AUTHOR: Micheal W. Armentrout, VP AM Appraisals, Inc. Mike has been involved in full time real estate valuation since early 1992 and has experience in numerous Central Ohio markets.
It’s all over TV, radio, the web and yes, our beloved lending institution policy updates. What has become the buzz of the entire lending and real estate industry? The dreaded “D” word…Declining Markets.
Now I’ll be the first to admit that I’m not the eternal optimist but this doom and gloom scenario has pushed me over the cliff toward a certain destiny with insanity. With the appraisal industry already suffering a communication breakdown with it’s primary users, this could be the straw that breaks the camels back.
Declining markets have always been there, lurking in the shadows but never able to rear their ugly head in the market of the past 15 plus year real estate boom (East and West coast markets excluded of course) but the current economic slowdown has many talking heads predicting Armageddon for the real estate markets.
Being a simple “appraiser on the streets” in Central Ohio allows me to agree that while sales volume has slowed dramatically leaving little upward movement for residential property values, declining markets are still rare. I must note an exception for newer tract developments that indicate a transition from a “new build” buyer to a “resale” buyer which has resulted in price decreases but that is another discussion for another time.
So what’s the fuss over the declining markets discussion? It is my friends the preponderance of sales data provided from vendors like First American, Site X, Criss Cross and even our beloved local MLS boards. Sales data collected in geo-coded areas, census tracts or zip codes is cumulatively compiled and extracted into Mean (average) Sales Prices for a particular time period.
Now as any appraiser remembers from Appraisal 101 class, averages are not a common word in our vocabulary. We instead rely heavily on the “mode” which is statistical speak for the most frequent. This promotes a much more quantifiable data conclusion by establishing a trend but does take significantly more expertise in data analysis; the kind that reputable appraisal professionals offer.
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Averages take into consideration all sales including the ever-increasing foreclosure transactions aka REO (Real Estate Owned) sales along with the typical “arms-length” buyers. Obviously, this will taint the averages downward and ignore comparison of similar markets.
Mortgage lending has historically asked the appraiser to complete a “fair market value” which of course was defined by Fannie Mae as “the most probable price which a property should bring in a competitive and open market…assuming the price is not affected by undue stimulus”. Under this criteria, we have subsequently appraised most properties by comparison to similar transaction types unless specifically requested otherwise.
In a nutshell, we use REO sales for REO appraisals and “Market” sales for market transactions.
If lending institutions were interested in knowing what a property would be valued at upon a foreclosure, then they should have been requesting appraisals with that extraordinary assumption. After all, REO sales are still considered the most reliable indicators of an REO value. My guess is that the majority of loans would never have been done and the real estate market would have collapsed.
If averages are not reliable, then how do we identify real declining markets? I can tell you it’s not found at the click of a button on a data source web page but within the data itself. It has been said that our job is so much easier than it used to be because the data is so much better and easier to get but I would contend that while the data is better, it requires that much more analysis. Identifying a trend of decline in a particular market must include observation of recent similar sales of properties compared to their individual prior sales histories. Again, not an average, not just one, but a verifiable trend must be identified. It is only then that a declining market should be noted.
With all this being said, I can only hope that the real estate appraisal industry makes a concerted effort to make these facts known to lenders. This should be conveyed in a professional manner that demonstrates that we are not their enemy but their best ally in terms of what’s really going on in the markets we practice.
Write those addendums with market-specifics instead of “canned” comments and hopefully once enough underwriters see the facts, maybe it will climb the chain of command where it could make a real difference.
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