In parts one and two of "First Impressions of the 1004MC", we identified the challenges presented by the new form. While its purpose is "to provide the lender/client with a clear and accurate understanding of the market trends and conditions prevalent in the subject neighborhood", the "unintended consequences" may (in all likelihood), provide the opposite.
From my perspective, the 1004MC perpetuates a long tradition of two flawed premises in FIRREA (The Financial Institutions Reform Recovery and Enforcement Act); "all appraisers (by virtue of being state licensed) are qualified to appraise" and "the secondary market (by virtue of its policymaking authority) understands USPAP and the appraisal process".
From Fannie and Freddie's perspective, they want consistent application of underwriting and risk management criteria. If appraisers report the same types of information, presumably you get consistency, which is the foundation of risk management. Eliminating "subjectivity" promotes reliability, a step in the right direction.
As I am developing a seminar and an automated solution to the 1004MC for appraisers, over the past several weeks I have been working through the form to "fill in the blanks", analyze the results and better understand what Fannie and Freddie hope to achieve with the form.
On the surface, the questions are "mere mathematics", medians and counts, products and percentages, along with the trends they foretell. However in practice, the math and the trends are neither simple nor clear. In fact, when examined from a broader perspective they can be "misleading" in terms of how they are calculated, applied and their indications of change and neighborhood trends.
"Competitive to the subject vs The Neighborhood"
How you define "competitive to the subject" will determine the "calculated results" and therefore the "overall trends". In the same dataset, a broad definition could indicate very different trends from a narrow one. How the appraiser determines "the criteria that would be used by a prospective buyer of the subject property", is the key.
"If it wouldn't appear on the comparison grid in the URAR", it should not be considered as "competitive to the subject". Before you do the math, eliminate the "outliers" and get your dataset down to what a buyer would consider "competitive to the subject" in terms of physical characteristics, price range, etc., so that you have "apples to apples". If you do not, everything that follows in the 1004MC Matrix will be "misleading".
The Matrix – "Medians and Misleading"
To solve the riddle of the 1004MC's "Matrix", the appraiser provides medians, counts, rates, and percentages of data sets (sales and listings) for specified time periods prior to the effective date of the appraisal and reports the "overall trend" for the past 12 months indicated by the results. Look at a few questions and the steps you need to take to answer them.
- The median for a specific time-period (7-12, 4-6 or 0-3 months), is calculated by using all of the sales or listings that took place during those time frames.
- How will you treat duplicates (listed, then expired, re-listed, sold, etc.)?
- You may need separate searches for the three periods or a search of the entire 12-month period, downloading the data into Excel and using the program to calculate the medians over the periods.
- If "competitive to the subject" is not consistent with "neighborhood trends", you need to repeat the process to determine the trends in the Neighborhood Section of the URAR .
- You will need to provide a "clarification statement" of what you did and why, and perhaps an "extraordinary assumption" if you use the 1004MC trends as a basis for the 1-4 unit trends in the Neighborhood Section of the URAR.
- Make sure you have cleaned the data to insure represents "competitive to the subject".
- Which "days on market" will you select for listings and sales; using the most recent listing date or the original date for days on market?
Once you have answered the questions in the matrix, you need to report the "overall trends" and this is where another conflict exits. The phrase "overall trend" applies to comparison of the results in the prior 7-12 months to the results for the prior 4-6 months and 0-3 months. See the dataset below.
In the example, the total # of comparable sales in the 7-12 months period is really 10 for each of the two 3-month periods represented. How would you answer the overall trends questions on the 1004MC for the dataset in the example? Over the 12 months analyzed, many of the indicators are declining, a few are increasing and still others are borderline stable.
Why is this problematic?
In analyzing the neighborhood, "the principle of change" mandates that the appraiser identify shifts in market conditions and trends to determine their impact on the subject property's value. From the appraiser's perspective, what defines a trend, 3 months, 6 months, 9 months or a year?
By use of "overall trend" and a 12-month comparative matrix, the 1004MC has removed the flexibility to "observe and report" a "shorter-term change in the trend". Despite the appraiser's observations and data support for "stable or increasing", the 1004MC requires a rating of "declining" if prices were higher 7-12 months ago than they were during the last 4-6 or 0-3 month periods.
In many neighborhoods, prices are correcting (or have corrected) and while they have declined from a year ago, at some point the market "bottoms" and when the bottom is reached, the trend stabilizes. While prices over the 12-month period will indicate "declining", the 0-3 or 0-6 month trend may be stable or increasing, but not at a point above that of the 7-12 month period.
For Fannie and Freddie's purpose, this may be fine but if the market for the subject has stabilized and you still select "declining" (months after the trend shifted), is this misleading from a USPAP point of view? The chart below is similar to the one above, except this time the indicators reflect a neighborhood that has "shifted over the last 3 months.
- The last two periods have stabilized but the "overall trend" will be based on the comparison of 10 per quarter in the 7-12 month period vs. 6 and 7 per quarter in the 4-6 and 0-3 month periods. The overall trend it is still declining, 10 compared to 6 and 7.
- Absorption Rate in the 0-3 month period is above the 4-6 month period but still below the 7-12 month period and the overall trend is declining, even though it improved.
The months of housing supply has actually increased in the 0-3 month period as compared to the 4-6 month period, but is still below the 7-12 period and overall (for the 12 month period), it's declining.
Overall trend refers to the 12-month period. Your conclusions must be based on that, even when the data may indicate the market has changed during the last 0-6 months. It seems to me that 'good appraisal practice' requires you to report the trends with respect to emerging patterns and to relate those trends to the affect on the value of the subject property. That won't happen in the 1004MC.
Closing thoughts on "medians and the matrix"
I think the 1004MC's matrix would be meaningful (and less misleading) if it used the "current trend" as opposed to the "overall trend". Since we are stuck with the form and as "generally accepted appraisal standards" would imply that we explain the current trends and label those trends appropriately, how will you address this in the 1004MC and your comments?
Given the format, underwriters will expect results in the 0-3 month period to be higher than in the 7-12 month period before accepting a conclusion of "stable or increasing". This creates a problem for the appraiser, lender and borrower.
Selecting the "declining box" in the 1-4 unit housing trends in the "Neighborhood Section" of the URAR will mandate a reduced loan to value, as required by the secondary market and PMI companies, long after market conditions have changed in the neighborhood.
Authors Note: Some have written asking when I will get back to the URARS Series. It's on the back burner for several reasons, the need for us to get up to speed on the 1004MC and many of my ideas for solutions to the 1004MC (in the course and the automated program) will become a part of the URARS, so this series is really somewhat of a subset.