Does Using One or More REOs in An Appraisal Affect Home Sales?

Even though most appraises are competent and submit appraisals that are complaint to Uniform Standards of Professional Appraisal Practice, why are others struggling to value a property accurately? Image: Fotolia

The real estate market is slowly recovering nationwide, but several hurdles still exist such as tight mortgage credit and valuation problems in some appraisal reports are impacting the home sales process.

A National Association of Realtors survey found that although 65% of Realtors out of 3,000 responses reported no contract problems related to home appraisals, 11% said a contract was cancelled because an appraised value came in below the price negotiated between the buyer and seller.

Also, 9% reported a contract was delayed and 15% said a contract was renegotiated to a lower sales price as a result of a low valuation.

“Though the real estate recovery is taking place, the combined issues of stringent mortgage lending requirements and appraisal frictions are hampering otherwise qualified buyers from purchasing a home in a timely fashion, and in some cases are preventing them from buying at all,” said Lawrence Yun, chief economist for the National Association of Realtors.

Even though most appraises are competent and submit appraisals that are complaint to Uniform Standards of Professional Appraisal Practice, why are others struggling to value a property accurately?

First, some appraisers are using foreclosures, short sales and run-down REO homes as a comparable in their appraisal for a nondistressed property. Those appraisers who are using these types of distressed properties as a comparable are not making proper adjustments for them being foreclosures or short sales that are in a run-down condition.

“There is a clear difference between the value of a distressed property and nondistressed homes, and some appraisers do not currently distinguish between these types of properties when making comparisons for valuation purposes,” the trade group mentioned in the survey report.

If an REO is used as a comparable in an appraisal, they are mostly sold at market value and don’t reflect conditions such as rising prices, the presence of multibidding and low inventory. According to NAR, a typical foreclosure is sold for an average discount of 20% relative to a traditional home in good condition, while a short sale is discounted by 15%.

“One of the big misconceptions of an REO sale is that the bank or owner—the investor—really wants to sell these properties quickly. But these are real dollars that go back to the investor so it’s vitally important that the asset manager realizes that every dollar counts,” said Roger Beane, CEO of LRES, a national asset management company and an REO outsource company. “The job is to get the most amount of money for that person.”

In the first quarter of 2013, the appraised value to sold price percentage for a sample of 212 appraisals done by LRES was 100%, while the list price to sold price was 102%. A year ago, based on a total sample of 178 properties, these figures were 99% and 98%, respectively.

Despite problems reported by NAR, LRES is not having too much trouble selling a home this year, as it is taking the Orange, Calif.-based company only 130 days to close a sale in the first quarter of 2013 compared to 244 days a year earlier.

Furthermore, out of that quarterly sample LRES provided this publication, the average days on market fell substantially on an annual basis, down from 142 days in 1Q12 to 57 days in 1Q13.

Another problem why appraisals are not being done properly is due to pressure from a lender or AMC to complete their reports in a short timeframe without doing the proper research that is needed to know the repair costs for an REO home, particularly if they are used as a comparable.

Tom Munizzo, president of Westwood, Kan.-based Accurity Valuation, told Mortgage Servicing News in an interview that many appraisers value an REO property incorrectly to begin with, therefore causing banks to wonder why they can’t move their distressed properties. He said appraisers are submitting a report to the lender without accounting for the contributory value of the repairs, which skews the value opinion.

For example, Munizzo said one house on a street that was appraised for $90,000 may need substantial home improvements that cost $15,000. But rather than just deducting this amount and submitting an appraisal for $75,000, the appraisal should really be valued at $60,000 to account for the contributory value, which is $30,000 less than the original appraised value.

“What happens is that you have a number of appraisers who come into a market and overvalue their REO properties in their present shape because the appraiser didn’t contribute for the contributory value,” Munizzo said. “A very important flaw in the valuation process for REO properties is the assumption that an appraiser or even the REO broker is estimating those repair costs correctly.”

“Anybody whose dealing with real estate owned properties needs to be aware and employ the correct techniques to properly segregate out the cost to fix curable items on a property which is essential when determining the contributory value of the overall repairs and effect on the marketplace,” Munizzo continued, noting that resources such as HM Facts (known as Decision Ready Data Solutions Inc.) and retailers like Home Depot and Loews provide home repair cost estimates.

Munizzo noted that if banks reviewed the REO addendum appraisal closely, they should be able to identify relatively quickly if an appraiser has several major repair items on their report with only a nominal amount for the cost of the improvements to be completed. This is where the “red flags should go off” in which the lender should ask the appraiser, “Where did you get your repair costs from? What’s the impact of those repairs on that property? What is the contributory value?

“If they have a really experienced review appraiser at the bank, they would go into the comparable sales and use them to see how they compare condition wise,” Munizzo added. “That’s really the first line of defense there. A lot of that due diligence is not being done from the bank side, that’s why you end up with properties just sitting there aging away and wasting away because those values were too high to begin with.”

Both Munizzo and Beane agreed that appraisers need to be more knowledgeable of a local area in order to value the property accurately.

“Lenders that are loaning on these properties are using the appraisal to determine the amount of money they will lend on the property,” Beane stated. “They need to verify accuracy to the best that they can. It’s extremely important to analyze data, knowing statistics at a city level, as well as a neighborhood and street-by-street level. So the valuation process is an extremely important part of the transaction.”