In business, as elsewhere, we’re often
involved in setting values . . . certainly the heart of human enterprise. The appraisal is vital, and this is so whether
you’re purchasing an ornamental clock from an antique store or foisting off
Aunt Emma’s Christmas gift on an unsuspecting shopper at your yard sale.
Nowhere is establishing value more important
than in real estate, where the numbers get big.
This deserves to be discussed. The
American Institute of Real Estate Appraisers, affiliated with the group known
as "Realtors," has effectively promoted real estate appraisal over
the years. The techniques are well
established and, on the whole, are valid and valuable when properly conducted
and interpreted.
Though there are probably some incompetent
appraisers around, the really bad property valuations that occur cannot
normally be blamed on lack of appraisal talent.
The actual reasons go deeper. Even
though a well-established Code of Ethics stressing the highest standards of
professional conduct exists in the appraisal industry, abuses are not only
possible, but often guaranteed. The
reasons are not hard to understand.
Consider this example: The services of an
appraiser are recommended by a real estate agent who receives a commission when
the property sells. There’s anticipation
by the agent that the value placed will benefit the sale and, conversely, an
expectation by the appraiser of future referrals. Is it unreasonable that the final valuation
may reflect factors other than the objective and unbiased conclusions called
for by the Code of Ethics? Is this not
even more evident if the appraiser is selected by a developer seeking to market
a number of properties or by a mortgage loan broker intent upon placing a group
of loans with an investor?
It’s also common practice in the
residential resale market for appraisers to rely upon local brokers to provide
sales information to assist them with their work. Consider the varied interests of these
brokers. Either to promote their own
sales, or to undermine a competing agent's listing, badly chosen
"comparable sales" are often passed to the appraiser, and it’s upon
these values that the final appraisal may depend. The following tale may not be typical, but it
illustrates how the process can malfunction.
This is a true story of a hilltop house in the fashionable community of
Dana Point in southern Orange County, California, regarded as an area of desirable
homes.
The house sold in June of 2008 to an
admittedly unsophisticated buyer at a price of nearly one million dollars. At the time of purchase a major savings bank
obtained an appraisal in connection with a mortgage loan to be placed on the
property by that institution. The fee
appraiser gave a valuation of $999,500, and cited three comparable properties
to justify the figure. On that basis,
the purchaser made a down payment of $298,000 and obligated himself on a
mortgage loan of about $700,000.
Several months following the purchase the
buyer arranged for a second appraisal, this time with an independent appraiser,
to see how his investment was holding up.
To his dismay, he discovered the property's value to be in the $600,000
range¾some $400,000 less than his purchase
price. The details of this second
appraisal revealed that between January and April of 2008, six comparable homes
sold in a price range of $579,000 to $644,000.
In addition he learned of an overstating of the house’s size by nearly
20 percent, and that two of the three comparable sales used had been more than
eight months old during a period of rapidly declining real estate prices.
The claims, charges and recriminations that
followed, together with the legal actions involving non-payment of the
mortgage, foreclosure and eviction, constituted an exhaustive effort. But what must not be overlooked in all the
turmoil is that the system is designed, in a perverse way, to function in this
manner.
And while we try to sort things out, there’s
another piece to fit into the puzzle.
The status of the appraiser as an in-house
employee rather than an outside fee appraiser can affect the valuation. A most striking example of this is the
Property Tax Assessor who, though posing as an impartial arbiter, is little
more than a governmental functionary in the tax collection process. It takes no great insight to deduce the
Assessor's position in establishing property values.
If there’s one thing to recognize concerning
real estate and its valuation, it’s that the outsider, or casual dabbler, is at
an inherent disadvantage. When you find
yourself involved, you must either develop expertise quickly or hire a reliable
expert to represent your interests. Sad
to say, this is more easily said than done, with "reliable experts"
often hard to find. One place not to look is in a law office;
attorneys may possess certain capabilities, but property valuation is not among
them. Neither can the local real estate
broker be depended upon, even though he or she may have intimate knowledge as
well as access to all the data. This is
because the broker's intentions must, by necessity, be questioned. Many of the truly successful real estate
agents learned early on to play the game tight-lipped and close to the vest.
Finally, merely retaining an independent
appraiser is no assurance of complete and competent representation, though it’s
probably the best that can be done in most cases. In circumstances where truly professional
appraisal service is warranted, what should be found is an experienced, fully
communicative member of the American Institute of Real Estate Appraisers
holding the designation M.A.I. As to
"fully communicative," this means one willing to dispense with
professional folderol and provide information
in basic and understandable terms. With
that achieved, you must then take as active an interest in the process as you’re
able, and hope for the best.
A last word to the wary: Whether it be real
estate, gemstones, colonial furniture, or Rembrandt masterpieces, the appraisal
must be suspect. A corollary to Murphy’s Law is accurate: If all the involved commission and fee
participants agree upon a price, it must be the wrong one.
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If you enjoy this weekly Straight Talk by Al Jacobs, you’re invited to check out my monthly Financial Newsletter, as well as my new book, The Road to Prosperity
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