Should Computers Replace Appraisers?
In the effort to create paperless transactions and cut closing costs we’re getting rid of appraisers. That sure sounds like a good use of technology — unless knowing the value of a home is important to you.
An “appraisal” can be seen as an independent judgment of value by someone familiar with the local marketplace. An appraiser is typically hired by a lender and paid by a borrower to determine a property’s fair market value.
In recent years we have evolved new underwriting standards such that appraisers do not stop by each and every home to certify their value. Instead, lenders are increasingly satisfied with automated computer valuations and drive-by viewings. (With a “drive-by valuation” someone zips past a property to assure it’s actually there, but does not enter the home. In the not-too-distant future look for drive-by valuations to be replaced with satellite photos that are automatically fed into lender computers.)
The theory is that most homes in given neighborhoods are somewhat alike and so values are largely similar. If you have a townhouse subdivision with 1,000 units, all “Ashwell” models will likely cluster around one price while the larger “Glendale” units will generally have an average price of their own.
As far as lenders are concerned it doesn’t really matter if an appraisal is or is not precisely accurate. What counts for lenders are actuarial numbers, betting that the odds are very much on their side.
Imagine that a lender originates 1,000 mortgages. The overwhelming number of these loans will either have 20 percent down, or buyers will be required to obtain FHA, VA, or private insurance coverage. Given such protection, and given rising property values because of inflation, if an owner does default a lender has virtually no chance of losing money. And, if a lender does lose money, the loss can be spread over those thousand loans, applied against a loan reserve, and used as a business tax deduction.
The situation for homeowners is different.
Homeowners don’t have private mortgage insurance or government programs to back them up — in the case of default lenders are the beneficiaries of such policies, not owners. If an owner is forced to sell a home at a loss the financial damage is real. Homeowners don’t have a loss reserve, they have a loss, and a loss from the sale of a principle residence is not deductible (it’s not a business expense).
Moreover, average prices even for generally similar properties may hide cost differentials worth thousands of dollars. An “average” price may represent a discount for one buyer and an overpayment for another.
Thus there are two conflicts.
One clash stems from the fact that lenders and consumers have different interests. It’s in a consumer’s best interest to get an appraisal by an actual human because that is the best way to assure that a home is not over-priced.
The second conflict is between common-sense and human nature. We all want a bargain. Automated computer valuations and drive-by reviews are cheaper than full appraisals, but we would be better off with a real appraisal. In too many cases, expediency wins — especially when the full consequences of an incorrect valuation are not fully explained.
Today we have a growing array of sites and services, both online and off, that have taken the automated computer valuation process one-step further. Big headlines announce that you can now find the value of your home at little or no cost. Little tiny type offers 600 reasons why the estimate is unreliable and useless.
One problem, of course, is that a property may be undervalued — bad news for sellers who ignore the small print and rely on such services to price their homes.
Under-valuations can result from any number of factors, including incorrect public information (the wrong number of bedrooms, baths, and floors), misleading public information (homes sold for “$1 and good consideration”), and incomplete information (the failure to include recent sales, not factoring in that school closing decision made last month).
Under-valuations are one problem, but so are over-valuations.
Standard & Poors has looked at automatic valuation systems and here’s what they found: “Systems can be extremely accurate for some property characteristics or geographic locales, and inaccurate for others. In some cases, a system may overestimate a property value by as much as 200 percent.” (See: Automated Valuation Systems Need Proper Review by S&P, February 29, 2000)
But there’s a third problem with automated systems that ought to concern consumers.
Even if sale price information is literally correct, it may not provide the negotiating data consumers need. For instance, it may well be that a home “sold” for $300,000. But it might also be true that the seller included a washer and dryer, replaced the roof, paid a 6 percent “seller contribution” ($18,000) at closing, and painted the entire house as a condition of the sale. In effect, the reported price was inflated to include terms other sellers might not offer. If a buyer pays $300,000 for a like house on the same block without such concessions, he or she will pay far too much.
I tried several valuation tools for my home and found some interesting results.
The last sale on my street was shown in one report as dating from four years earlier — news sure to interest the families who have moved here during the past several years. My home was valued by one service within a range where the bottom and top figures were separated by more than $75,000 — so do I sell at the top of the range and perhaps overprice or at the bottom of the scale and possibly lose big dollars? One service showed prices for allegedly-comparable homes — but none were on my street and the examples given were eight to 14 months old, despite the fact that I live in an active market area. My home, I was told, had a given amount of livable square footage, a debatable matter but about 43 percent less than what I calculate from my purchase survey.
What to do?
- Why do we license appraisers if anyone with a computer program can also offer property valuations? It may be useful, as one example, to look at Oregon’s appraisal rules and consider how they deal with the issue of property valuations by unlicensed and unqualified individuals.
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If a licensed appraiser boots a valuation you just know that the next day attorneys for the lender, the buyer, and the seller will be in touch. What about those who operate automated valuation systems? Should they have a liability? If not, why not? If yes, how much?
- It’s time to end the tiny type game. To be valid, property valuation disclaimers should be in a type size no smaller than the text used to describe the program. The disclaimer should be positioned so that a reasonable person can readily and easily find such warning language.
- It may be claimed that the various services now being offered are not called “appraisals” and thus should not be subject to the same standards as licensed appraisers. But do consumers know the difference? Is the difference seen in big type? How are such services marketed? Do consumers see such services as anything other than a way to determine the worth of a given property?
A drive-by valuation should be seen for what it is: Not an appraisal. It assumes that the interior of a home does not add or subtract from the final market price of a residential property, an unsupportable assumption. As an example: When a kitchen fire in a rental property did damage worth more than $10,000 there was no visible evidence of damage from the street.
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Consumers should get that for which they have paid. If a lender relies on a drive-by valuation and charges for a full appraisal, then the consumer should be assessed the lender’s actual cost. And if a lender charges for a full appraisal but only uses a drive-by, then bank regulators and state attorney generals should determine if bait-and switch, fraud, and deceptive practice statutes apply. The appraiser’s actual, full and final invoice should be presented to buyers at closing. (Lenders ask for a bunch of verifications, so why shouldn’t they get a discount?)
- Consumers as a matter of right should automatically receive copies of appraisal reports at the same time as lenders. Buyers should get ‘em because they’re paying the bill. Sellers should also get copies because they’re allowing appraisers on their property, properties that buyers don’t own yet — and maybe never.
A good use of regulatory time and money would be to survey valuation sites and services, both online and off. Perhaps provide annual grants for real estate educators to compare 100 recent sales with valuations done by automated systems. The results, of course, should be published.
In addition, appraisal groups should conduct and publish surveys which compare recent sales with computerized valuations from various automatic services. No doubt members would be eager to volunteer, and industry associations would be doing something important for their members — and for the rest of us.
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Published originally by Realty Times on June 6, 2000 and posted with permission.
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