As the Mortgage Bankers Association celebrated its 100th anniversary this year, it was interesting to think about the changes in the mortgage industry during all those years. The basis of lending really has always been the same. Offer for sale, negotiation of price, and an agreement; and often the inclusion of a financing institution to provide the means to the buyer who is not able to use personal capital.
In a perfect world, the buyer and seller set a price. A seller can come up with any number they want, but without a buyer to agree to it, it is all hopes and dreams. This has worked for 100 years and is an accurate description of what determines price. However, there seems to be a new path in the current housing market. There is an agreement on a price after some negotiation, and this price is honored if there is no financing. However, if a buyer is seeking financing, the appraisal now plays a very important role in that price. It has made the shift from being a subjective report to guide and comfort both the financial institution and buyer, to the definitive determination on value and, in more cases than ever, is now determining the price rather than letting the market decide.
The challenge seems to be the shift in weighting the collateral in a new way. In years past, appraisers were charged with finding the comparable that most resembled the subject property. Ideally, that comparable property was also close by and sold recently, but appraisers would expand their search for the home that felt and looked like the subject property to start. That property, coupled with similar properties that have been sold within the same year and usually within a one to two-mile radius in a suburban setting (that can be expanded in a rural setting or narrowed in an urban setting), produced a great report for the investor and buyer to feel comfortable with the collateral.
The weighting has now shifted from a comparable property that is similar to the subject property, to focusing first on the proximity and/or recentness of the sales. In some markets, this really does not change the overall outcome of the report. For example, in a large subdivision, this might provide the same, if not very similar, comparables to the subject property. However, in a lot of settings, this is a big, big change. Neighborhoods, streets, and even blocks can make a huge difference, and if recentness of sale is the weighted variable, you are bringing in sales that can be in different school districts, busy streets, or odd ball lots that turn buyers off. If using proximity to subject as the weighted variable, you can be bringing in houses that are very close by, but not similar in features. For example, comparing the value of a house with a finished basement to a house on a slab.
Appraisers are struggling with this because they might feel that the house two miles away that is nearly identical is the best comp property, but they know underwriting will want the house that sold two months ago, one block over, even if it is not remotely similar. Appraisers are between a rock and a hard place, and, after what they have been through the last few years, tend to err on the side of caution knowing that the report has to pass underwriting. This is good in practice, but the housing market continues to suffer because of it. It is hard for prices to rise without allowing the market to set the price.
Solutions are tough because we know the reality of having no oversight or regulation. In speaking with a number of appraisers, underwriters, buyers, sellers and real estate agents during the last year, one of the common thoughts seems to be an allowable margin built into the appraisal. If a buyer is looking at a home that is selling for $100,000 and the appraiser (using the weighted variables as stated above) brings the value in at $98,000, a margin of 2% would be all that is needed to meet the seller’s and buyer’s agreed upon price. A small margin could equate and compensate for all of the intangibles that are challenges on paper when it comes to appraising a home (i.e., we love this house because it’s a block away from our favorite bagel place and from us; that’s worth $2,000 easy!). Giving the appraiser the freedom to value the home as they feel is most accurate, but also allow them to comment via a standard allowable margin on the intangibles of the home, seems to be a step in the right direction. Of course, some might say that exists and it is called cash. Buyers can always make up the difference in cash and some choose do so. However in a jobs market that still hovers in the 7 to 8% range nationally, additional capital is not exactly flowing through most people’s doors.
Is a 2% margin the answer? That is tough to say, and there is certainly more to it than that when all said and done. But does it at least start a conversation, help the buyer and seller set an accurate market price, allow the financial institution to be comfortable with the collateral, give the appraisal some breathing room, and allow the housing market to continue to expand? I hope so.