Why the contract?

Why does the appraiser need the sales contract?

 

This is a question we hear over and over again.  It seems counter-intuitive, that if an appraiser is hired to come to an independent opinion of market value in a sales situation, that they would require a copy of the contract.  There are a couple reasons that the appraiser will request the contract.

 

One is that it is a requirement of the Uniform Standards of Professional Appraisal Practice (USPAP) to which appraisers must comply. Specifically, the appraiser needs to comply with Standards Rule 1-5 (a), which is:

 

When the value opinion to be developed is market value, an appraiser must, if such information is available to the appraiser in the normal course of business: analyze all agreements of sale, options, and listings of the subject property current as of the effective date of the appraisal; and (b) analyze all sales of the subject property that occurred within three (3) years prior to the effective date of the appraisal.

 

This is the development standard, meaning when the appraiser is doing the analysis portion of the assignment.  The reporting standard, the meat of what the public sees, applies to Standards Rule 2-2(a)(viii). In it, the comment section, third paragraph is:

 

When reporting an opinion of market value, a summary of the results of analyzing the subject sales, agreements of sale, options, and listings in accordance with Standards Rule 1-5 is required. If such information is unobtainable, a statement on the efforts undertaken by the appraiser to obtain the information is required. If such information is irrelevant, a statement acknowledging the existing of the information and citing its lack of relevance is required.

 

As noted above, analyzing and reporting on the contract is a requirement of USPAP. This is the primary reason you will be asked for a copy of the sales contract.

 

Another reason that you will be asked for a copy of the contract is to analyze what the meeting of the minds was, as the negotiation process can be meaningful. If the house was listed for $250,000 and there were five offers from $250,000 to $260,000 and it sold for $260,000, then the seller was in a very strong position and it is evidence of a seller’s market. If it was listed for $250,000 and sat on the market for six months, before getting an accepted offer at $200,000, then the buyer was in the best position. What if this house sold for $240,000 and the appraisers’ sales were from $220,000 to $245,000, and the value indication was $238,000?  What if the adjusted range of the sales was from $235,000 to $240,000, but the most similar of the sales was $240,000 and adjusted at the same?  Even if the indication from other sales was $238,000, that $240,000 was also supported, and it was the most relevant sale. If the appraiser opted for that $238,000 value instead of considering the negotiated contract between willing buyer and willing seller, they may be remiss. It is one data point in a series of other data points, and should be considered. Now of course, if the best indicator was $235,000 and there was only one odd sale supporting $240,000, we would expect the opinion to be at $235,000. There is normally some swing in range, in which one sale will stand out as better than the others. This is one of the reasons that the appraiser asks for a copy of the contract. It is also one reason that appraisers do not average adjusted sales prices, as there is often one or two sales that are more similar to the subject property than the others.

 

If the lender underwriters could make a decision based on the adjusted and unadjusted range of values, it would make this contract analysis less important. Unfortunately, a range of values has not been accepted by the government sponsored entities as a viable position, in spite of it being most relevant from the appraisal standpoint. As long as a point value  is required in the reporting of the value opinion (and required by USPAP), appraisers will need to keep analyzing the contract.  It bears repeating however, that an appraisal should never be a “bulls-eye” and if the value falls lower than the sales price, then it is quite simply possible that the property sold over market value. This happens in particular in highly undersupplied markets, or with buyers who are unduly motivated or lack knowledge of the market.  The appraiser’s role as the unbiased third party is critical at that juncture. Reading the tone of the market and completing a true market analysis is vital, as markets are fluid.

 

Regardless of whether the appraiser is able to obtain a copy of the contract, they still need to address what steps they took to obtain it, and they need to analyze the listings of the property. Although USPAP addresses listings current as of the effective date of the report, the Fannie Mae/Freddie Mac forms go further with the specific question “is the subject property currently offered for sale or has it been offered for sale in the twelve months prior to the effective date of this appraisal?”  That means that even if it is not offered for sale today, but was offered for sale six months ago at $200,000 and is now under contract for $250,000, there is going to be a need to discuss what happened in the interim. Did the market change drastically in those six months, such as the city being awarded the second Amazon Headquarters?  Did the house undergo substantial renovation? Was it taken off the market six months ago in order to mitigate the problem points with buyers, such as installing a new roof and a new kitchen after complaints indicated those were huge sticking points?  The appraiser is going to have to address it regardless, if the report is for mortgage financing.

 

Even though it may seem strange that the appraiser is requesting a copy of the contract, or even asking about prior listings, it is part of our due diligence process. It is a requirement of our professional standards.  Please be forthcoming with all information that has been negotiated, including any sales concessions or repairs that may be on a separate addendum. Afterall, it is part of what is required of the appraiser in their analysis of the sale.

 

What is a comparable sale?

 

You have been working with your buyer now for five months. They have written six offers and have lost out on each in a bidding war. A new house comes on the market which meets their needs, and frankly, they are tired of making offers and losing out on the deal. This time they decide to come in with an offer substantially above asking price in order to beat out the myriad other offers they expect are coming. The strategy works and they win the deal. Trouble is, they still have to obtain financing. The offer does include a three percent concession for closing costs, which the seller was happy to agree to considering they accepted an offer that was twelve percent higher than asking price. They were particularly happy as the only other offer they received was slightly less than asking. This happens. The seller’s agent is not under any obligation to say how many offers were received nor what the offer prices were. The weary buyer offered in good faith to secure the property. They simply did not want to lose out on yet another property.

 

Along comes the appraiser for the buyer’s mortgage lender. The appraiser studies the market, notices that the market has started to cool, and that instead of houses receiving ten or more offers at a time, now they are receiving only one or two, if any. Houses are starting to remain on the market a bit longer than they were. The sales the appraiser analyzes are good comparable properties, but they all sold slightly lower than the asking price for the property, and 12-14% lower than the agreed upon sales price. After analyzing the market and the sales, the appraised value falls short of the sales price by 12%, in line with the asking price. The question is, do you try to renegotiate the contract immediately, or do you take the route of requesting a reconsideration of value claiming the appraisal was inaccurate and submit several sales that you say are better than those included in the report?

 

How are they better?  Is it just that they sold higher than any of the sales the appraiser used, or are they actually comparable properties? Are they already addressed in the appraisal report? Sometimes there is a narrative section which addresses sales that were considered and were not included in the comparable sales grid for one reason or another. If you have the opportunity, read the appraisal report in its entirety first, as you may find the report had a compelling discussion related to why the sales included were the best available and how the value was arrived at.

 

A comparable property is one that is a substitute for another property. It is uncommon to have properties that are directly comparable since every house has something unique about it. A car analogy might help you in choosing comparable properties for your market analysis, or to provide appraisers on your sales when you meet them at the property (and no, we do not mind having sales offered as long as there is no expectation that we are going to use them, just consider them).

 

Most people will want to buy as much as they can for as little as possible. If you have a budget for a new car of $25,000, it is unlikely you would be out looking at BMW’s or Mercedes, whereas if you have a budget of $60,000 and want a German car, you are unlikely to be looking at VW Bugs. Is the VW Bug comparable with a BMW 5-Series? Not likely. Are they both German Cars? Of course. Would the buyer of a VW Bug choose a BMW 5-Series if they were the same price? Most likely. Would the buyer of the BMW 5-Series buy the VW Bug if they were the same price? Highly unlikely. You get the picture.

 

This is the same idea with comparable properties. While a buyer of a good basic 1,500 square foot tract house would likely jump at the chance to buy a 2,500 square foot semi-custom house if they were the same price, in equal locations, the converse would not be the case. The reason for these basic terms is that we have all seen agents provide appraisers “comparable” properties that are anything but. To be comparable, the likely buyers of one would have to consider the other, so it is not only that the buyer for the subject will consider a far superior property, but the buyer of that far superior property would want to be reasonably considering the subject.

 

What does this mean when you provide sales to an appraiser? First, look for what the typical buyer for your property would truly look at as a substitution. When you do that, look at those sales in the same vein, as whether your property would be a reasonable substitution. Sometimes there is nothing even approaching comparable to your property. In this instance, look to what else has sold that has some element of comparison, such as location, or quality and size, and then try to find something that is obviously not as good as your property as well as something that is better. In that manner, at least you will know that the property should be worth more than something and less than something. Appraisers will do this on those unique circumstances when there is truly no comparable property to chose from.

 

This bit of wisdom will help you choose the comparable properties for your market analysis, and give you a good basis of comparable properties for the appraiser should you wish to share them.

 

 

 

Who are you going to call?

…Ghost busters!

 

building-joy-planning-plans

 

Social media can be rife with misinformation, such as when the information presented is well intentioned, but of a national scope. National studies are not local studies, and blanket statements presented as fact are potentially misleading. Real estate agents are professionals who are involved in selling houses on a daily basis and know their markets — as well as what drives interest with the buyers and sellers they are working with. Their job is difficult; often rewarding, and they make lasting relationships with the people they have worked with. Most agents are “people persons” who thrive on human interactions, and on being able to make a difference in the lives they touch.  Agents do know what their buyers are willing to pay for certain features in certain markets and price ranges, but often do not approach the valuation process in the manner that appraisers do.

 

Take this ad for example. The agent had a great talking point related to how various remodeling projects can add to the appeal of a property and perhaps the eventual sales price, but the talking points were incorrectly presented. There are a few issues with this ad, one is that there are very specific percentages expressed, and another that there is no source citation for these percentages. The main issue however is, if a real estate agent is the right individual to state what adds value on a home appraisal?

 

odd question

 

While advertising is critical in today’s market, advertising specific percentages or numbers about specific remodeling projects gleaned from national sources, can be misleading. Stating that these features add value to an appraisal, and that the reader should ask a real estate agent about what adds value to an appraisal, is illogical. Instead, simply go to a source, such as your local appraiser and get an appraisal completed.

 

For the percentages above, we have no idea where this hypothetical property is located; what price range or market segment it is in, or what the source for information is. In addition, the numbers are so precise that they are not logical. If one were to replace a garage door for $3,000, would it truly add a return of 98.3% or $2,949?  Would that manufactured stone you put on the house, that some buyers will like and others hate, truly add 97.1% return? Do buyers even look at a property and say that they will pay $50.47 more per square foot than another house that was 95-sqft smaller? These types of advertisements are catchy, but they could also be misleading.  In addition, the ad clearly points the reader to contact a real estate agent to tell you how much value a renovation adds to a home appraisal. This too is illogical, since an agent is not an appraiser and the job functions are not the same.

 

A professional appraiser, who knows the local market, has the ability to both provide a current value, and a value “subject to” the proposed changes. Appraisers approach each problem to be solved in a competent, independent, impartial and objective manner. There is significant training and experience required to become a certified appraiser.  Real estate agents have a lot of specific training and education as well, but their roles are different and agents work on helping buyers and sellers achieve their goals of purchasing/selling real property. They are often functioning in multiple roles, such as acting as mediator, stager, chauffeur, diplomat and therapist. While they deal with sales prices, and know what buyers are willing to pay for properties, their view on the properties is much more “larger picture” than an appraiser specific, researched and analyzed determination.

 

When considering buying or selling a property, the agent is the first to call. When considering a remodel or addition and the effect on the value on the property, the appraiser is the first to call.

Bye-bye 1004MC, hello analysis

man-and-dog-jumping-in-air

On July 31, 2018, at the Appraisal Institute Annual Conference, Fannie Mae announced the end of the 1004MC. News quickly spread among the appraisal blogosphere, and on August 7, 2018, the new Selling Guide showed that the 1004MC was no longer required.

Rejoicing was heard throughout the land.

Although the 1004MC is no longer required by Fannie Mae, the appraiser still needs to support their opinion of market trends, supply and demand, and marketing time. The exact verbiage found in the 8/7/18 updated Selling Guide is:

The appraiser’s analysis of a property must take into consideration all factors that affect value. Because Fannie Mae purchases mortgages in all markets, this is particularly important for neighborhoods that are experiencing significant fluctuations in property values including sub-markets for particular types of housing within the neighborhood. Therefore, lenders must confirm that the appraiser analyzes listings and contract sales as well as closed or settled sales, and uses the most recent and similar sales available as part of the sales comparison approach, with particular attention to sales or financing concessions in neighborhoods that are experiencing either declining property values, an over-supply of properties, or marketing times over six months. The appraiser must provide his or her conclusions for the reasons a neighborhood is experiencing declining property values, an over-supply of properties, or marketing times over six months.

When completing the One-Unit Housing Trends portion of the Neighborhood section of the appraisal report forms, the trends must be reflective of those properties deemed to be competitive to the property being appraised. If the neighborhood contains properties that are truly competitive (that is, market participants make no distinction between the properties), then all the properties within the neighborhood would be reflected in the One-Unit Housing Trends section. However, when a segmented or bifurcated market is present, the One-Unit Housing Trends portion must reflect those properties from the same segment of the market as the property being appraised. This ensures that the analysis being performed is based on competitive properties. For example, if the neighborhood contains a mix of property types not considered competitive by market participants, then a segmented or bifurcated market is present. The appraiser should also provide commentary on the other segment(s) of the neighborhood when segmentation is present.

What does this mean to the residential practitioner operating in the mortgage space? It means that the requirement for analyzing the market remains, and it is now up to the practitioner to support their opinion, without the benefit of a flawed format. Appraisers can now choose how they present their analysis, which may include multiple sources to support an opinion. Fannie Mae is clear that the one-unit housing trends section should reflect properties that are directly competitive with the property being appraised. The following information relates to several different ways to support trends, but is not an exhaustive list.

Appraiser developed trends

sample macro image

The data array above considers all sales other than the “to be built” properties in a specified school district, over a 20-month period. The sales are run year-to-year, advancing on a monthly basis. This way it is possible to see changes in a subtler manner as opposed to year-to-year study, when related to any adjustments that are made for changing market conditions. For example, comparing a property that went under contract in April 2018 to the appraisal effective of August 13, 2018, lines 16 and 20 would be compared. This can be used in combination with the submarket chart, to see what is happening with the market. Ideally both median prices and price per square foot are analyzed.
The columns in the chart relate to the timeframe, number of sales, the median list and sales prices, the list to sales price ratios, gross living area (GLA) and price per square foot (PPSF). The reason that GLA and PPSF are included relates to changes in size affecting sales prices. The final two rows in the chart relate to how many listings are active and under contract as of the date of the study, referred to as the “contract-to-listing ratio” which is relevant. In my opinion, this is one of the most relevant pieces in the analysis, as indications of change are noted before sales close. It also supplies information related to supply and demand.

price over time
Laying the sales price information out in a chart can help the visual reader as well.
It is evident by observing this data, that the market has increased over time — from $328,000 to $355,000 or 8.23% (row 8 to 20) — but in the past year, not as substantial an amount, from $349,900 to $355,000 or 1.46% (row 8 to 20). Price per square foot has increased from $148.08 to $160.49 over the 20-months period (8.38%), and $156.72 to $160.49 year to year (2.41%). What this shows is that, although there was an increase of over 8% in the measured period, the past year does not show as marked an increase, and it could be construed as stabilized or stabilizing, based on the appraiser’s analysis, in particular after studying the current contracted sales.

There is another piece to this puzzle, and that is how many houses are showing as under contract in this macro market, and what the supply looks like relative to demand. This is the “contract-to-listing ratio” which shows 90 houses on the market total, with 22 under contract. This is a ratio of 24.44% in this segment. Through employing this type of analysis on each appraisal report completed, it is possible to see a shift in the market start to occur, before sales prices reflect it. In my market, 24% of sales under contract is indicative of a normal market, one that is neither favoring buyers or sellers. What is also extremely meaningful is the listing prices of the houses under contract compared to the listing prices of the previous segments sales. The listing prices of those properties under contract are now $10,000 lower than the list prices of the previous period, in spite of a small increase in median size. This tells us that we may have a price correction occurring, but before closing, we cannot be certain. We can however use this information and explain to our client, what we see happening in the market.
Fannie Mae wants to see the specific market segment, and not necessarily the macro market — although that is relevant as well since understanding the larger macro market is necessary before an assignment specific market can be analyzed. The submarket in this instance shows an increasing market in prices, but the median asking prices of the contracted sales are 13.33% lower than the asking prices of the previous segments sales. This is in part due to a decrease in median gross living area, and also in part due to a much smaller segment of data for analysis. Nevertheless, the market also shows a greater absorption of these properties than the macro market as the contract to listing ratio shows over forty percent of the properties offered as under contract. We could easily see this market as either stable, or still increasing slightly. It is up to the appraiser to explain their thought process on the conclusion of market trends.

sample micro
It is possible to structure something similar to what is reflected in the chart above with whatever is considered relevant by the appraiser doing the analysis. The appraiser might wish to do year-to-year, month-to-month, monthly, weekly, or whatever period the appraiser considers relevant. Whatever is chosen provides support for the appraiser’s opinion as to market trends. In the event of a change in the market, we have some evidence-based data supporting our market trends conclusion.
Additional sources
As much as we might want to rely on our own data, there are other sources available that can also help with a determination of market trends. Using the same hypothetical property above, it is easy to pull various sources such as Realtors Property Resource (RPR), Realist, Trulia, Movoto and others.
The RPR sample below uses a sale in the same area above, and shows the following graph. The property price increased over time, but is generally stable over the past year. The zip code shows an increasing price, and the county prices increasing steadily, as to, the entire state of Michigan. This is useful additional data to include either in the report itself, or in the workfile for posterity.

RPR sample
Most appraisers have access to both RPR and Realist via their MLS. An example of market trends from Realist is shown below. This data is not related to the subject submarket, but does include the zip code and city, as well as county, showing mixed trends data compared to the appraiser developed data addressed above. If one relies on this information, the market shows as increasing after a dip over the winter.

realist

Trulia, Movoto and other similar applications are not able to differentiate between the submarket and the overall market, but are useful and provide additional sources of support. Movoto enables the user to observe data trends over different segments of time, and by price per square foot as shown below. It also allows segmentation between single family properties and condominiums. Examples of properties in the same market as the sample discussed throughout this report are shown below.

movoto
(snapshot from Movoto on price per square foot over 2-years)
Trulia allows the user to identify the number of bedrooms, or include all sales.

Trulia
(snapshot from Trulia for Dexter)

Sale/resale
Another way to support change is to observe sales that resell in a defined period. This is particularly useful when the subject property has a recent prior sale. It helps provide a basis for where the property was at the time of the prior sale, compared to the market today. Most MLS have a data export ability, and it is simple to set up a search within your parameters, observe any sales that resold, and then compare possible changes between the sales periods. My research in this market isolated two sales that were within my search parameters over a 2-year period. One set sold 4/17/17 at $399,500 and then again on 4/9/18 for $647,500. That is an increase of 62% and unlikely market appreciation. Looking at the MLS comments and photos, the difference relates to the first sale as a more original property, somewhat tired to today’s standards. The second sale shows a gut-rehab with HGTV style bling. I could use this sale/resale as evidence of value added for a significant remodel, but would not want to rely on it for market change.
My second set of data included a property that sold 8/9/16 for $411,500, and then again on 6/27/17 for $439,000. This is an increase of 6.68%, but the most recent sale was over a year old. The only change noted was a new roof in the interim. Given the data shown in the charts above, the increase was in line with the submarket increase and is further support for the increase that was occurring before January of this year, but does not provide good information for the current trends.
Conclusion
All of this information combined can help support the opinion of where the market is as of the effective date. More importantly, it can help defend the report in the event that the market changes and the appraiser is accused of having ignored market conditions that were noted at that time.
Many participants in the market are concerned there is a shift that is inevitable, either on the immediate horizon, or off a few years. In any event, with the elimination of the 1004MC as a requirement, appraisers are not absolved of supporting their opinion of market conditions at the time of the appraisal report, and all of these tools, and others, are available to the appraiser to better help support the decision.
Let’s view the elimination of the 1004MC as an opportunity to really shine and support our work. After all, we are the neighborhood experts, but we need to be compelling in our decisions when faced with increased computer models and data alternatives. This is our opportunity to show the value that we bring as analytical researchers.