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Monday, September 19, 2011

Low Appraisals: Why Housing Is Going To Zero

Home price appraisal disputes are the latest issue gaining notoriety as economists try to determine why the housing price crash has not hit bottom, five years after the housing bubble burst.

Political observers are also becoming resigned to the lasting nature of the housing crisis and the effect it will have on the 2012 presidential election.

Unlike the years in the run-up towards the real estate bubble's apex, appraisals now are generally on the ultra-conservative side (that is, the "low" side).  Many buyers are having difficulty closing purchases because appraisals often don't support the original bank loan sought for the property.  (This is in addition to the myriad of other problems confronting buyers.)

During the halcyon real estate days -- that is, 2003-06 -- appraisers were pressured to increase their appraised values to support bank loans, as banks aggressively competed to underwrite mortgages which they then offloaded to other parties through securitizations of bundles of mortgages into mortgage-backed securities which ostensibly spread the risk of any one bad loan.  Some appraisers were blackballed for refusing to abandon their standards and insistence on using comparable home sales. 

Now, a strange reverse process is occurring.   Appraisers are reluctant -- or outright refusing -- to use comparable home sales because they argue that the age of the sale means that the current value is significantly less than the last reported comparable sale price.  For a different reason, banks are pressuring appraisers to ignore the traditionally strongest indicator of value, recent comparable home sales.  Before, the motive was to compete for loan underwriting.  Now, the motive is to reduce as much risk as possible.

One danger that is not yet perceived by most observers is the risk that the Department of Justice will soon use its prosecutorial power to convince appraisal and realtor industry groups to adopt uniform procedures for price appraisals.  One practical problem, however, is that certain properties are often distinguishable from "comparables," mostly because of location issues.  A particularly dynamic view of a nearby skyline or shoreline can vastly increase the appeal of a particular property. Buyers who appreciate this fact will validly bid a higher price; the problem is that the bank will not issue a mortgage for more than, say, 75-80% of the total value which it determines the property to have.  

Of course, another problem with Justice Department lawmaking is the deterrent effect it will have on all real estate activity.  Anything that discourages the issuance of mortgages will hurt the real estate market, and perhaps for years. 

This is no problem on an all-cash deal.  When a buyer is using "other people's money" or good old OPM for the purchase, however, the strings attached can be formidable. Uniform standards can help give appraisers and the banks which use them some comfort in assessing the approximate true value of  property, at the present or near past, and hence in assessing the true level of risk involved in a given mortgage.  However, the true issues and the true problems are the impossibility in forecasting future price movements and the high degree of fear that home prices will continue to decline significantly for at least the next few years.  No amount of regulatory oversight or prosecutorial monitoring will take care of these issues.

The only way for banks to totally guard against the risk of losses from mortgages they underwrite in the current climate is to avoid writing any loans at all. 

Buyers currently need downpayments of at least 20-25% of the value of the home.  But banks' desire to conservatively appraise values (which I do not necessarily oppose, to be clear) often mean that, as a practical matter, buyers need 50% of the home price in cash.

Buyers' continued inability to finance home purchases threatens to become the biggest factor causing prices to continue to fall.  Nevertheless, several other major factors (foreclosures in the pipeline, a glut of homes which buyers hope to place for sale, the general economy) also are weighing on prices.  Until all of these factors are resolved, the residential real estate market may be in for a prolonged decline.

Eric Dixon is a New York lawyer.







 

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