Apprizing the Appraisal

By: 
Al Jacobs

In the world of business, as in life generally, we’re often involved in the setting of values – certainly the heart of human enterprise. The appraisal is a time-honored tradition in business, and nowhere more so than in real estate.

The American Institute of Real Estate Appraisers, affiliated with the group known as Realtors, effectively promoted real estate appraisal over the years. The techniques are well established and, on the whole, can be valid and valuable when properly conducted and interpreted.

Though there are probably some incompetent appraisers around, the really bad property valuations … and there are many … cannot normally be blamed on lack of appraisal talent. The actual reasons go far 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 an anticipation by the agent the value placed by the appraiser will benefit the sale and, conversely, an expectation by the appraiser of future referrals from the agent.

Is it unreasonable under these circumstances 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, even though much raw data is increasingly available from a variety of electronic sources.

Consider the varied interests of these brokers. Whether 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 is upon these values the final appraisal may depend.

The following tale may or may not be typical, but it illustrates how the appraisal process can malfunction. This is a true story of a hilltop house overlooking the Nellie Gail Ranch equestrian trails in southern Orange County, Calif., generally regarded as an area of desirable homes.

The house was owned by a marketer of high-priced real estate on cable channels in the Los Angeles and Orange Counties area, who previously acquired it at a reported price of $2,100,000. Thereafter, in June of 2016, it sold to an admittedly unsophisticated buyer at a price of nearly two million dollars.

At the time of purchase a major savings bank performed an appraisal in connection with a mortgage loan to be placed on the property. The bank’s appraiser gave a valuation of $1,995,000, and cited three comparable properties to justify the figure. On this basis, the purchaser agreed to a down payment of $395,000 and obligate himself on a mortgage loan of about $1,600,000.

Several months following the sale the buyer arranged for a second appraisal, this time with an independent appraiser in the area, to see how his investment was holding up. To his dismay, he discovered the property’s value to be in the $1,200,000 range – some $800,000 less than his acquisition price.

The details of this second appraisal revealed that between January and April of 2016, six comparable homes sold in a price range of $1,160,000 to $1,285,000. In addition he learned of an overstating of the house’s size by nearly 20 percent, while two of the three comparable sales used had been more than six months old during a period of 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’re trying to sort things out, there’s another piece to fit into the profession. 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 a chore 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 one of them. Neither will you receive any help from your accountant, whose expertise is geared in other directions.

Furthermore, the local real estate broker cannot be depended upon to provide reliable advice, 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 suspect – if for no other reason than the pervasive dog-eat-dog environment prevailing in the business. Many of the truly successful real estate agents learn early on to play the game tight-lipped and close to the vest.

Finally, merely retaining an independent fee appraiser is no assurance of complete and competent representation, though it’s probably the best which can be done in most cases.

In circumstances where truly professional appraisal service is warranted, you’ll want 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 to you in basic and understandable terms. With this accomplished, you must then take as active an interest in the process as you’re able, and hope for the best.

Before I close on this subject, I want to offer a testimonial. Many years ago, before I acquired any real sophistication in the real estate business, I regularly checked out areas in which I had little familiarity, in the hopes of discovering underpriced properties that might be purchased and resold for a profit. One such location I visited was the City of Elsinore in Riverside County – a modest little community on the shore of Lake Elsinore, a natural freshwater lake of about 3,000 acres.

While there, I was persuaded to make an offer on six lake front lots, after assurance by a local real estate agent of their potential value as home-sites. Included in the documentation he provided were formal appraisals verifying their values to be almost double my purchase price. Fortunately my offer contained an escape option, and I exercised it after learning the lots were in a location customarily flooding whenever the lake expanded following massive rainstorms.

If nothing else, I learned two important lessons as a result of the experience. First, never rely upon the representations of a person receiving a fee for effectuating a sale. Secondly, the less you know about the details of a transaction, the greater your chances of misfortune.

A final word to the wary: Whether it involves real estate, gemstones, colonial furniture or Rembrandt masterpieces, the appraisal must be suspect. A corollary to Murphy’s Law says it all: If everyone agrees upon a price, it must be wrong.

Al Jacobs, a professional investor for nearly a half-century, issues weekly financial articles in which he shares his financial knowledge and experience. Al may be contacted at al@abjacobs.com

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