The real estate appraisal system is broken and needs to be fixed.
The fundamental problem is the conflict of interest among the lender who selects the appraiser, the borrower who pays for the appraisal and the investor who relies on the adequacy of the appraiser’s opinion. Lenders are in a powerful position to pressure the appraiser to “hit” pre-ordained numbers since, as a group, lenders don’t suffer the consequences of inflated valuations. Rather, the loans are sold to investors, who have become so mesmerized by the prospect of high returns that they’ve willingly ignored the reality that too many of the loans are justified by fictional appraisals.
Realtors are culpable as well since they can become complicit in these scams either actively through added pressure on the lender or appraiser or passively through the guise of feigned ignorance that the appraisal is fictional. This complicity isn’t surprising since the Realtor’s motivation is not to protect the borrower or investor, but rather to ensure the sale, which results in compensation to the Realtor. The borrower, who trusts the Realtor and participates in the process only very infrequently, has no idea that the system is rigged or that the appraisal serves only to create the illusion in the buyer’s mind that the property was purchased at a fair-market price.
A better approach would be for the buyer to select the appraiser and purchase and pay for the appraisal for the buyer’s own purposes and peace of mind. The buyer’s choice of a home inspection and presentation of the inspector’s findings to the seller offers a possible model for this approach. Granted, that system isn’t flawless or free of undue influence, but it’s less dysfunctional than the current appraisal process is.
Lenders should hire in-house appraisers who are employees and who work to protect the lender’s interests. If the lender and appraiser believe a drive-by or automated valuation is adequate in some circumstances, that choice should be theirs, but they shouldn’t rob the borrower of an independent opinion of value.
Investors should insist that lenders disclose the criteria they’ve used to select the appropriate type of appraisal and the types of appraisals that were obtained on packaged loans. Historical data should be collected to measure the risk of default on loans originated with various types of appraisals, and investors should then utilize that information in their own assessment of investment risk.
Federal and state laws that require appraisers to be trained and licensed were enacted years ago after the savings-and-loan crisis. Those laws were a reasonable approach at that time, but that was then and while those laws are still on the books today, they haven’t accomplished the desired results. More regulation clearly isn’t the answer to this problem. However, more enforcement of current laws and more regulatory audits of appraisal practices would be most welcome, especially in states where appraisal fraud has been identified as a widespread problem.
A new Web site, My-currency.com, has proposed a solution that tries to tap the collective wisdom of multiple people to derive an opinion of a property’s value. The idea may be applause-worthy as a novelty, but whether more opinions will result in better valuations in addition to revenue from online advertising remains to be seen.
Groups can make sound decisions, but a more likely outcome may be a sort of group-think in which the first expressed opinion sets a focal point for general consensus. Worse yet, the approach seems to invite gamesmanship in which ill-qualified people attempt to play the system for their own ends. Whether a large enough population of experts will participate on their own time simply to earn bragging rights as the chief pooh-bah of valuations also remains to be seen.
Meaning no offense to My-currency.com, what’s really needed is not another clever Web site, but rather a restructuring of how appraisals are bought, paid for and used.
Finally, appraisers need to rethink their traditional approaches to valuations in a world of fast-paced housing markets, instantaneous information, AVMs, online home valuations and the like. The market feels at liberty to pressure appraisers because their methodology doesn’t make enough use of pricing trends, new construction, rental income and other market-based factors along with the almighty recent sales of comparable properties. A much more sophisticated appraisal, even at a higher cost, would make the appraiser’s work product more valuable to borrowers, lenders and investors alike.
Marcie Geffner is a real estate reporter in Los Angeles.
Copyright 2007. Marcie Geffner. All rights reserved. No part of this article may be used or reproduced in any manner whatsoever without written permission of the author.
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