This is the third in a four-part series dealing with the new 1004MC form (MCF) by David Braun, MAI, SRA. In Part 1 of this series, David began with a discussion of where appraisers are NOW . . .and gave some direction on where we're headed. In Part 2, David looks at appraiser's frustration with the 1004MC and in Part 3, he gives us a "What Goes Where and Why" look at the 1004MC.
The 1004MC-71 form (MCF) is primarily a trending analysis. Perhaps the most important trend is property values over time. The MCF investigates this directly and indirectly. It does directly by trending prices (closed, listed, and SP/LP as a percentage) over time. It does this indirectly by trending the “months of housing supply”, “days on market”, and “sales activity”; and by monitoring seller concessions, and “the number of sales that were foreclosed properties”.
This writing is too limited to address each of these issues; however, I do want to discuss a couple of issues to help appraisers avoid reaching incorrect conclusions about the market. The first, addresses the limitations of trending the sales price per property over time.
In Part 2 we discussed that we are trying to trend the value of a specific property type over time. However, often the data collected will not be as tight a property fit as hoped for. In this case, the appraiser must consider that there may be factors other than market conditions (time) that are causing the trend. Trending the sales price per square foot will typically be more accurate as it considers the differences in size for the data. In very slow markets keep in mind that one or two sales that are low or high may not be fully representative of the market. So, the appraiser should consider the entire body of evidence that is available before coming to a conclusion.
The second issue addresses the calculations which the “months housing supply” (MHS) is based on. In the brief discussion above I have tried to point out that a correct opinion on the state of the market’s condition will have to be based on a body of evidence. The logic for this is based the probability that any one indicator by itself could be indicating an incorrect trend. If the analysis is to have any credibility it is especially important to address the data that is meaningful with a high degree diligence.
The appraiser must be able to recognize the data that is meaningful, organize the data into information, and analyze it in such a manner that the data ends up contributing to a credible market conditions analysis. While some data like the days on market are suspect, the MHS is based on quantifiable data and is typically a good indicator of what is going on in the market. This is data that closely monitors the relationship of supply and demand over time.
The first three rows of data on the MCA gathers the information necessary to calculate the months of housing supply. For example, if at a given time there are 20 listings and the market is absorbing 2 properties per month then there is a 10 month supply of housing. The fact is that even though the information (number of sales and the number of active listings) used to calculate the MHS is very quantifiable there is a great amount of confusion on how it should be calculated. It appears that the confusion is primarily related to the “Total Number of Active Listings” (TNAL) count.
There appear to be two basic theories on how to count up the TNAL. These are:
- Some variation of “Cumulative” TNAL, and
- An “Average” TNAL
A cumulative TNA counts up all of the properties that were listed at any time during the time period. It counts even if it is sold, expired, or withdrawn. It is my belief, based on mathematical evidence presented later in this report, that a calculation based on the average TNAL will produce the correct MHS, while a calculation based on a cumulative TNAL will almost always produce an MHS that is over 100% to high. I have found nothing in the written information distributed by Fannie Mae that ask for a cumulative type of TNAL, in fact the word “Active” seems to always be paired with the word “Listing” in most everything that Fannie Mae has written.
I am personally very confused because I have been told that my Total Solution application is the only one that is based on an average type of TNAL count. While I spent many hours working through a scope of work decision and programming the Total Solutions to produce an accurate MHS it appears that many others simply asked Fannie Mae officials how it should be done.
Their answer was to use the cumulative method of TNAL. While this communication was unofficial I have seen the Emails and I believe this statement was made to several people. I never dreamt of asking Fannie how they would calculate the MHS for several reasons;
I never dreamt of asking Fannie how they would calculate the MHS for several reasons;
- Fannie already gave a pretty good written example of how it should be calculated.
- Fannie clearly explained the purpose of the form and the purpose of the MHS.
- The appraiser is responsible, not the client, for using a scope of work that will result in a credible opinion or conclusion.
- As an appraiser I know the client cannot ask me to use a technique or formula that will compromise the opinions and conclusions of my results.
- As an appraiser I am trained to complete analysis such as the MHS.
- They might give me the wrong answer.
Overstating the MHS by 100%+ could lead me to an unrealistically pessimistic view of the current market conditions. If this happens a lot of people could be hurt starting with the lender and moving to the borrower, real estate sales company, etc. The MHS is not something that only appraisers use. It is a common term in the real estate industry and is discussed in the April 2009 REALTOR® magazine. On page 20 it states that, “Although there are no steadfast rules to determine future pricing, .months’ supply of inventory (total inventory divided by the number of houses sold per month) is a great guideline. A normalized or balanced market has five to six month of inventory.”
Appraisers are not a liberty to recreate a new meaning for the term “months of housing supply” as its meaning is already in place and being used by many others in the real estate community.
I have no doubt that the lender, borrower, Fannie, Freddie, FHA, and VA (did I forget anybody) really does want me to report a “clear and accurate understanding of the market trends and conditions”.
Let’s consider the appropriate way to decide how to calculate the MHS and any other part of the appraisal process; by making an informed scope of work decision.
The first step in deciding a method for calculating the information on the MCF is to understand its use. The use of the TNAL is to help calculate the Monthly Supply of Housing. There are some other factors which should be considered when performing each task on the MCF.
- The purpose of the form
- Guidance from Fannie & Freddie
- USPAP compliance
- Accepted Appraisal Techniques & Methodology
- Liability management
Official information from Fannie & Freddie can be found:
- On the form itself • Fannie Mae Announcement 08-30
- Fannie Mae’s Appraisal and Property Report and Forms (FAQ)
- Freddie Mac’s Bulletin dated 11-24-08
Factor One; The purpose of the form: is stated at the top as;
“The purpose of this addenda is to provide the lender/client with a clear and accurate understanding of the market trends and conditions prevalent in the subject neighborhood.”
An accurate count and trending of the MHS will both provide information on the market trends and its current market conditions. While the trend is very important to underwriters, the point in time condition is also important. In other words, if a market has positive economic trends it is still important for the underwriter of the loan to know if the market is in good condition or is it in a dismal state. An accurate MHS and its trend are excellent indicators of the state of the subject’s sub-market’s health.
Factor Two; Fannie & Freddie: Fannie provides a formula and example for finding the MHS over a 6 month period which follows:
Step 1: Calculate the absorption rate. If there are 60 sales during a 6 month period (e.g., “Prior 7-12 Months” column), the absorption rate is 10 sales per month (60 / 6).
Step 2: Calculate the months housing supply. If there are 240 active listings, there is a 24-month supply of homes on the market (240 active sales / 10 per month)
The MCF (1004MC-71) asks for the “Total # of Comparable Active Listings”
Factor Three; USPAP Compliance: The Appraisal Standard’s Board has some specific things to say about the appraiser’s utilization of a pre-written form.
It is the responsibility of the appraiser to properly develop an appraisal, and to properly report the assignment results. A template or form may or may not adequately report the assignment results. It may be necessary for the appraiser to supplement a form with addenda to comply with USPAP requirements. iii
In reporting the results of a real property appraisal, an appraiser must communicate each analysis, opinion, and conclusion in a manner that is not misleading. iv
Factor Four; Accepted Appraisal Terminology & Methodology:
Supply: “...the amount of a type of real estate available for sale...in a given market at a given time.” v
The form asks for Total # “Active” Listings. All realtors, appraisers and most laymen understand what an “Active Listing” is. Once a property is sold, withdrawn, or expires it is by definition no longer an active listing.
Factor Five, Liability Management: The designers of a form may have a specific technique that differs from accepted appraisal techniques and methodology in mind.
An appraiser is put in a precarious liability predicament if his/her opinions and conclusions are affected by a technique that is specific to the client’s specifications, but different than would have resulted if the calculations were performed by accepted appraisal techniques and methodologies. In such cases it is the appraiser’s responsibility to clearly present the definition and clearly demonstrate how there technique affects the outcome of the analysis.
This no small matter especially when the forms that require the MCF to be a part of the analysis include specific statements that the borrower may be an intended user. This means if the borrower’s loan situation changes for the worse because of the appraiser’s market condition analysis and the borrower can show that the appraiser used a flawed method or technique to calculate the MHS or other indicators, the appraiser better have some specific reasons for calculating it incorrectly. I have not observed or been made aware of any specific formal directive by Fannie and Freddie to calculate the MHS anyway other than they have described in their example or what is accepted appraisal principles and methodology.
Calculating the Monthly Housing Supply on the 1004MC-71 form
As simple as the calculations for estimating the MHS appearse Monthly Housing Supply on the 1004MC-71, in practicality there are many interpretations how to calculate it. It appears that the discrepancies result from different opinions on how to calculate the “Total Number of Active Listings” (TNAL). The breakdown in logic results from the fact that the TNAL can only be measured at a “point” in time, while the form is asking for a count over a period of time. This has produced some very different counts of the TNAL by appraisers and by the vendors of automated solutions to the 1004MC-71 form. Some appraisers and vendors use a cumulative or aggregate method of counting the active listings during the period. In this method every listing coming on the MLS is counted, but none that fall off are netted out of the total. I have found no formal directive from Fannie or Freddie to calculate the TNAL in this manner in the above listed sources.
To begin with let’s simplify the analysis by avoiding this glitch in theory of point in time VS Period of time by calculating the MHS for a sample of data that occurred over a six month period. We will achieve this avoidance by estimating the MHS at points in time on a weekly basis. Then we will compare those results to the results of a cumulative counting method and to the results of an Average Total Listing Count.
PRACTICLE EXAMPLE
- Let’s say there are currently 5 active listings
- A new listing comes on the market each week
- There is a closed sale every other week
- A listing is either withdrawn or expires every fourth week
- This is 6 month (26 week) period.
Summary:
- The MHS for points in time on a weekly frequency ranges from 3 to 5.5, and averages 4.25.
- The cumulative method over the six month time period estimates a MHS of 12, almost 3 times the average above.
- The Average Total Listing method over the six month time period estimates a MHS of 4.15.
Conclusion:
The MHS based on the “Average” Total Listing method meets the requirements of all of the following factors of influence.
1. The purpose of the form
“Clear & Accurate”- It better reflects the actual MHS at any point in time.
2. Fannie & Freddie
(See example Fannie presented on page 4 of this document)
3. USPAP compliance
The MNS is properly developed and a misleading conclusion is not reported
4. Accepted Appraisal Techniques & Methodology
Meets accepted techniques * methodology
5. Liability management
The borrower will not be able to show that the appraiser reported an exaggerated MHS. The article in the REALTOR® magazine previously mentioned states that double-digit depreciation is likely with anything over a 9-10 month housing supply. The following chart (Source: Westcourt Funds) is found on page 21 of April 2009 REALTOR® magazine.
In the housing market example shown earlier the actual MHS of around four to six months is about in balance according to the chart, however, a MHS of 12 which results from the cumulative listing count indicates that the market is in or going to be in a serious decline according to the chart. These overstatements of the MHS will likely cause users of the appraisal report to inappropriately penalize the loan underwriting. It may have caused the appraiser to inappropriately make negative adjustments for market conditions in the direct sales comparison approach. The bottom line is the appraiser will have produced a “misleading” appraisal report.
This indisputable logic does not mean that Fannie & Freddie will not come out with a formal directive that will require a listing count based the cumulative method in the future for calculating the Months of Housing Supply. But, I cannot change to a method that I believe typically produces errors of from100%-200% without an official mandate to do so. I have presented this writing as an explanation of why the “Total Solutions” application calculates the Total Months of Housing Supply based on an “Average” TNAL versus the “Cumulative” TNAL and to demonstrate that I have performed adequate due diligence in my selection of the method used.
My personal take on this situation is that Fannie & Freddie have done their job; they have presented a clear purpose of the analysis and have even provided a good outline for the appraiser to follow. Now it is time for the appraisal Industry to do ours. We do not need Fannie & Freddie to fill in the form line-by-line for us as we are experts in appraisal techniques and methodology. I suppose they will have to if we do not step up and do it ourselves through a proper scope of work analysis. It may be their form, but is your analysis and your signature on that form. I know ignorance is bliss, but appraisers must know what goes where and why for every line on the MCF.
Look for Part4 (if Fannie does not drum me out of the business); MAKING MARKET CONDITION ADJUSTMENTS ON THE SALES GRID BASED ON A POLYNOMAL TREND.
Sources/References
- i APPRAISING IN THE NEW MILLENNIUM; Due Diligence & Scope of Work, page 5, AVT inc., 2006
- ii Announcement 08-30, Fannie Mae
- iii USPAP Frequently Asked Questions, Appraisal Foundation 2008-2009, Page F91
- iv USPAP Frequently Asked Questions, Appraisal Foundation 2008-2009, Page U21
- v The dictionary of Real Estate Appraisal, 4th Edition, Appraisal Institute, Page 283
Author: David A. Braun, MAI, SRA (President, Braun & Associates, Inc.) has been actively engaged in real estate appraisal, review, and consulting since 1976. David is also the author of Appraising in the New Millennium - Due Diligence & Scope of Work, 3rd Ed. All of his products can be found on http://www.ScoopGear.com
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