that came about in the last few years. Now the loan originator has no say in who does the appraisal. (This is good.) The lender’s QC folks have to order the appraisal. They can maintain their own list of qualified independent appraisers, but most choose to order appraisals through an Appraisal Management Company (AMC), which maintains its own panel of appraisers, and assigns the work out.
The benefit to the system is that appraisers are no longer pressured to inflate values. However, like all solutions that are based on regulation and enforcement, rather than education and culture, it has had an unintended negative consequence.
In theory the objective of the AMCs is to provide high-quality appraisals to the lenders. An appraiser must do three things very well in order to consistently produce high-quality appraisals: thorough research, thoughtful analysis, and clear reporting. This means they have to:
- Find and consider all of the comparable sales and listings that might be relevant and speak to the real estate agents involved in each of the transactions that are most relevant.
- Thoughtfully analyze the differences between the comparables so that they understand how buyers and sellers are evaluating different features and benefits.
- Write a report that clearly explains why the comparables sold for different prices from each other and make adjustments to each to reflect what typical buyers and sellers in that particular market would do if they had been negotiating for the subject rather than the comparable sale.
As it turns out, it’s a lot of work to do all these things, and do them well. But it’s their job, so as long as appraisers choose to earn money by appraising, they should do all these things. But here is where things get dicey.
AMCs also want to make a profit; it’s a business, after all. In practice, they can best maximize profits and please lenders (who direct the work to them) by finding the appraiser who will do the appraisal the fastest and for the lowest price. (This leaves them more of a profit margin, and the fast turn time lands them in good favor with the lender.)
So the appraiser, in order the get the assignment from the AMC, has to quote a very fast turn time and a low price, both of which are not exactly in alignment with producing a high-quality appraisal. In fact, I can tell you from my experience with appraisals in the last few years that many appraisers take every short-cut they can to minimize their time on the assignment and turn the appraisal around as quickly as possible. But they have learned that an underwriter will review their work and, if the underwriter is afraid the value is too high, ask for additional work (like more comparables, more photos, deeper explanations, etc.)
What’s an appraiser to do? The simple answer is they have learned that if they remain conservative they will be asked for fewer conditions. Since we, as originators, don’t have any say in whether they get work in the future or not, they don’t have to worry about what we want. (And that’s a good thing, except for the unintended consequence.)
So the difference between the old system and the new system is that in the old system there was very explicit pressure for appraisers to inflate values in order to get work in the future. In the new system there is very real, but implicit pressure for appraisers to deflate values so that they can make a decent living.
In the old system, in theory lenders were hurt by making lending decisions on inflated values. I think it could be argued that complete insanity with regards to loan programs hurt them far worse, but that’s another blog.
In the new system it is borrowers who are being hurt; real people paying good money expecting a quality product in return, who instead get an appraiser who only looks for lower-priced comparables (to minimize research time and – by being conservative- minimize conditions), makes a cursory inspection, and writes a generic report that raises fewer questions that might warrant further conditions.
In about one-half of the appraisals that have been done for my clients in the last three years, my client paid good money for horribly substandard work. In some cases we could do the loan anyway, but it often cost my client more money because the loan-to-value ratio appeared to be higher than it really was. Each time I chose to appeal the appraisal the appraiser’s response was “blow it out your ear,” and the AMC’s response was “there’s nothing we can do.” (I’m paraphrasing, but not by as much as you might think.)
Remember, I trained over 100 appraisers and held the highest designation in the state as an appraiser. I only appealed if I thought the appraisal was indefensible.
In some cases we ordered a second appraisal (at additional cost to the borrower) and the second appraisal was more realistic, and the loan was completed. In one case the first appraiser came in at $319,000, and the second came in at $440,000. The first appraiser missed a recent comparable sale ½ block from the subject, and refused to consider it after the fact.
So what does all this mean?
- Real people are being hurt badly by the broken system. Homeowners are paying $450 to $500 (on average) and are often getting very low quality product in return. In some cases they have to pay another appraiser to get a good product, or have to pay more for the loan as a result of the bad appraisal; in other cases they simply have to walk away, they lose the initial fee, and don’t get the loan.
- The AMCs are caught between a rock and a hard place. In order to make a profit they need to keep as much of the fee as they can (so they need someone to work cheap), and not invest more time in working on the appraisal after the fact (so they need quality.) And when an appraisal is bad and is appealed, they can’t make the appraiser redo their work. If the appraiser digs in their heels, the AMC has to either defend the appraisal (which takes time for which they are not paid) or order a second appraisal at their cost.
- Loan originators and lenders are being hurt, as they have to invest more time into most of their deals in order to get the deals finished, and work on some perfectly good loans that never close because of the low quality appraisal work.
In other words, there really are no winners in today’s system, although some folks are hurt more than others. (Consumers, for instance, have no control over the situation and are being forced to pay for bad product.) The appraiser, while not exactly getting rich, at least gets paid for his or her work no matter how bad the product is.
What is the fix?
- If lenders (via their QC department) managed their own panel of appraisers (rather than use an AMC) they would be more directly involved in the process and could better monitor the quality of the reports. The AMCs provide too much distance between the appraiser and the lender for lenders to see clearly what is wrong in the process. One major lender already does this, and has far fewer issues as a result.
- If an appraiser consistently comes in too low or too high, the lender could remove him or her from their approved panel.
- Lenders should report appraisers to the Office of Real Estate Appraisers (OREA) if they produce values that are too high or too low on a consistent basis. Appraisers would soon find that the time they have to spend defending bad work is more onerous than the time it takes to do the job right in the first place.
- If AMCs do remain as middlemen, they need to be separately licensed and regulated. (This is in the works in some states.) If a loan originator submits a request for reconsideration of value and the appraiser simply dismisses the additional market data submitted, the originator could then submit the case to an independent review board for appeal. If the review board rules that an appraisal was poorly done, the AMC would have to order a second appraisal at their cost.
- In the above scenario, I would have the originator pay the (reasonable) cost of the appraisal review board’s review process. If the review board decided in the originator’s favor, the AMC would be required to reimburse the originator.
In this system an appraiser would be selected not on the basis of price, but on the basis of consistent quality. I’ve heard some appraisers argue that their prices would have to go up if they did their job the way I think they should. I’m not convinced that would be necessary, but if they did rise, that would be fine. What matters most is serving consumers honestly and ethically, something that isn’t being done today. The current price for an appraisal, if it is too low, isn’t serving anybody well.
What do you think? I welcome comments on this thread.
My name is Casey Fleming. I originate mortgage loans in California, and am based in Silicon Valley.
I am also the author of The Loan Guide: How to Get the Best Possible Mortgage
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