livevaluation magazine - february 2011

Something About a Forest

and TreesLELAND TRICE, p28

prior acts: will your past

haunt you? p20

have we

ouTgRowN uspap p34

leave your ego behind p40

?

2 | LVM ACI is a division of Verisk Analytics (NASDAQ: VRSK), a leading provider of risk assessment solutions to professionals in insurance, healthcare, mortgage lending, government, risk management, and human resources. Verisk Analytics includes the holdings of Insurance Services Offi ce, Inc. (ISO) and its subsidiaries, which provide essential solutions to the insurance, mortgage lending, and healthcare markets. For more information, visit www.verisk.com.

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FEBRUARY 2011 * LIVEVALMAG.COM | 3ACI is a division of Verisk Analytics (NASDAQ: VRSK), a leading provider of risk assessment solutions to professionals in insurance, healthcare, mortgage lending, government, risk management, and human resources. Verisk Analytics includes the holdings of Insurance Services Offi ce, Inc. (ISO) and its subsidiaries, which provide essential solutions to the insurance, mortgage lending, and healthcare markets. For more information, visit www.verisk.com.

Good work is dignifi ed. Throughout our history, ACI has forged partnerships with valuation professionals across the nation.

Working with appraisers drives the passion behind the people and makes it easy to produce technology that is smarter, faster and better. We look forward to

the road ahead in 2011 and in fostering the relationships that have made us who we are.

ACI—The Appraiser’s Choice™.

YOU ARE INSPIRATIONAL

NEW! Worldwide ERC®Summary Appraisal Report

Interior Photo Pages with Drop-Down Menus

ACI2010™$699* All Inclusive Package

Form100 01/10

t 800-234-8727 f 386-246-3811AppraisersChoice.com










ACI2010™

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AppraisersC

hoice.co

m

Printed on Recycled Paper

ACI2010’s new interior photo pages are designed to assist you in fulfi lling the new GSE requirements regarding interior photos. Also includes expanded comment area.

NEW! Just Plain S.M.A.R.T.™

NEW! ACI Text Alerts

Be in the know about the latest industry news and ACI product promotions.

The S.M.A.R.T. Market Analysis solution works with your MLS* system to Import Active, Expired, Pending, Withdrawn and Sold listings. S.M.A.R.T auto-populates the 1004MC.

Get started by texting:

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› Photo Management

› Comps Database

› ChoiceCredits™(500 to use for S.M.A.R.T.™ Market Analysis Tool, Flood Maps, Location Maps, MLS Import Service, AppraiserBASE™, Long-Term Storage, File-Sync and more)

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*Call to verify MLS availability. MLS providers are continually updated.

4 | LVM

&

contents

28

Featuresomething about a Forest and trees Scope Creep: What lax standards caused, unreasonable standards will not cure.LELaND TRICE, sRa, FRICs

Now that Warren Buffett would have difficulty getting a mortgage, every data point must be perfect and more data points are added every day. Unfortunately, I am not convinced this makes for better appraisals. I am convinced it makes for very disgruntled and disaffected appraisers.

table oF contents

| contents |

FEBRUARY 2011 * LIVEVALMAG.COM | 5

contents

LVM02.11LVM LVM LVM LVM LVM LVM LVM LVM LVM LVM LVM LVM LVM LVM LVM LVM LVM LVM LVM LVM LVM LVM LVM LVMLVM LVM LVM LVM LVM LVM LVM LVM LVM LVM LVM LVMLVM LVM LVM LVM LVM LVM LVM LVM LVM LVM LVM LVMLVM LVM LVM LVM LVM LVM LVM LVM LVM LVM LVM LVM

your monthlyvaluation publication

9

14

do short sales save Lenders Money?Occupancy and attitude can make a difference.mIChaEL skLaRz, ph. D.

paTRICk CaLLIsoN, CRa

18

Love is Efficient!“Relationships” from a different perspective.RogER sTaIgER I I I

20

Who Needs Prior Acts Coverage? Giving up prior acts coverage to save money is risky business.bETsy a. magNusoN

22

Geographic Competency vs. CompetencyCompetency is demanded, geographic or otherwise.JoRDaN pETkovskI

kRIsTINE hughEs

24

regression analysisAppraisal is still an art, even with the science of regression.sTEvE FERgusoN

34

the Law of real estate appraisalHas real estate appraisal practice outgrown USPAP?DENNIs a. sCaRDILLI, maI

40

state appraiser coalitionsLeave your ego at the door and unite with other appraisers.JuLIE FRIEss

44

the next Generation of avMsAVMs are more accurate when they use data sources beyond public records.JoE EmIsoN

6

publisher’s note

8

contributors

10

staiger on stats

48

Voices of Valuation

49

Directory

50

For what it’s worth

up Front

20

Departments

44

something about a Forest and treesScope Creep: What lax standards caused, unreasonable standards will not cure.

LELaND TRICE, sRa, FRICs 28 FEBRUARY 2011

cover

*Inside This month

34

Something About a Forest

and TreesLELAND TRICE, p28

PRIOR ACTS: will your past

haunt YOU? p20

HAVE WE

OUTGROWN USPAP p34

LEAVE YOUR EGO BEHIND p40

?

6 | LVM

1. Founder | Aman Makkar

2. publisher | Ernie Durbin, SRA, CRP

3. Editor-in-Chief | Emily Vannucci

4. Copy Editor | Kersten Wehde

5. Creative Director | Traci Knight

6. National sales | David Peck

printer | ovid bell press

advertising Information | P : 858.832.8900 / E : [email protected]

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© 2011 LiveValuation Magazine.

All rights reserved. LiveValuation Magazine is a California limited liability company and is the publisher of LiveValuation Magazine. Reproductions or distribution of any materials obtained in the publication without written permission is expressly prohibited. The views, claims and opinions expressed in article and advertisement herein are not necessarily those of LiveValuation Magazine, its employees, agents or directors. This publication and any references to products or services are provided “as is” without any expressed or implied warranty or term of any kind. While effort is made to ensure accuracy in the content of the information presented herein, LiveValuation Magazine is not responsible for any errors, misprints, or misinformation. Any legal information contained herein is not to be construed as legal advice and is provided for entertainment or educational purposes only. Postmaster : Please send address changes to LiveValuation Magazine, 16745 W. Bernardo Drive Suite 450 San Diego, CA 92127

Scope of work, as understood by USPAP, puts the onus on the appraiser to assure that it is “sufficient” to produce a credible result. USPAP states, “Appraisers have

broad flexibility and significant responsibility in determining the appropriate scope of work.” It sounds like appraisers are in the driver’s seat when discussing scope of work with their clients. Is that what really happens in the typical mortgage appraisal assignment? I

don’t think so. Nowadays, most appraisers are providing much more research and analysis than is necessary to develop a credible result. Lenders and appraisal management companies have added layer after layer of additional requirements. Enter “scope creep.”

I’m not sure who coined the phrase “scope creep,” but it has become a part of the appraiser’s vocabulary over the past several years. Week after week, new orders come into appraisers’ offices with longer and longer lists of requirements. USPAP clearly states that scope of work is acceptable when it meets or exceeds “the expectations of parties who are regularly intended users for similar assignments.” Providing the additional details to meet “expectations” would be fine if appraisers were compensated for the additional time it takes.

Leland Trice addresses scope creep in his feature article this month. Along with proposed solutions, Lee shares a list of “war stories” that exemplify inane requirements that don’t really contribute to a credible result. Unfortunately, many of our readers can join in chorus with these war stories. Lee argues that lax standards may have gotten us into the real estate mess, but unreasonable standards will not get us out. We have to focus on the overall credibility of the report and not the minute details. It should all be about the soundness and reliability of the appraisal report.

After reading our feature article, you might have some war stories to share yourself. Feel free to do so on our webpage, livevalmag.com. Be sure to redact specific client and property information!

On a personal note, I would like to tell my wife and valentine of 30-plus years: “Velina, you are my efficiency!” Sweetheart, you’ll have to read Roger Staiger’s article to understand this. 6

| PUBLIShER |ERnIE DURBIn, SRA, CRP

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8 | LVM

Contrib-utors

44Joe eMison

Joe began his career by building the first Windows interface for the Apple iPod and

winning the 1996 Weird Software Contest. Over the past decade, Joe transitioned from development to systems design and data analysis, creating the first BuildFax engines in 2003, the original architecture in 2007 and designing the Pragmatic Extract-Transform-and-Load (PETL) architecture that makes the current national footprint possible. Joe graduated with degrees in english and mathematics from Williams College, and has a juris doctor degree from Yale Law [email protected] x444

24steve FerGuson

Steve Ferguson began his career in real estate as an appraiser for 20 years, starting

in Cincinnati, Ohio. In 2004 he closed the appraisal chapter in his career and continued his formal education in economics where he began applying statistical tools to the field of real estate. He currently is the lead Realtor working for a medium-size firm in Indianapolis, IN where he lives with his wife and three children. [email protected]

40JuLie Friess

Julie Friess-Johnson began appraising in 1988 in Long Island, NY. She is

currently the managing director of the Northern Arizona franchise for IRR Residential. Julie is Vice President of the Coalition of Arizona Appraisers and actively involved in the appraisal industry and legislation. Julie has been a consultant to the FBI and the Arizona Department of Financial Institutions.

14PAtrICk CALLISoN, CrA

Mr. Callison has been an appraiser since 1977. Currently he is the Chief Appraiser

for Collateral Intelligence and performs regulatory research and data control functions as well as monitoring AVM accuracy and applications. His career history includes Owner and Chief Appraiser of the appraisal firm Callison and Associates and 12 years as a Senior Appraiser and researcher for several government agencies. He attended Portland State University and holds an M.S. degree. co-intel.com

contrIbUtors ?


Contrib-utors roGer staiGer iiiRoger Staiger III is Managing Director for Stage Capital, LLC. His areas of expertise are commercial and residential real estate portfolio investing, corporate business; and strategic planning, forecasting, valuation, financial modeling, asset repositioning and risk mitigation through financial hedging for physical assets. He holds positions at Johns Hopkins, Georgetown, and Loyola universities. [email protected]

LELAND trICE, SrA, FrICSLeland “Lee” Trice holds an economics degree from the University of Maryland and has been an appraiser since 1985. Lee is Owner of The Trice Group, a regional residential and commercial firm in the Mid Atlantic. He is also a Partner in LiveValuation, a technology company developing solutions for the valuation industry. Lee is active with the Appraisal Institute, RICS and the Coastal Association of Realtors.

50Fred hoLtsberrY

Fred Holtsberry has over 20 years experience in commercial banking and

appraisal services. He is a Certified Residential Real Estate Appraiser and has evaluated over 3,500 homes in the central Ohio region over the past 13 years. He is the owner of a small appraisal company in central Ohio.

22Jordan petkovski

Jordan Petkovski has worked in the residential appraisal industry for

most of his career. Currently, he is the Director of Staff Appraisal Operations at TSI Appraisal Services®, a wholly owned subsidiary of Title Source®. His primary focus is the successful development of operational processes based upon a greater understanding of the industry as a [email protected]

22kristine huGhes

Kristine Hughes earned her bachelor’s degree in business management

from Robert Morris University. She has worked in the appraisal industry since 1990. Kristine began her career at Lender Service Inc. as a Risk Manager. In 1998, she took a position at Metro-West as Vice President of Operations. She currently serves as Chief Collateral Officer for TSI Appraisal Services®. Kristine is a member of the Appraisal Institute and is a licensed appraiser in Michigan and Nevada.

34DENNIS A. SCArDILLI, ESq*., MAI

Dennis Scardilli is an attorney, admitted to practice law only in New Jersey and Pennsylvania, MAI, NJ State Certified General Real Estate Appraiser, AQB Certified USPAP Instructor, NJ Professional Planner

(PP), NJ Certified Tax Assessor (CTA) and NJ Civil Court R.1:40 Qualified Mediator. He has served, in various roles, at all levels of government and in the private sector. * Admitted to Practice Only in NJ & PA

10,18

28

MIChAEL SkLArz, Ph.DDr. Sklarz, President of Collateral Analytics, has more than 25 years of professional experience in real estate research, analysis and real estate technology product development in the United States. Dr. Sklarz holds a B.S. in engineering mathematics from Columbia University and an M.S. and Ph. D. in ocean engineering from the University of Hawaii. collateralanalytics.com14

20BEtSy A. MAGNUSoN

Betsy A. Magnuson is the President of the Herbert H. Landy Insurance Agency

and has been involved in Errors & Omissions Insurance for more than 25 years. [email protected] | 781.292.5408

10 | LVM

Bad! that was my one-word response at christmas dinner when the family asked my thoughts on housing. Sure, equities rose and there is some talk of a 2011 bull, but realistically, are equities the best benchmark for financial health? Equities are the smallest of the three main asset classes, fixed income, real estate, and equity, and do not represent the majority of household wealth in

America. Besides, equity performance lags real estate recoveries, e.g., Great Depression (it took 25 years to recover from the fall). So, after the family settled and demanded holiday cheer, I suggested I begin our discussion with fact rather than my conjecture (which was discounted, only because it apparently was not “merry”).

One of the main drivers for housing pricing is affordability. Given the overleveraged American culture,

staiGer on stats

Industry’s latest stats

RogerStaiger III

stats


this means interest rates are critical for housing to remain affordable. The Fixed Rate Mortgage (FRM), 30-year conforming rate for November 2010 according to Freddie Mac was 4.30% with 0.80 point. This is basically a 40-year low. Why is that important? Based on history, interest rates can only go one direction: UP! This makes the payment on housing increase and makes housing less affordable.

Since 1972, the average 30-year fixed rate mortgage rate has been 8.93% and the median 8.50%. In simple statistics, the current rate is less than half the historic average rate. In historic terms, the rate on housing debt is FREE, therefore the cost of owning a home can only increase.

Let us analyze the house payment for the median priced home, approximately

$200,000. For a 30-year FRM at today’s rate of 4.30%, the payment is $989.74 (note: Points are ignored for simplicity). When considering the average American household that in 2009 earned approximately $50,000 and pays roughly an all-in tax rate of 30%, an 80% loan on the typical $200,000 home at today’s rate of 4.30%, will represent 34% of a household’s net income. That, of course, is at today’s prevailing rates. Now consider that given today’s unemployment, 9.8%, a freeze on federal pay raises for two years, and efficiency in industry replacing hiring, a reasonable assumption is that household income will remain unchanged in the short- to medium-term. Thus, exposing Americans even more to interest rate increases which would most likely occur without a corresponding wage growth increase.

Now, let us consider that rates increase to the 40-year historic average according to Freddie Mac, i.e., 8.93%. At this rate the payment increased by $609.44 to $1,599.18. Now, housing for the same priced home represents 54.83% of household net income. Further, if rates escalate to 1 standard deviation above the mean, historically, the payment for a $200,000 home is $2,028.02. This represents 69.53% of household net income. Clearly this would require a drastic reduction in housing prices to compensate for the 100% rise in housing cost. When looking at the history of interest rates from 1972 to present, 95% of all the values are greater than current rates. The Fed, by keeping rates artificially low, has not helped the housing industry and America, but rather forestalled our day of reckoning. Housing Armageddon is far from over! >>

12 | LVM

A month-over-month analysis of November from October does not support a recovery. Nationally, housing reduced 1.32% according to the composite-20, Case-Shiller. This translates into a net loss of asset wealth (value) for the U.S. residential market of approximately $264.0bn. With the current administration’s newly announced stimulus part deux of $200.0bn with the Bush-era tax cut extension, Americans remain $64.0bn poorer. $64.0bn thus translates to about $390/tax-paying person in the United States. Once again, the administration’s holiday cheer was a nicely wrapped invoice.

What is also telling about the month-over-month data is the performance of the DC-MSA relative to the nation. Once again, DC outperforms the rest of the nation by a factor of six to one. Further, the commercial performance was actually positive month-over-month. Given the 16-month lag of commercial from residential, this is overhang from the 2008/’09 stimuli and will be short-lived, as was the bear bump in residential.


The year-over-year (YoY) analysis ending November 2010 marks an important event for the national composite index: The YoY is again negative, i.e., 0.80%. The DC-MSA posted a strong YoY gain of 3.65%, again demonstrating that the true benefactor of the stimuli is not the nation but rather the power elite situated in the DC-MSA. The national composite-20 index remains only 4.3% above its low point for this recession. The current direction, again, supports the idea that housing has not bottomed out and that the stimuli have only prolonged the pain, deepened the void, and forestalled the recovery.

The Case-Shiller futures market continues to push the bottom further to the right on the time scale. The capital markets have priced in a new bottom of early 2012 with the reduction from November 2010’s value being approximately 5.00%. This contradicts this author’s analysis and recent Financial Times article stating at least another 10% reduction in housing pricing before the true bottom is achieved. This author contends that as a general statement, investment in physical real estate is akin to catching a falling knife. The prudent investor, understanding the physical and financial side of real estate, will look to the financial and synthetic real estate for profits in 2011. Sell with the Bears, Buy with the Bulls! 6

14 | LVM

hort sales are a better alternative to foreclosure and rEos because they save legal and administrative costs necessary to foreclose; get someone

out of a home; and then sell it, often after some repairs. But do they also result in a higher price? Most brokers suggest that occupied homes will sell at higher prices than empty homes, especially if they are nicely furnished. Occupied homes are also more likely to be better maintained, with grass trimmed, plants watered, swimming pools filled with clear water and broken windows repaired. Short sales are also likely to avoid the kind of destruction and desecration of properties committed by resentful subprime borrowers. Our initial thought was that short sales would not be as deeply discounted as REOs. Knowing in advance that, even if short sales observed the same kind of discount as REOs, most lenders would be ahead on transaction and carrying costs and most borrowers would feel more in control of their destiny, we decided to examine a host of metro markets and compare the various prices.

Collateral Analytics used sales data from the past several years through the present to track median home prices on a per-square-foot-of-living-area basis for non-distressed residential single-family homes and compared these to REO sales and short sales, where the seller was engaged in the marketing

and sale transaction. The result of this analysis for a number of major U.S. counties is as follows:

In markets that have been hit hard by foreclosures and where many homes are underwater by a significant margin, i.e., Phoenix and Las Vegas, we find little difference in price between REO sales and short sales. In other markets, where there are many healthier submarkets and the underwater gap is less, we find a significant price advantage for short sales, i.e., Palm Beach, FL; and Chicago. We also find some markets that have been hit hard by unemployment. like Detroit, where short sales are significantly higher than REO sales. In these markets REO sales prices are much lower than short sale prices.

Another factor that could play into the difference between short sale and REO prices could be the change in attitudes about default. Ruthless or strategic default is defined as borrowers walking away from negative equity situations even when they can pay. Normally borrowers will not default unless they are significantly underwater because of

do short sales save Lenders Money?Occupancy and attitude can make a difference.mIChaEL skLaRz ph. D. / paTRICk CaLLIsoN, CRa

UP Front

SU


Los angeles county ca

Single-Family Median sold

Price Per Living area

Maricopa county aZ



1 Working papers # ECO2009/27

Palm Beach county FL



the effects on their credit rating, the inability to buy a home and the loss of put options in the future as well as the stigma attached to being foreclosed upon. But in a paper by Guiso, Sapienza and Zingales (2009) from the European University Institute of Economics1, the authors surveyed those who were underwater on their mortgages and found that if you knew of others who had strategically defaulted, you were more likely to default. That is, the more people in your situation who walked away when they could have paid their mortgages, the less social stigma attached to the default. Taking the implications of this study further, if borrowers knew of neighbors who had successfully completed a short sale, they may be more willing to try and avoid damage to credit ratings.

It is a sad but important fact to consider, but in communities where economic conditions may propel borrowers through the foreclosure process so rapidly, >> w

16 | LVM

another point to consider as residential

appraisers is our responsibility to direct our client’s

attention to neighborhood trends

known to impact the subject property value. Using data

collected within the subject’s market

area, we may accurately infer

that if short sales and non-distressed

transactions are occurring to a greater extent than the reo,

it is more likely the neighborhood will present well

to prospective purchasers.

it may leave a volume of vacant homes as REO that may take months or even years to be absorbed by the shrunken faction of qualified buyers. Clearly, any lender will suffer less by accepting reasonable terms for a short sale rather than allow the borrower to give up and, in a moment of anger or retaliation, strip or otherwise damage the home as they leave. Additionally, the short sale generally does not leave the home vacant for any significant amount of time, mitigating opportunity vandalism.

Another point to consider as residential appraisers is our responsibility to direct our client’s attention to neighborhood trends known to impact the subject property value. Using data collected within the subject’s market area, we may accurately infer that if short sales and non-distressed transactions are occurring to a greater extent than the REO, it is more likely the neighborhood will present well to prospective purchasers. 6

Wayne County MI Single-Family Median Sold Price Per Living Area

Cook County IL Single-Family Median Sold Price Per Living Area

Clark County NV Single-Family Median

Sold Price Per Living Area$


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18 | LVM

t’s February and Valentine’s is upon us. For many it is the time we hold others close and profess our feelings for the first time – or reconfirm our feelings for the umpteenth time. For others, the day marks the end

of the breakup blackout period between Thanksgiving and Valentine’s, when it is socially unpalatable to end a romantic relationship. Regardless of which camp one falls within, the

Love is Efficient!“Relationships” from a different perspective.RogER sTaIgER I I I

UP Front

day is about “love,” real or departed.

This begs the question, “What is love?” For how can we know if we are in love without being able to define love?! Is love the state of euphoria when our thoughts become singular of a betrothed or when our parlance becomes garbled from lack of clear thought? Rather than author more poems, sing more songs or build greater monuments, let us focus on the definition and quantification of love. For when we define and quantify love, we know when it has been achieved.

When we are in love, we are happier. When we have fallen from love, we are sadder. Quantitatively, love

is the balance of return (feelings), risk (personality

extremes), and correlation (how two assets/people fit together in a relationship/portfolio). Using portfolio theory to quantify love, it can be considered the positive or negative (in the case of hate) marginal change in a person’s happiness (efficiency) brought about by the

inclusion of another in a single person’s life. Further, love is the creation of one (two-asset portfolio) from two (individual assets) where the one has a marginal happiness, as measured by efficiency, greater than the twos. in

real estate parlance, the two

persons coming together in

“love” are more efficient than

apart. therefore love is all

about finding efficiency!

We will know when we have found love, as we will have achieved efficiency. Efficiency, as defined by Harry Markowitz, is any point in a portfolio where return is maximized for any given level of risk. Quantitatively, efficiency is measured by the coefficient of variation (CV), which is the risk/return ratio. (Note: Portfolio risk is quantified differently than traditional methods of risk quantification as it accounts for the correlation of assets, i.e., risk is reduced when negatively correlated assets are grouped within a single

portfolio.) Therefore, for the chosen personality

extremes (risk) that one has fallen in

“love” with, the return

(happiness) must be I Love

return

correlationrisk

U


maximized to be efficient. For a person’s goals in love are equivalent to the goals of a portfolio manager, i.e., to maximize efficiency.

To extract this concept further, Markowitz’s theory supports that there is not a single soul mate for each individual but rather many soul mates, all of whom are found on the efficient frontier. For all individuals whose personality extremes and happiness cause the portfolio (couple) to be on the efficient frontier is therefore “in love” as they are efficient. (This will be expanded upon in another article.)

Now that we have defined love as “efficiency” and learned to quantify love using efficiency measures, i.e., coefficient of variation (CV), which is risk/return, we must focus on the visual display. To truly understand a concept, I am a firm believer that a person must be able to draw it. Cupid and Hallmark draw love in the shape of a heart with an arrow. However, as we have all learned from Markowitz, efficiency, i.e., layman’s love, is drawn graphically and titled the “efficient frontier.”

Each point along the efficient frontier represents a point of efficiency, i.e., maximum return for any given level of risk. Therefore, there is no single, optimally efficient point, i.e., single soul mate, but rather a plethora of soul mates, all having different risk levels (personality extremes).

When one meets a person and courts them, the intention, provided lifetime commitment is the goal, is to find the individual with whom efficiency is achieved, i.e., maximize return for the given level of risk. It is at this point where the marginal contribution to happiness is maximized from being a single asset, i.e., single person, and the two-asset portfolio is efficient. Individuals that do not “lie” upon the efficient frontier are inefficient; for the same level of risk, a greater return (happiness) can be achieved.

As an example, were a person to be with an individual and form a relationship and the characteristics of the two-asset portfolio did not fall upon the efficient frontier, as indicated by the black dot, the relationship is doomed to failure. Efficiency/love is not achieved because for the chosen level of risk (personality extreme) there is another individual with

whom, when combined into a two-asset/person portfolio, provides a higher return than the current relationship/portfolio. If the couple is euphoric but not efficient, this author argues they have found lust and not love, i.e., efficiency.

So, this February 14, when you arrive home with your roses, chocolates, jewels, or other token of your affection, and after you embrace, do not be so financially unsophisticated as to whisper, “I love you!” Rather, embrace the one that makes your heart skip, look into their eyes, and with the full depth of your heart, and complete financial understanding of portfolio theory and love, tell them, “You are my efficiency!”

Note of warning to readers: I tried this once; it did not go very well! Good luck!!! 6

Eff c

ient Frontier

5Eff c

ient Frontier

When one meets a

person and courts

them, the intention,

provided lifetime

commitment is the

goal, is to find the

individual with whom

efficiency is achieved,

i.e., maximize return

for the given level

of risk. It is at this

point where the

marginal contribution

to happiness is

maximized from being

a single asset, i.e.,

single person, and the

two-asset portfolio is

efficient. Individuals

that do not “lie” upon

the efficient frontier

are inefficient; for

the same level of

risk, a greater return

(happiness) can be

achieved.

Y

20 | LVM

who needs Prior Acts coverage?Giving up prior acts coverage to save money is risky business.bETsy a. magNusoN

UP Front

I realize that these are tough economic times, and with the downturn of the market, many

real estate appraisers are struggling to survive. However, one of the most important business decisions you can make is to continue your Errors & Omissions Insurance coverage. No one ever thinks they are going to have a claim. However, as long as homeowners continue to struggle to meet mortgage payments and fall short of refinance requirements due to lowered property values, real estate appraisals will be scrutinized and questioned. Many real estate appraisers assume that if they paid for an insurance policy, they have coverage under that policy forever. This is not true and this is not how claims-made policies work.

If your policy is written on a claims-made basis (most professional liability policies are), your prior acts date is typically the date of the first policy you purchased. Some carriers will offer what is called “full prior acts.” This means that there is no specific date in the past by which your prior acts are limited. Your prior acts date is carried forward each year if you renew your policy without a lapse in coverage. You are then covered back to your prior acts date in the event

of a claim, subject to your policy terms, conditions and exclusions.

let’s demonstrate how a claims-made policy works.

John Smith purchased a real estate appraiser policy February 1, 2000. He renewed his policy each year by February 1 to avoid having a lapse in his coverage. His current policy will have a prior acts date of February 1, 2000. Mr. Smith’s policy would respond to a claim that is reported during his current policy period for work he performed between that date and February 1, 2011, subject to the terms, conditions and exclusions of the policy form.

scenario 1If Mr. Smith were to switch insurance companies before his current policy expired February 1, 2011, his new carrier should pick up his prior acts coverage back to February 1, 2000, and the new insurance company would respond to new claims reported during the policy period for work done between February 1, 2000 and February 1, 2012.

scenario 2If Mr. Smith let his policy lapse and did not renew it by February 1, 2011, or went with an insurance company that did not offer prior acts - should he have

Don’t be fooled by marketing gibberish implying that you don’t need to maintain your prior acts coverage in your real Estate Errors & omissions Insurance

policy. yoU NEED It.

U


a claim for work he did between February 1, 2000 and February 1, 2011 – he would have no coverage unless he purchased an Extended Reporting Period Endorsement.

Most claims or complaints are reported several years after the actual appraisal was performed. There are statutes of limitations that typically vary by state and by allegation, which may protect a real estate appraiser from being held responsible for damages. However, there is still the cost of defense, which can far exceed the cost of your insurance contract.You can purchase an Extended Reporting Period Endorsement from your

current carrier during a specified time period if you do not renew your policy, retire, or switch to another carrier who does not provide you with prior acts coverage. It is an extension of time to respond to a claim for work done between your prior acts date and your policy expiration date. Costs vary depending on the insurance company. Some may offer free options for retirees and Death and Disability, as well as options you can purchase for a one-, two- or three-year period of time. An Extended Reporting Period does not cover any services performed in the future. It only provides an extension of time in which to report a claim for work done in the past. It is a one-

time option and cannot be renewed once the extended reporting period expires.

The long and the short of it: giving up prior acts coverage may be one of the worst business decisions a professional could make. All those years of maintaining adequate protection by renewing each year and keeping your prior acts coverage would be gone – just when you most need coverage. Maintain your prior acts coverage until you are no longer performing any professional services, then review your policy options and/or discuss with an insurance professional your extended reporting period options.

The terms, definitions and examples of insurance coverage are used here for demonstration only. Insurance policies and coverage can vary widely amongst insurance companies and you should consult an insurance professional and your policy for more information.6

Most claims or complaints are reported several years after the actual appraisal was

performed.

?

22 | LVM

Geographic Competencyvs.CompetencyCompetency is demanded, geographic or otherwise.JoRDaN pETkovskI / kRIsTINE hughEs

UP Front

istory Lesson

After WWI, and during the run-up to WWII, the French decided it would be in their best interest

to fortify the border region they shared with Germany in case of an unprovoked attack. The French were incredibly focused on defense after the Treaty of Versailles was signed June 28,

H

1919. The concern felt by the French was well founded since the Germans – agreeing to the Armistice in 1918 – were ultimately forced to sign the treaty in spite of their disagreement with the terms of surrender.

These fortifications would become known as the Maginot Line, named for André Maginot, France’s Minister of War from 1922 to 1924. This line of defense, stretching the entire length of the Franco-Germanic border, was thought to be the best way of dissuading the Germans from attacking. What the French didn’t count on was a flanking of the Maginot Line; Germany’s blitzkrieg attack occurred at the French-Belgian border, which hadn’t been reinforced with overages in the same way the French-German lines had. At this point, you may be wondering what any of this information has to do with the modern argument about geographic competency (geo competency). This historical fact is actually analogous to what our industry is experiencing today. So much effort has been afforded the geo competency argument that we’ve missed the real issue: the concept of competency in the aggregate.

The rules

As I recall, geo competency is a derivative of a comment provided within the

Competency Rule found in USPAP.

Per USPAP, 2010-2011 Edition:An appraiser must:

Be competent to perform the assignment. Acquire the necessary competency to perform the assignment. Decline or withdraw from the assignment.

Being CompetentThe appraiser must determine, prior to accepting an assignment, that he or she can perform the assignment competently. Competency requires:

The ability to properly identify the problem to be addressed. The knowledge and experience to complete the assignment competently.Recognition of, and compliance with, laws and regulations that apply to the appraiser or to the assignment.

Comment: Competency may apply to factors such as, but not limited to, an appraiser’s familiarity with a specific type of property or asset, a market, a geographic area, an intended use, specific laws and regulations or an analytical method. If such a factor is necessary for an appraiser to develop credible assignment results, the appraiser is responsible for having the competency to address that factor or for following the steps outlined below to satisfy this competency rule…

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Acquiring Competency Comment: In an assignment where geographic competency is necessary, an appraiser who is not familiar with the relevant market characteristics must acquire an understanding necessary to produce credible assignment results for the specific property type and market involved.

After reading the preceding passage, one can conclude competency has many nuances above and beyond the appraiser possessing a requisite knowledge of the subject’s geographic area. So why are we continually harping on one not-so-well-defined aspect of the competency rule? The answer is simple: It is one of the last bastions of hope for anyone contesting the results of an appraisal assignment, most often brought about by a borrower, broker or banker crying foul because the value conclusion provided has killed – or at least maimed – their deal.

After years of experience analyzing appraisals completed throughout the country, the need for increased educational requirements specific to overall competency in generally accepted appraisal methodology becomes apparent. Our industry has been sidetracked as a result of this argument over a small piece of the bigger issue. This derailment of our focus is an affront to appraisal professionals everywhere.

experiences

Being a homeowner, I’ve experienced the appraisal process as a consumer. The appraiser shows up, inspects the property, drives the comps and submits the report to my lender. Once received, the lender schedules a closing date and I move on with my life. What if the lender, after receiving the appraisal report, realizes they will not be able to refinance my loan due to insufficient equity, a result of the appraiser’s value conclusion? I’ll admit having spent very little time reviewing appraisals completed on my home in the past, but this scenario would immediately prompt a deep-dive into the appraiser’s report. What if, during the course of my research, I determine the appraiser traveled a distance of 40 miles from their home to inspect my property (in addition to other perceived deficiencies noted within the appraisal)? That’s 40 miles in a semi-urban to suburban market area. This could be perceived as the proverbial “chink in the armor” and it would likely be exploited accordingly.

It’s fair to say that most appraisers would rather provide appraisal services in as localized an area as possible. The problem many have faced is the degradation of appraisal fees and a decline in the volume of assignments available, resulting in an appraiser’s need to expand coverage into areas previously considered too distant. This is

cause and effect in its purest form. Is this an indictment of those appraisers who have been forced to expand their coverage area in order to survive? The answer is NO! It is simply a retelling of what many have experienced.

At TSI Appraisal, we realized the multitude of benefits afforded us by restricting our appraisers’ coverage to their immediate market area. The appraisers no longer drive ad infinitum; instead they spend their time appraising. This has increased the appraisers’ overall efficiency, allowing them to produce credible assignment results in less time. Another byproduct is their increased proficiency within their immediate market area. The appraisers are exposed to the same streets, subdivisions and neighborhoods every day, giving them much-needed insight into areas ripe with submarkets. These subsequent benefits aside, the appraiser is likely competent, or can gain the necessary competencies required to complete an appraisal assignment outside of these immediate confines.

What Now?

The energy being spent on contesting an appraiser’s geo competency is akin to the time spent developing the Maginot Line: misguided, poorly thought out, and yielding little ROI. Our focus must be on the continued development of our profession. We have no choice but to insist on the betterment of those participating in one of

the nation’s most critical fields of practice. Continually educating the appraisers, lenders and AMCs is our cross to bear. Understanding:

Why this sale is more competitive with the subject property than that sale. Why regression analysis is a critical skill all appraisers must master. When REO sales should be considered as comparables when appraising a property for an arms-length transaction, are all aspects of competency that deserve additional focus.

In the end, our fight may not yield traction. If the lender/client demands appraisers remain within a five-mile parametric distance from their home address in order to ensure geo competency, we may in the end capitulate. As a colleague and close friend said to me, “Guess how I know [the lender] is right on this? They send their business elsewhere!” It’s a challenge trying to find a countervailing argument to that logic.

causa latet, vis est notissima, or “the cause is hidden, but the result is well known.” I ask the industry to forgo building our own Maginot Line. We know what will happen if we’re not able to redirect our focus from geo competency to overall competency, even if we can’t figure out how we got so far off course in the first place. 6

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24 | LVM

AnAlysis:AnAlysis: Tools of The TrAde

| steve FergUson |

Appraisal is still an art, even with the science of regression.


Valuation is seeing leaps ina u t o m a t i o n and data access,

and due to ever-increasing p r e s s u r e s , there is a need to be

more efficient. In 2001 I went back

to school to study

economics. Part math

and part study of

consumer choices, it seemed like a

g o o d a d v a n c e m e n tfor my career in real estate. In the two years that followed I worked my way through another major to the capstone in my undergrad studies: econometrics. At the time I never knew there was such a study but it opened my eyes to a branch of work that has only recently gained traction in the real estate valuation industry.

In this article I will explain some parts of the regression process, as well as the art that is part of this mathematical tool. This article explains the ordinary least squares assumptions that underlie any good study.

Regression vs. Econometrics

The field of econometrics is based on the development of statistical methods for estimating economic relationships between independent and dependent variables, such as gross living area and price; or education levels and salary. Other factors affect price and salary in this example, but by employing the correct data-generating process, all other variables can be held constant so that the part of the gross living area that contributes to the price can be estimated. This is called ceteris paribus, or “all other things being equal.” In introductory appraisal classes we learn this as matched paired analysis. It is a similar principle but regression requires a larger sample. When applied correctly, it will yield statistically unbiased results.

A proper understanding of the data-generating process is important in econometrics because we are using observational data, not experimental data. It would make appraising a lot easier if we had a lab where we could study how much one would pay for one more square foot or one more garage. If this were the case then there would be no need for a valuation professional. This is an important distinction between regression and a field of study that happens to use regression, among other statistics, as part of the process. The reality is that we do not have experimental data in real estate; we have observational data, which is not perfect. This is why those who use regression as part of the process of evaluating data should understand its limitations. Appraisers who are now using and relying on regression output need to know how to build a good explanatory model, the strength of the methodology, and what the data means.

the ForMuLa For sinGLe Linear reGression is siMiLar to the ForMuLa For sLope:

Y=a+bxwhich is the same as the mathematical formula for the slope of a line. Econometrics uses different symbols for regression formulas. As an example, a multiple regression formula for real estate might be:

Y(price) = β0 + β1* (SqUArE FEEt) + β2* (GaraGe)….. + βkxk+u.

In the above formula, β is the estimator and u is the error term. Because we >>

26 | LVM

cannot create a control group and an experimental group, we will always have an error term, which is simply all the variance in y we cannot explain in a stochastic model. It is important to note that there are many assumptions in ordinary least squares (OLS) regression.

Two of these assumptions are that there is zero correlation among the variables (xi); and zero correlation between the variables and the error term (u). These are important assumptions to note when selecting independent variables. For instance, is bedroom count necessarily independent from GLA? Some floor plans may have multiple adaptations to include a three-bedroom with a loft or a four-bedroom with the same square footage. In these instances you may see a distinction between the value of a four-bedroom versus a three-bedroom and it may be more or less than the cost to change (cure). In general it is not very interesting to control for square footage while separately attempting to address the bedroom count. Bedroom count is somewhat of a redundant square footage count (not in all cases, but again, one must be skilled in the art of regression to determine the difference). It is generally hard to add a bedroom and not add square footage. Instead it may be beneficial to look at an independent variable that takes into account the interaction between the two variables.

Another assumption in OLS regression is random sampling. This one is particularly interesting in real estate these days and one I have been wrestling with for the last six months. Are sales random in this market? The post-tax incentive market has brought about a real shift in demand. Much of the 2010 demand, at least for the first-time homebuyer market, was brought forward to the first quarter. The intuition is that lower demand after April 30, 2010, should bring about lower pricing in most markets. But when I recently tried to get a glimpse of what the incentive did to the arms-length market, I was surprised on many levels.

First, my methodology is to try and minimize independent variables and compare homogeneous properties within a large neighborhood to estimate the impact of an event. My go-to neighborhoods, where sales are typically abundant, were reduced significantly since May. Further, the pricing does not reflect the theory that

lower demand would create a drop in pricing; at least two variables are at work in this example. The number of arms-length transactions in the post-incentive market was not sufficient to show any significance in the coefficient

on the tax incentive, but the coefficient, while weak, was strongly going in the “wrong” direction. In other words, prices have been increasing since May in the retail sector of these neighborhoods.

Secondly, closer examination of the 20-35 sales indicated significant quality and condition differences. prior to the tAx INCENtIVE DEADLINE, AVErAGE hoMES WErE SELLING; SINCE thEN, onLY the creaM oF the crop have BEEN SELLING. For thE MoSt PArt the coMMents in the MLs were Not SUBjECtIVE IN NAtUrE. thE updates to these saLes incLuded NEW rooFS, GUttErS, hVAC, UPDAtED kItChENS AND NEW FLoorING. IN othEr WorDS, thE SALES WErE UNMIStAkABLy UPPEr-tIEr CoNDItIoN AND qUALIty.

Of course the only true way to determine the quality is a site inspection, but a strong indicator is to look at residual analysis. If you have a good functional form, the observations that fall significantly above the line of best fit would be worth further investigation, possibly indicating quality or condition differences. So how random are the sales in this market? Is this representative of the market as a whole? This brings about the next topic: qualitative information.

Regression analysis is really efficient at looking at quantitative data, but is less so with qualitative data. It is difficult in real estate to remove the subjective nature of quality and condition and one must create a metric for scoring the data. So in order for the data to be uniform, the scoring must be done by use of primary information, not secondary (MLS). More observations are required due to the advanced techniques utilized to analyze the data. Many of these techniques are not new and are used in market research, botany, and political polling to analyze consumer ratings of a product, color qualities of a plant or a rating of how well a candidate is performing. Again, it’s not impossible, but it’s very labor-intensive and not very conducive to a small project

1

2


of estimating the value of one property. In normal markets the value of this qualitative data would be minimized. A market in equilibrium has more buyers and fewer sellers than today’s market. As a result, homes along the middle and lower end of the quality and condition spectrum would sell instead of just the upper tier. Sales of high-quality, homes in good condition would balance out the lower-quality, average-condition observations in the sample, thereby mirroring the real population. In other words, the error in the sample would be the same as the general population, which is another assumption in OLS regression.

Application

So what is the best way to use the regression output? It depends on the assignment. If you are trying to determine the effect of an event, it would be less interesting to look at the value of an individual property than the coefficient measuring the effect. One of the first assignments where I used econometrics was for a partial taking of a property. Acquiring enough relevant sales, I was able to isolate the land value per acre and then apply the coefficient to the subdivided piece of land. Because there was only one possible buyer in this transaction, I used a 95% confidence interval to explain the high and low end of potential value. The same method can be used if looking at the value of

a property: Running the model on the independent variables of the subject would produce a point value estimate or, with additional steps, a 95% confidence interval could be used. Alternatively, set up a hedonic model where the comparable independent variables can be adjusted based on the regression model output.

This method allows the appraiser to apply local market knowledge and experience using the mathematical strength of the regression. The methods could be used to support each other or in the background of a typical appraisal to add strength to the valuation.

Of the many applications of an econometric study, one I have frequently used is a way to calculate marginal return. In a large sample using the assumptions outlined in this article, run a regression on the model identifying the proper independent variables. Square footage is a good example. iF You are LookinG at a neiGhborhood with hoMes ranGinG in GLA FroM 1,000-1,600 SqUArE FEEt, At what point is there MarGinaL return on A hoME WIth 2,000 SqUArE FEEt? The way to determine this

is by creating a quadratic equation. Run the regression again with the variable in which you are interested, squared. In other words, for each observation in the square footage example, add the variable square feet2. When the coefficient on square footage is positive, and the coefficient on

square feet2 is negative, the quadratic has a parabolic shape. The point at which GLA has diminishing returns is the inflection point of the parabola. Taking the first derivative of the variables square feet and square feet2 and solving for the point at which the slope is zero can solve the inflection point. If you have not studied calculus, this is achieved at the coefficient on square footage over twice the absolute value of the coefficient on square feet2. For example, assume your output gives coefficient on square feet $35, and coefficient on square feet2 -.01, solution is 35/2(-.01) = 1,750. In this example there will be a diminishing return to each square foot above 1,750. Applying this to an appraisal with proper explanation can help reduce the number of callbacks for additional support. It looks much better in a report and will add to your credibility if you can show the point of marginal return empirically rather than by theory.

The end users are asking for more and more market support from the appraiser. Proper use of regression tools can increase efficiency by adding the objective substance needed for the industry. Many vendors in the industry either have or are in the process of creating a seamless application that will sort, convert and analyze data as a way to incorporate this power into an appraisal. My only warning is if you have not studied descriptive and inferential statistics, take a class or read a book and become familiar with its application and limitations. There will be several statistics accompanying any regression output; know what they mean and what they measure, at the very minimum. I used a stats application in grad school that was very powerful, but most of the work for simple applications can be done using a spreadsheet with an analysis pack installed. It takes a little time to clean up data but it is a good exercise. 6

alternatively, set up a hedonic model

where the comparable independent variables can be adjusted based

on the regression model output. this

method allows the appraiser to

apply local market knowledge and experience using

the mathematical strength of the regression. the

methods could be used to support each other or in the background of a typical appraisal to add strength to the

valuation.

28 | LVM


Scope Creep: What lax standards caused,

unreasonable standards will not cure.

leland Trice, Sra, FrICS

30 | LVM

During the days of property appreciation, I would cringe at having the reputation for being “too conservative.” Anyone in the real estate biz knows that “too conservative” is just code for being honest and not rubber-stamping the desired value. I now have Realtors who considered me too conservative, hiring me to help convince sellers they need to be “realistic.”Now that the massive real estate bubble has popped, our industry is often chided in drive by journalism pieces as for enabling the poor, misguided buyers. Perhaps we as a group were not conservative enough. But in reality we were and still are trapped by conventions. To steal a line from

Who had a tougher 2010: Tiger Woods or appraisers? Tiger Woods is an over-sexed billionaire who can reach most par 5s with a 7-iron. Appraisers are still the whipping boys and girls of the real estate finance industry. I have a hard time weeping for poor Tiger.

I now have more than 25 years – OUCH – under my belt in the appraisal industry. I am so used to being told I am wrong that I get nervous when someone agrees with my value opinion. More often than not, I am “wrong” in both directions in the same day. I yearn for a Goldilocks scenario. This appraisal is too high. This appraisal is too low. Rarely is the appraisal “just right.”

Comp 2 has 1,800 SF above grade area and 800 SF of basement. So, that is how I report it. Underwriter comes back and says that their data shows the home has 2,600 SF. I send a note explaining that it appears that the database she is using is combining the above grade area and the finished area. I also send copies of the MLS and tax card, which both show 1,800 SF up and 800 in the basement. Response from the underwriter – OK, but how can I prove which one is correct? Yikes!

Underwriter wants to know why, if I indicated that there were no sales concessions for the comparable sales, no adjustments were made for sales concessions. Ummmm.

I appraised a property where the master bedroom door was padlocked. This was a rental and one of the tenants was deployed to Iraq and didn’t want anyone going into the room while overseas. The owner didn’t have a key to the padlock. The underwriter demanded a second inspection to photograph the padlock. I guess the appraiser can never be trusted again for anything they say and every single property characteristic requires photo documentation. If there is an alarm system, take a photo. If there’s a furnace, hot water heater, and electric panel, take those photos too; and make sure each bathroom fixture can be seen in the bathroom photos. If there are six and a half baths, you better have six and a half bathroom photos in the report.

I have received a request from XXXXX Mortgage through an AMC to revise a report; I am not permitted to put N/A on the 1004MC, and must write out “not available” or “not applicable” as the case may be. The underwriter also requires additional location maps that show the actual street name the balloon is located on, even if extra maps are required to get the detail. No allowance for mapping programs that may not have new streets; I had to copy and scan pieces of ADC maps and edit with balloons in order to comply. The whole revision process took over one hour.

Underwriter wants to know why there is a ladder lying down on the rear patio of the house. Seriously???

All appraisers love to share

2

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?

In order to drive home the point about how ineffective and unproductive this new level of appraisal scrutiny can be, I thought it would be useful to share examples from people in the trenches:“war stories.”


LiveValuation Magazine contributor Roger Staiger, residential appraising is dependent on the “Greater Fool Theory.” The sales comparison approach is quite simply a recitation of what the last fools paid. And by 2005 things had indeed gotten quite foolish. But what did our clients ask of us? Did they ask what those fools should be paying? No. Our clients asked what the fools actually were paying. Everyone lost their collective minds during the bubble, and market value became a reflection of that mass hysteria.

From 1959 through 2000, the average ratio of median house price to income was about 2.2. Even after a severe correction,

that ratio remains at 3.3. That suggests another 30% fall in housing prices are needed to revert to historical benchmarks – assuming we do not have a significant increase in median income. Another telling index is the ratio of housing price versus rent. This speaks more to the income approach. While most decisions to purchase a primary residence are not rooting in income potential, the trend in rents moved parallel to housing values until 2000, when the bubble began. The comparison of rent to price has recovered more than price versus income, but it still suggests more correction in price is forthcoming.

So other than stating what is now obvious, where am I going with this? As I see it, the problem is that two wrongs don’t make a right. We got into this mess with lax standards and we will not get out of it with unreasonable standards. When anyone who could fog a mirror qualified for a mortgage (or several), the only data point on an appraisal that was examined was the value. Now that Warren Buffett would have difficulty getting a mortgage, every data point must be perfect and more data points are added every day. Unfortunately, I am not convinced this makes for better appraisals. I am convinced it makes for very disgruntled and disaffected appraisers. >>

The most insane trend is an expectation for the appraiser to justify just about every <bleeping> adjustment with paired sales analysis. Talk about fantasy land! The underwriter asked that any view, quality, and condition adjustments be supported by matched pair analysis or statistical regression – or those comps should be replaced by more similar sales not requiring adjustment. This was for a report that described in vivid detail the severe limitations in the quantity and quality of data. Given such limited data in a non-metropolitan or homogeneous market, how would one find either numerous sales of identical characteristics or adequate data to statistically derive any adjustments?

The appraiser needs to indicate his exact mileage from the subject and document number of appraisals done in the subject market over the last 12 months. Shouldn’t the appraiser’s “geographic competency” be determined prior to completing the assignment?

First “correction request” from AMC (three days after original report was delivered): “Appraiser must report whether utilities were on and appeared to be functioning properly during the inspection.” First reply (four days after delivery): “The improvements section of the 1004 form (second section from the bottom of page 1 of the 1004) notes that “All utilities were on and appeared to

be operating normally during the appraiser’s inspection.” (Emphasis added) Second “correction request” from AMC (six days after delivery): The statement must read exactly “utilities were on and appeared to be functioning properly.” (Emphasis added) Second answer (seven days after delivery): After much hair-pulling and not a few primal screams, the appraiser complied with the pointless demand.

I submitted the report 10 days ago +/-; they informed me today that XXX Bank will not accept it unless I add the word “View” after each photo on subject photo page. Each photo is labeled “subject front,” “subject street”...etc. Wow.

r Q

Bv ie w

Anyone in the real estate biz knows that “too conservative” is just code for being honest

and not rubber-stamping the desired value.

32 | LVM

Beyond the unanimous grumbling and frustration amongst appraisers, it is appropriate to ask if these examples of “due diligence” make for sound lending decisions. Are these the elements that identify collateral risk?

What is the solution? Thanks for asking! I would suggest the following ... stop the horribly inefficient process of inflexible and rote protocols for quality control. First, ensure that those doing quality control have appraisal experience and knowledge and do not simply follow a checklist. Second, treat the QC process more like a Standard 3 Appraisal Review. Consider how an appraiser does such a review. Do they demand that the original appraiser correct every typo, add a 12th comparable, or get a better bath photo? NO – a good review appraiser documents their finding and opinions and whether the appraisal is sound and credible. Why can’t such a QC report accompany the appraisal and document the typo, document the fact that the Subject Property Value exceeds the Predominant Neighborhood Value by 5% and the appraiser forgot to comment, and any other non-critical

findings? Why not reserve requests for additional information or corrections to those appraisal reports which may not truly be fully supported and credible in the original submission? I don’t think that suggests tolerating sloppiness but would inject some common sense and also substantiate the QC process itself. In the era of mortgage repurchase risk, would that not satisfy the need to demonstrate good collateral risk management?

Appraisers are also constantly asked to “tell the story.” And I applaud reinforcing the need to fully and clearly communicate the appraisal opinion. Unfortunately, the mortgage-lending arena has become a “checklist” or assembly line type of process. Worlds are colliding. Appraisers now face Scope Creep – with demands for more information, more description and more analysis than what fits on the original forms. Once outside the box, there are no standards, no conventions, no protocols. If the quality control side of the equation is working from a checklist, why not have the production side (i.e., the appraisers) work from that same checklist? Wouldn’t it be more efficient if every

On my hit parade of Idiot Underwriter Tricks is the recent fixation on whether the subject is an “Over-Improvement” or “Under-Improvement”; ill-defined buzzwords at best with no universally accepted meaning. When asked to provide a definition of either term, so far every AMC has failed, but still insisted that I must tell them whether the subject is or is not something they cannot define. So, even though we have already told them that yes, the subject does generally conform to the neighborhood, we have also added the following to our boilerplate: For purposes of this report, the terms “Over-Improvement” and “Under-Improvement” are both defined as: Improvements which fail to conform to established market area norms of size, quality, and/or function to the extent that prospective buyers would not consider the subject as a directly competing alternative to other homes

in the local market. In the appraiser’s opinion, assuming the definition given above, the subject is not an over-improvement or under-improvement relative to competing homes in the market area. The nabobs at the AMCs don’t even understand the terms they are using, but as long as we include those ill-defined buzzwords and the word “not” in a sentence somewhere in the report, they are happy.

“Appraiser to comment on comp photos – grass appears to be a different shade for each comp.” These were clearly high-resolution and good-quality photographs. Is the original photo taken shortly after the transaction less reliable than making an appraiser drive by the same property months later to retake the same photograph?

Just received a request to change the address spelling of the subject property. I spelled the way it shows on the street sign in front of the house, in addition to a street map provided, county map provided, plat provided, public records provided, and county records provided. But apparently I am required to change my report because the title company has it differently? Even when right, we are wrong.

“Appraiser to retake interior photos with no family photographs visible. Family photos must be removed from the wall if necessary.” The people in these photos were indecipherable unless the photo was significantly enlarged.

#$

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!


appraiser were prompted to address each and every deviation from conventional guidelines? I am not suggesting the appraiser merely gets to tick off an acknowledgement that some item is out of compliance, but it would be quite easy and efficient to organize these items, prompt for specific analysis and commentary, and organize them in such a manner that it is no longer necessary to flip back and forth through pages of a report to locate a statement about whether private wells and septics were typical and accepted in the market!

Collateral risk management is a highly essential part of lending, and while we seem to be doing more of it, we also seem, in my humble opinion, to be far more concerned about the boxes on the form than the true risk and reliability of the appraisal professional’s opinion. And for goodness’ sake, can we all understand that “ugly” appraisals don’t automatically equate to “bad” appraisals?!

Appraisers love to appraise cookie-cutter homes in tract housing communities with three model match sales within a few blocks that sold in the last 90 days. But alas, we also get saddled with the assignment of the manufactured home that was disguised with an addition, situated on 9 acres, has two outbuildings, and is in a rural location with few relevant sales in the past two years. Some of the best reports I have ever read were “ugly.”

I do think we have lost sight of the forest while cataloging every tree. Appraisers are desperately trying to fulfill our clients’ requests. And certainly all appraisers are not created equal. However, perhaps if we stepped back and looked at what exactly was being asked of appraisers and how our clients are digesting and using that information, we could find a more effective way to manage collateral risk. 6

Underwriter wants an explanation for the location adjustment when multiple aerial maps are provided of the subjects and the comparable sales, and the subject are backing an interstate. They say they cannot understand why the comparable sale on the same street would not have the same location. The aerial map shows that the comparable sale on the same street borders neighborhood houses and the subject property borders the interstate. They still don’t understand, and state they want photos of what the comps border and what the subject borders, despite my labeled aerial images and narrative description. What else can I do?

I provided a one-line report from the MLS showing every sale in the subject’s small town in the past year. There were only 20 sales, and only

five of those were remotely similar. I used all five in my report and included narrative comment and analysis about the number of sales. You guessed it: Underwriter wants “a better, more recent sale or an explanation for lack of such sale.”

The following was proactively communicated to client upon receipt of appraisal order: “Preliminary research indicates the subject is located in a very small town (XXX) on YYY Bay. There are limited sales/listings available for use and any reasonably competing locations are separated by long distances. It may not be possible to meet all client guidance regarding comparable currency, distance, adjustments etc. If this is not acceptable, please advise as soon as possible. We do not want to produce a product that will not meet your needs. Thank you.” In the appraisal report itself there was

extensive discussion of the market area and the limited comparable data. Despite the pre-emptive caution and extensive discussion in the report, the following addendum request was made: “Upon underwrite of the appraisal submitted, it has been determined that the appraisal does not meet lender requirements for the following reason(s): subject is located in a declining market and we require two comparables that support the value that closed within 90 days; and if not available need 3 sales that closed within 6 months. Please review and provide one additional comparable to support the subject indicated value within either 90 days or six months. Any variation from lender requirements must be fully explained in the report.”

Q

7

4

I do think we have lost sight of the forest while

cataloging every tree. Appraisers are desperately

trying to fulfill our clients’ requests.

34 | LVM

| DennIs a. scarDIllI, esq., MaI |

thelawof

Has real estate appraisal practice outgrown USPAP?

Real Estate Appraisal

lawAdmitted to Practice Only in NJ & PA


In the spirit of

L i v e V a l u a t i o n ’ s m o d u soperandi of bringing you cutting-edge industry issues in

thought-provoking articles,

I pose the question: “H a s r e a l e s t a t e

A P P R A I S A l P R A c t I c E

oUtgRown USPAP?”

No, I’m not suggesting that we do away with USPAP. And no, I’m not dissing The Appraisal Foundation, the Appraisal Subcommittee or state regulators, all of whom I hold in the highest regard.

Rather, I am merely asking what is now a rhetorical question. Real estate appraisal practice is far from being the “cottage industry” that it was often called when I performed my first appraisal in 1980. The changes that may occur over the next several years could make the past few years look relatively tame by comparison. It’s time for real estate appraisal law to go beyond USPAP.

The Dawning of The age of Real esTaTe appRaisal law

The Mortgage Reform and Anti-Predatory Lending Act of 2010 (MRAPLA) makes it clear that the law of real estate appraisal must go far beyond USPAP.1 For the past 20 years, real estate appraisal has been a regulated industry, but the importance of real estate appraisal law has not been recognized. Under MRAPLA the industry is even more regulated. The law of real estate appraisal must, therefore, be recognized as an important component of

the education of real estate appraisers and an important part of real estate appraisal practice.

I started to think about this issue in 2009 after taking the USPAP instructors course sponsored by The Appraisal Foundation (TAF). As an attorney, my discussions with other students got me thinking about real estate appraisal law and the future of appraisal practice.

At the Appraisal Institute (AI) January 2010 Federal Update conference, it was clear that in many ways, appraisers are increasingly dependent on government, both for work and to create the regulations under which that work is performed. The AI’s Washington Summit took place last summer, days before MRAPLA was signed as part of what is popularly known as the Financial Reform Act. Even after the summit’s luncheon speech by MRAPLA’s prime sponsor, Rep. Paul Kanjorski (D-PA), there was a lot of uncertainty regarding what MRAPLA meant for the industry.

The joint meeting of the Association of Appraisal Regulatory Officials (AARO), TAF and the Appraisal Subcommittee (ASC) brought the issue into focus. That conference included an appraiser discipline mock trial, which was videotaped and can now be viewed on TAF’s website.2 Federal agents made presentations on mortgage and appraisal fraud. We were told how MRAPLA became law and about the changes that it was bringing to appraisal practice. Immediately after that joint meeting, the National Association of Realtors (NAR) held an appraisal summit in Washington filled with industry leaders. The presentations included how MRAPLA and other governmental actions affected the industry.

Virtually everyone with whom I spoke at these conferences agreed that real estate appraisal law had become part of the

appraiser’s world. The only question was, “But, what does that mean?”

Today, there is no question that real estate appraisal practice is a regulated industry. Under MRAPLA, it will become even more so. Everyone involved with real estate appraisal knows that the industry is being increasingly regulated. But few understand the relationship between that dynamic and the law. Perhaps that is because both fledgling appraisers and more experienced appraisers are taught only one part of the picture. That’s right, just USPAP.

Yes, some states require at least a two-hour block of state-level instruction in addition to the seven-hour USPAP update. And yes, organizations such as the Appraisal Institute have a number of courses involving appraisal and law, but those courses typically deal with valuation litigation. No one addresses the regulatory aspects of appraisal practice, risk management or other process-driven issues in real estate appraisal law.

As a result, I believe that it is time to encourage appraisers, regulators, educators and users of appraisal services to start thinking about real estate appraisal law that goes beyond litigation valuation.

whaT is Real esTaTe appRaisal law going To Do foR Me? What does real estate appraisal law do for a real estate appraiser? For that matter, what does it do for a lender, an attorney, or other users of real estate appraisal services?

For one thing, real estate appraisal law goes beyond functionally obsolete appraisal education and regulatory paradigms, which are currently focused exclusively on USPAP. That’s part of what I mean when I ask if we have outgrown USPAP. >>

1 11 P.L. 203 2 http://www.globalpres.com/mediasite/Catalog/pages/catalog.aspx?catalogId=97b75dbc-da29-4ac2-b603-caa7705cf271

36 | LVM

The answer is yes – certainly as a means of training new appraisers. The same is true in regard to regulating those currently in the field; ditto for cutting-edge regulatory legal issues for lenders. Most users of appraisal services, including a majority of lawyers and judges, don’t know what I’m talking about when I utter the acronym USPAP. When I say, “appraisal regulatory standards,” I can see that they understand.

Let’s face it: Appraisal practice has changed. the present real estate appraiser regulatory and educational paradigms need to change with it.

Real estate appraisal practice must deal with certain facts of life. Its future is as an increasingly regulated industry. Appraisal practice is in the midst of change that has more “unknown unknowns” than even known unknowns. The issue is how to structure that change so that it does not ruin the industry.

Those facts lead me to believe that real estate appraisal law is a steadying influence in an uncertain world. Law is based on precedent. The Latin term stare diesis means “to stand by things decided.”3 This bedrock principle of law can be described as “intended to ensure that people are guided in their personal and business dealings by prior court decisions through established and fixed principles…”.4

Courts typically follow precedent, except when that precedent needs to be broken, such as in Brown v. Board of Education5, the 1954 landmark civil rights decision by the U.S. Supreme Court. At other times, court decisions include a dissenting opinion that creates societal change, such as Justice Clarence Thomas’ brilliant dissent in New London v. Kelo6, the Supreme Court’s 2005 landmark eminent domain case. Through his dissent, Justice Thomas established the basis for numerous political, legislative and

judicial rejections of the Supreme Court’s unpopular majority opinion. In both instances, the “established and fixed principles” of the law established the parameters of dramatic cultural change, even when the court’s decision went against precedent.

Appraisers should embrace real estate appraisal law as a means of delineating similar “established and fixed principles” that go beyond the common law and cottage-industry history of appraisal practice. Real estate appraisal practice has seen a topsy-turvy world of change over the past several years. The Government Accountability Office (GAO) statutorily mandated study on the valuation industry, along with the myriad rules and regulations that will be evolving out of MRAPLA, portend even more changes in the relatively near future. Real estate appraisal law can provide the structure necessary to keep tumultuous change from destroying the industry.

issue aReas

Now that I’ve told you why real estate appraisal law is important, let’s drill

down into some substance. The three most important issue areas in real estate appraisal law are regulation, education and the future of appraisal practice.

regulationPerhaps the greatest regulatory issue in real estate appraisal law today is how MRAPLA will affect the industry. That act brings about the greatest changes in appraisal regulation since the passage of the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA). MRAPLA’s Subtitle F, Appraisal Activities, establishes a significantly revised regulatory regime for real estate appraisal practice at the state/territorial and federal levels. In addition, both MRAPLA and the other acts in what is popularly known as the Financial Reform Act affect a wide range of real estate-related services. Thus, real estate appraisal activities for a wide range of real estate practitioners will be affected by statute or regulation, thereby creating a knowledge economy demand for real estate appraisal law.

One area of that demand should be among providers, and regulators, of appraisal practice services. Unfortunately, the regulatory knowledge of most appraisers and regulators is limited to USPAP. Even more unfortunately, the lack of a body of information on state disciplinary actions and interpretations has caused USPAP’s application to essentially be anecdotal.

USPAP actually evolved from what would be akin to common law. In the mid-1980s, appraisal organizations created USPAP by meshing their individual ethics rules. Those rules were essentially common law, just like the legal standard before the relatively modern practice of codifying the law and making written decisions of courts available to the general public.

3 Black’s Law Dictionary (8th Ed.). 4 Corby v. McCarthy, 154 Md. App. 446, 840 A.2d 188 (2003).

5 Brown v. Board of Education, 347 U.S. 483, 74 S. Ct. 686, 98 L. Ed. 873 (1954). 6 Kelo v. City of New London, 545 U.S. 1158 (U.S. 2005).

Most users of appraisal services,

including a majority of lawyers and judges,

don’t know what I’m talking about when I utter the acronym UsPaP. When I say,

“appraisal regulatory standards,” I can see that they understand.

G


USPAP was designed to be like the Uniform Commercial Code, but for real estate appraisal practice. It sets up a broad general national standard that is then applied to specific facts and circumstances by a state-level statutory and regulatory process. This was true under FIRREA and will be increasingly true under MRAPLA.

USPAP is merely a guide to be used by regulators to make decisions, under its standards, similar to the manner in which the UCC is employed. State legislatures use the UCC as a general guide. Then, they draft specific state-level laws based on certain provisions of that general guide. Courts and administrative bodies look to these specific laws, and the case law based on them, in adjudicating matters involving the UCC within a jurisdiction. This is virtually impossible to do with USPAP due to the lack of a publically available body of law on the interpretation of that general guide by state appraiser regulatory entities.

Litigation will inevitably develop in regard to disputes under MRAPLA’s provisions for appraiser independence, mandatory complaints against appraisers and appraisal management company regulations, and unknown issues that will arise out of the mandated GAO studies.

Appraisers are not the only ones who need to know about real estate appraisal law. For example, accountants will soon be using appraisal concepts and, along with appraisers, will be applying world-level accounting standards of Fair Value. Lawyers and courts will need to know how appraisals are supposed to be performed and how appraisals are regulated beyond USPAP. This need goes well beyond representation of appraisers in disciplinary matters before state boards. Just ask lenders about the appraisal-related conundrums they face with regulators and investors, let alone borrower lawsuits. Numerous other real estate industry

participants will also need to know this information, including real estate licensees performing BPOs.

educationThe Appraisal Qualifications Board (AQB) has proposed a significant change in criteria for both the qualification of new real estate appraisers and requirements for the upgrading of existing appraisers, with a projected implementation date of January 1, 2015.

today’s young blood in real estate appraisal practice is going to want courses that provide credit for both academic requirements and appraiser qualification. Current appraisers who seek to upgrade their license or certification status will similarly demand courses that provide both appraiser and academic credit.

Nonprofit real estate education providers will have to determine the elements of real estate appraisal laws that should be included in appraisal education. Profit providers of continuing education will have to determine what can be profitably marketed to practicing appraisers. It will come down to what elements of real estate appraisal law should be included, for whom, when, and how those elements will be presented.

This may surprise you, but I believe that a real estate appraisal law academic course could be built around the current 15-hour USPAP course. Other topics should be added, such as risk management and state and federal regulation. Ethics and critical thinking would become an important part of such a curriculum. Hot Topics should also be included. These elements could then be mixed and matched to a variety of academic and continuing education offerings.

the Future oF appraisal practice

Hot Topics brings up the future of appraisal practice. At all levels, there needs to be integration between a real estate appraisal law curriculum and other cutting-edge courses in real estate appraisal practice. Such course topics could include sustainable real estate development, administration of the outsourcing of appraisal work to developing economies, and digitally driven future valuation methodologies exemplified by NAR’s development of a national database of sales and listings as well as Freddie and Fannie’s mandated XML formatted 1004s.

The future is here. Now we have to deal with it. But how? One way to address the future is to understand the past. Real estate appraisal law can help provide the necessary structure to both understanding the past and addressing the future.

How can appraisers rely on the law when “the courts aren’t even enforcing USPAP”? How many times have you heard that from appraisers? I recently searched the LexisNexis database for cases containing both the words “appraisal” and “BPo,” and found that courts routinely confused the two. What kind of future does a regulated industry have if the courts do not understand the difference between a regulated valuation and an unregulated one?

Don’t think that I’m criticizing the courts. Judges only address issues that litigants and their attorneys bring before them. That’s their job. Judges are not the USPAP police. Look to activities that are generally considered professions. Courts understand what they do because a body of law has been developed for each profession. That body of law combines with, and builds upon, the body of technical information >>

7

U

38 | LVM

for each recognized profession. The result is a public perception of competence and professionalism.

If appraisers expect to be treated as professionals, there needs to be a body of real estate appraisal law developed that is recognized by the courts, embodied in precedent, and accepted by related professions. A body of real estate appraisal law would help create a perception of professionalism by delineating “established and fixed principles” of law in this field. Such principles would then help control the type of change that could destroy the industry.

wRap-up anD nexT sTep

Real estate appraisal practice will never go back to being a cottage industry. For real estate appraisal practice to achieve the recognition necessary to maintain the public trust, it must go beyond relying upon its common law tradition, recognize its nature as a regulated industry and coherently present itself to both practitioners and to users of appraisal services. Real

estate appraisal law provides the structure for that process, especially in light of the changes that the industry has experienced and will undergo in the next few years.Where can we go with the issues discussed above? Well, for one thing I’m going to the Seattle conference of the American

Real Estate Society (ARES) April 13-16, 2011. At that esteemed conclave, I will be moderating a panel of equally esteemed real estate appraisal industry experts who will be discussing the thesis of this article. The panel presentation will primarily consist of a lively and productive interactive discussion among panel members and the audience. The starting point for that panel discussion will be my academic manuscript on the issues discussed in this article, to be posted by March 1, 2011, on the ARES website.

I hope that you will participate in that discussion. See you in Seattle.

DISclAImER:This article is published only for educational purposes. It does not constitute the establishment of an attorney-client relationship nor does it constitute legal advice. If you need legal advice, you should establish an attorney-client relationship with competent legal counsel. 6

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and unite with other appraisers.

a p p r a i s e r co a l i t i o n s

leav e yo ur ego at the d oo r


Up in the Pacific Northwest, an ill-advised scheme was afoot.

residential builders in Washington state were working hard

to persuade the legislature t h e r e t o r e q u i r e

“ G r E E N ” continuinG education (ce) for all appraisers, regardless of whether an appraiser works

on such appraisals.

Every appraiser there would have had to take seven hours of “green” CE credits out of the 28 hours of instruction required for biannual license renewal. Add in the USPAP coursework and that would have left just 14 hours for other elective credits.

Enter the Appraiser Coalition of Washington (ACOW). Among the pioneering industry coalition groups, ACOW went to work dispatching its lobbyists and members to explain why such a blanket requirement would be inappropriate and counterproductive to the professionals who would have to adhere to it.

The residential builders and lawmakers backed down. Why? Because ACOW spoke up, organized and focused on protecting its members’ interests.

It’s the sort of unity that should exist in every state across America, but sadly that’s not the case. In many states, appraisers don’t have such an assertive and organized voice and, as you’re probably aware, the results can be disastrous for the industry and the public whose interests we serve. We get scapegoated for the housing disaster, pushed around by lenders and regulated by legislators who have no idea how our business works.

Consider this your wake-up call. If you want to see serious changes, every appraiser needs to join their state coalition. If none exists, get one going. The future of your livelihood depends upon it.

In setting out to write this piece, I shot off emails to several credible state and national appraisal organizations seeking information about their groups and soliciting ideas for how to promote unity among appraisers both statewide and nationally. Among the many encouraging and heartwarming responses was one from Tom M. Ferstl, President of the Arkansas Appraisers Association, who shared a document that included a laundry list of steps he recommends for organizing an appraiser coalition. ThE kEy LINE wAs ThIs: havE a mEETINg wITh aT LEasT oNE REpREsENTaTIvE oF EaCh gRoup pREsENT (NaIFa, aI, ETC.) … you ask ThEm To LEavE ThEIR Egos aT homE aND ComE To ThE mEETINg wITh ThE IDEa ThaT ThEy aRE DoINg somEThINg To bENEFIT aLL ThE appRaIsERs IN ThEIR sTaTE, NoT JusT ThEIR INDIvIDuaL oRgaNIzaTIoN’s poINT oF vIEw.

Ferstl cuts to the quick with that zinger. Appraisers, he is acknowledging (and I am agreeing), can be their own worst enemies. We shut ourselves up in our offices, constantly afraid that others will steal our clients by charging too little, questioning the integrity of our work, and other nefarious business practices. We want independence, yet we don’t want independence. Without independence there is pressure to hit values, daily threats, but appropriate appraisal fees and some measure of freedom, but with independence there are firewalls, AMCs with increasing “scope creep,” reduced fees, huge time constraints and a completely different kind

of pressure. What we really want is some semblance of balance, rational behavior from the lending community, and to be treated fairly and with respect like other professionals in the business community.

I’m not trying to preach; I’m one of you. We appraisers can be terrible at marketing ourselves. We can be unwilling or incapable of socializing with one another or even getting to know one another. We may believe we’re doing this out of self-preservation, but we’re actually destroying our profession with this approach.

What we overlook is that we don’t need to be in love with one another to work together for our shared interests. Believe it or not, not all real estate agents like each other. Agents also compete intensely, but realize that there is strength in unity; and in through cooperation, they are empowered by their massive numbers. They too may gossip about one another behind each other’s backs or revel in petty mockery of another agent’s hairstyle or fashion sense, and may totally resent successful or overachieving competitors.But when it comes to legislative power, they have it and we appraisers do not. However, by now it should be fairly obvious that we need it, so we can either change the way we deal with each other or perish as an industry.

thIS MEANS yoU!

The time has come for every appraiser to become a member of their state appraisal coalition. These groups are inexpensive to join but provide invaluable opportunities to network, be proactive and, instead of feeling powerless and complaining constantly about the state of the business, do something about it! We all have as much control as we wish to have, but we must proactively decide to confront the problems that we face. Get out of your house, office or basement and start >>

42 | LVM

doing something about everything and anything that upsets and unsettles you. I was recently elected vice president of the Coalition of Arizona Appraisers (CoAA). Last year, I was a Director to the Board. That’s a pretty quick ascent, given that I only started attending meetings about 18 months ago and initially felt like an outsider in a group made up mainly of zealous Phoenix-area appraisers. I was a newcomer with a loud New York voice and opinion, who drove more than two hours each way to appear at every meeting I could, and no one knew who I was. Other people I knew advised me not to go or told me that this group was dominated by cliquey industry insiders from the Appraisal Institute (AI) or the National Association of Independent Fee Appraisers (NAIFA), among others.

That was a misconception. While some CoAA members are affiliated with other appraisal organizations, many are not, and all turned out to be great, nice, energetic, hardworking volunteers striving to improve the status and reputation of appraisers across the Grand Canyon State. Each member takes time away from their practices to address important appraisal issues with no compensation. There are no ulterior motives.

Certainly, some members can be highly opinionated, and some have quit or stopped attending after failing to force their agendas on the group as a whole. But that’s standard for any group of professionals, and those bad apples are far fewer than the vast majority of my fellow members, whose attitudes and behaviors are uplifting, respectful and collegial.

thE PoINt IS, yoU CAN SIt oN thE SIDELINES or GEt IN thE GAME. It’S yoUr CALL.

At the recent Appraisal Summit in Las Vegas, Mike Brunson, President of the

Coalition of Appraisers in Nevada (CAN), defined the word “coalition.” Pointing to the Merriam-Webster Dictionary, he said a coalition is “a temporary alliance of distinct parties, persons or states for joint action; the act of coalescing; union.” Very specifically, groups of people unite to become coalitions.

When responding to my outreach about coalitions, Brunson spoke openly about CAN. He said that in 2008 the Nevada Real Estate Commission formed a BPO task force to deal with the problems they were having with BPOs. Two appraisers, Pam Kinkade and Tony Wren, put together a committee, conducted research, and gave a presentation. This was the group that ignited the spark that lit the fire.

That’s all it takes to get started. Looking back, he also said that there were several key factors that made them successful. First off, they had a unified voice. CAN and the other active appraisal organizations came together and supported a common position. Mike said, “I realize that not everyone is going to agree on every point, but having multiple appraisal groups presenting conflicting views is detrimental to the credibility of all appraisers.”

This point is very important and we all need to keep it in mind: a united voice and a common position. If we want to be treated like professionals, we need to behave like professionals. Being a part of a coalition is one way to show support for your profession. By voicing your opinion, paying the nominal dues and supporting your state coalition, you are giving back to your industry as well. The few appraisers who are presently doing the work need your help. They can’t do it all alone.

State coalitions are nonprofit and run by volunteer appraisers. Their primary aim is to support the maintenance and improvement of the Uniform Standards of Professional Appraisal Practice (USPAP) and its effective enforcement at the state level. As Brunson explained in Las Vegas, coalitions raise funds to carry out that mission, which also entails fostering greater public trust and confidence in professional appraisal practice through nonpartisan interaction with legislative bodies, government regulatory agencies and other related groups. The mission statement of my organization, CoAA, specifically refers to using a “united voice” to carry out these aims.

what kinds oF thinGs do the state coaLitions do and accoMpLish that beneFit the appraisers in their states?

ACOW is, of course, an impressive example. Like most of the coalitions, ACOW advocates and lobbies for members and provides educational programs. Last year they managed to get a state AMC law passed, one that ACOW President Justin Slack predicted will be a model for the nation.

They also succeeded, as noted earlier, in preventing the legislature from foisting

an arbitrary licensing requirement that bears no relevance to many appraisers. Preventing bad laws is at least as important as fostering good ones.

The Illinois Coalition of Appraisers (ICAP), meanwhile, boasts a full-time lobbyist and an extremely active organization, says Randy Neff, Seminar Committee

appraisers, he is acknowledging (and I am

agreeing), can be their own worst enemies.


Chair for the group. It’s critical that they work in unison across the state because it is at the state level that most legislation impacting appraisers passes or fails, and licensing and certification programs are administered by state governments.

The Arkansas Appraisers Association was formed in 2005 and may have the highest percentage of statewide participation of appraisers of any organization in the U.S. Ferstl said about 40 percent of Arkansas’ 1,000 appraisers are members. They employ a professional lobbyist when the legislature is in session. Ferstl asserted their membership continues to grow because they are successful and because many appraisers want a “home” in the industry without paying exorbitant dues.

The Arkansas example was particularly fascinating because that state’s lawmakers passed an appraiser lien law that gives the appraiser the ability to file a lien on the

property that he or she appraised within 120 days of doing the work. Ferstl believes this triumph has attracted many appraisers to their association.

There is some dissent about what ought to happen next. A long-term goal of ICAP is to unite the state coalitions, sharing information and networking across state lines. A National Appraisal Coalition is in its beginning stages. Ferstl, however, doubts a national coalition will be effective or practical given the diversity across the country.I side with ICAP on this one. If the realtors can do it, so can we! We should never underestimate what the appraiser community is capable of!

CoAA also employs a lobbyist who helped us work first toward the passage in April 2010 of the AMC bill and now on its implementation. In addition, we are working to alter Arizona’s appraisal board

statute loopholes, among other front-burner issues.

These are just a few examples of what state coalitions do. Across the United States, coalitions offer encouraging stories of appraisers going to bat for appraisers. If you don’t want to be vocal or active but still want to show your support for the goals and work that others are doing, you’re still permitted and encouraged to join your nearby group. Some state coalitions, like ours in Arizona, allow appraisers to attend meetings via a conference call phone line because so many of us are spread out and time is so valuable. Many coalitions also offer more localized meetings as well.

The cost of joining is very little, but the support goes far. Feel free to contact me for information about the coalition in your state. Let’s get that attitude changed out there! 6

44 | LVM

| joe eMIson |

generationof

the

AVMs are more accurate when they use data

sources beyond public records.


1

M o s t

automated valuation models (AVMs)

estimate property values

b y l o o k i n g a t the internal characteristics of properties

as part of a “hedonic model,”

a n d b y l o o k i n g at historic sales around t h e p r o p e r t i e s

as part of a “repeat sales index.”

In theory, the combination of the hedonic and repeat sales evaluations captures the full range of factors necessary to value a property automatically. In practice, the quality of the data that drives the hedonic model leads to imperfect results. This article describes a better type of AVM using building permit data.

The Structure of Automated Valuation ModelsAutomated valuation models provide instantaneous property values using mathematical formulas and property data. Most AVMs consider the age of a structure, its square footage, number of bedrooms and other characteristics that make up the property. These characteristics are used as part of a hedonic model, which is a specialized term for a type of mathematical formula that estimates value from a list of characteristics.

However, property characteristics cannot determine a property’s value on their own. The real estate agent mantra “Location, location, location” implies that two structures with identical characteristics may command different prices depending on their location. So the hedonic model is not enough; AVMs need a way to capture the market conditions around the property. Most AVMs achieve this through a repeat sales index, which calculates localized market fluctuations by looking at repeat sales of the same properties over time.

Market conditions / historic saLes(repeat saLes index)

propertY characteristics(hedonic ModeL)

Fig.1 - The Structure of Most AVMs

The Problem with Property Characteristics“Effective Year Built” is merely a term used in Florida mass-appraisal of properties. It does NOT reflect the actual age of the property, or many upgrades which may impact the condition of a property. Our effective year built data should never be used by insurance companies and others as a substitute for an actual physical inspection of property, nor for determining the true year a property was constructed or the current condition.—Lori Parrish, CFA, Property Appraiser, Broward County.

Even with the sophisticated structure of a hedonic model weighted against a repeat sales index, AVMs are not perfect. Zillow, the provider of a widely-used consumer-facing AVM, says that at least 20% of the time, their estimate is more than 20% off the sales price, and in some top metro areas, their estimate is more than 20% off the sales price more than 40% of the time.1

One of the main reasons that automated valuation models are inaccurate is that the underlying property characteristic data

is inaccurate. Property characteristic data comes almost exclusively from tax assessor offices and MLS listings (largely derived from tax assessor data). Tax assessor data has a lower level of accuracy because it must be filled out for the Computer Assisted Mass Appraisal (CAMA) system to run and calculate taxes. If a value is not known, the CAMA system can’t run, so values—accurate, inaccurate, or guessed—are entered into the system.

Tax assessors are efficiently calculating accurate estimates for tax purposes, which the CAMA method enables. Every tax assessors’ office has a working appeals process for correcting inaccurate values (and thus the tax amount itself), resulting in taxes that are either accurate or underestimated, which is fine from a political as well as a personal standpoint.

The problem arises when third parties take data from tax assessor offices and interpret it not in the proprietary and specific way that the assessors use it, but rather as a completely accurate determination of property characteristics. This practice leads to many problems with the resulting hedonic models. Why? Four Reasons:

First, there is no dialogue between the hedonic estimate and the homeowner. If the underlying values used to calculate property tax are significantly off, they will be corrected when the assessor’s office >>

1http://www.zillow.com/howto/DataCoverageZestimateAccuracy.htm

“The most accurate way to value a property is to find out how much someone will pay for it. Unfortunately, sales data is only updated when a home sells.

However, building permit data allows us to take property sale values and bring them up to date, thus giving us a newer, better way to value properties.”—Holly tachovsky, President of buildFax, a national aggregator of building permit data.

46 | LVM

4

3

2and homeowner take a closer look at the actual home. For the hedonic estimate, the homeowner is not directly notified and has no way of correcting the value.

Second, hedonic models now rely on data that is stored in many different locations, and often updated infrequently or not at all. Thus, even if the tax assessor fixes the problem in the assessor’s data, the majority of the tens of thousands of copies of that data in existence will not be updated, and the inaccuracy will persist.

Third, hedonic models are much more sensitive to small inaccuracies than CAMA systems. This is largely due to the fact that they are estimating much larger numbers: home values, which are around 100 times larger than property tax amounts. There are many cases in which the data is wrong at the tax assessor’s office, but not so wrong to make the homeowner notice the error or want to go through an annoying dispute process. It is in these same cases that the hedonic estimates are far off, because the errors are significant when applied to estimating home value.

Fourth is the inaccurate-data feedback loop that retains a level of inaccuracy over even accurate assessor numbers. Because the hedonic models assume that the data is correct, the underlying mathematical formula assigns incorrect coefficients. For example, if household square footage values are either accurate or underestimated, then the hedonic formula coefficient associated with square footage will be too high, as it compensates for numbers that are too low on average. A coefficient that is too high because only some of the data points are inaccurate will adversely affect all of the estimates generated by the model.

The quote from Lori Parrish, Broward County’s property appraiser, shows that county’s belief that their “year built” designation is inaccurate, and Broward

County has stopped showing “year built” on their website because they are concerned about others relying on it. Moreover, Roger Arnemann, Vice President of Global Consulting and Data Services at Risk Management Solutions, has examined many different commercial insurance portfolios and has found that they can have up to 50% inaccurate construction information. Further, in residential portfolios he has found that single family dwelling portfolios can have up to 20% inaccurate number of stories, among other field-level accuracy issues. While the theory behind the hedonic model part of AVMs is sound, the accuracy of the underlying data is on much shakier ground.

Correcting the Property Characteristics Problem with Building Permit DataWhat can be done about this inherent problem with the crucial hedonic model part of AVMs? The solution is to replace the standard hedonic estimate—based on square footage, number of bedrooms, year built, etc—with a different formula, driven by more accurate data, that delivers the same underlying estimate of the non-market-adjusted value of the underlying structure. In short, use the last sales amount of the property, and add to it the values of the building permits issued on the property since the last sale.

Building permit data is essentially a “change log” for a home. Every permitted work for an increase in the value of the underlying property, from an addition to a roof replacement to fire damage repair to an electrical upgrade, is logged by the building department and available through public record request. And most importantly, building permit data has an extremely high level of accuracy. Unlike tax assessor’s data, there is never any need to estimate or guess about the presence of a building permit.

Market conditions / historic saLes(repeat saLes index)

Last saLe + propertY chanGe LoG(buiLdinG perMit data)

Fig. 2 - Replacing the Hedonic Model with Last Sale + Property Change Log

As the property “change log,” building permit data has one core weakness: it cannot reveal the absolute or total value of a property that was built before available permit data coverage starts, often no more than 20 years. Building permit data is only effective when paired with a starting point, the sales data. The core weakness of sales data is that it happens infrequently and is only effective right after sales, which is where building permit data comes in. Building permit data brings sales data up to date by logging all of the significant changes to the property since the last sale.

Testing an AVM Based on Building Permit DataOne note on pulling values from building permit data: Each building department has its own criteria on what constitutes a proper valuation for a particular project. For many jurisdictions, permit valuation is a measure of the cost of materials; for some, it also includes the cost of labor. For the purposes of the tests below, I used the permit valuation as it was stored by the jurisdiction. I would expect that any professional AVM that uses building permit data would apply some adjustments to permit valuation amounts on a jurisdiction-by-jurisdiction basis.

I recently conducted an analysis of whether building permit data does in fact capture individual property characteristics in the way that a hedonic model is supposed to work.2 Using a random sample of 10,000 properties across 10 different cities in Florida and sales data from AVM data supplier Real Info,3 I looked at those properties that had been

2 Full details on the analysis are available in BuildFax Internal Research Paper No. 15; email [email protected] to request a copy. 3 For more information on Real Info’s AVM data, please contact Jacob Garcia at [email protected].


sold at least twice in the past 20 years to see whether building permit data after the first sale would more accurately predict the amount of the second sale.

For example, a home in Apopka, Florida, sold for $306,000 on April 21, 2000. The same property sold again on June 12, 2006. The repeat sales index for the local area showed that prices of comparable homes had increased by roughly 75% between those two sale dates, which would give an estimate of around $535,000 on June 12, 2006. Tax assessor data available on June 12, 2006 was unchanged from its April 21, 2000, values, and a mixed (hedonic model and repeat sales index) estimate for the home on June 12, 2006, was $522,000.

However, building permit data on the property shows that in late 2000, an in-ground pool, cool deck, boat dock and boathouse were all built, for a total of $44,861 in permit valuation. Ignoring the hedonic estimate and instead adding this to the 2000 sales amount and including the repeat sales index estimate, we get a total of roughly $580,000. The actual sales amount on June 12, 2006 was $590,000. In this case, the AVM based on building permit data was less than 2% off the actual value, whereas the traditional model was more than 11% off. To the right are two charts from my analysis showing how building permit data increases the accuracy of a pure repeat sales index model.4 The first shows that on properties with permits totaling more than $25,000, the building permit data AVM estimates the proper value within 5% for around four times more properties; the second looks at properties that had any number of permits and finds that the building permit data AVM still beats the repeat sales index model across the board. In summary, in the situations where significant building permits have been

issued, ignoring the building permit data leads to less accurate results. Including the building permit data improves the repeat sales index, and may obviate the need for the hedonic model altogether, as it captures the underlying property value from a more accurate data source.

Enhancing Today’s AVMs with Building Permit Data“We are continuously developing new datasets to be on the forefront of enhancing AVMs, and we believe that building permit data will be a must-have AVM data source in the near term.”—Jim Kirchmeyer, CEO of Real Info, Inc.

It may not be necessary to discard hedonic models altogether. Building permit data can be used in a blended repeat sales index/hedonic model AVM in at least three different ways. First, building permit data can be used to establish better confidence levels on AVM estimates.

In particular, where extensive permitting work has been done on a property, building permit data provides a more accurate estimate.

Second, as explained above, one insidious aspect to the inaccuracies in tax assessor data is that they make the mathematical formula less accurate for all—even accurate—property characteristic values. Building permit data can be used in the creation of the hedonic formula to mitigate this issue.

Finally, last sale + property change log (building permit data) could be added as a third estimate of valuation in AVMs, and weighted just as both the hedonic model and repeat sales index are weighted against each other. This could provide significant lift to existing AVMs without having to start development from scratch. 6

Fig. 4 – Building Permit Data-Enhanced AVM Beats the Simplified, Traditional AVM

4 Unfortunately, it was not possible for me to get historical values from a blended repeat sales index/hedonic model AVM, although it is unlikely that such a model would have yielded significantly different values from a repeat sales index because the average time between the two sales was four years, which is very little time to expect updates in even the most up-to-date tax assessor data.

48 | LVM

2AMCs: The Good, the Bad and the OligopolyGUyM1Mr. Verrett is dead on in his opinion that hair-cut pricing will still exist. I currently do work for an AMC that recently decided to create a preferred fee appraisal panel for preferred appraisers. The rub of course is that you are only “preferred” if you’re willing to accept the lower preferred fee. It has nothing to do with quality of your work, just the dollars and cents. The writing is on the wall that this AMC is trying to create a lower fee standard in hopes that the final “reasonable and customary” definition will change and will be what the AMC was paying before the April deadline.

BAnkERS1Ken, you missed an important point, the appraisers ability to market themselves and directly solicit bankers/brokers is now so limited that it takes the “spirit” away from old timers like me to “chase” business. After 24 years in the industry, I have spent hundreds of thousand hours and countless $$$ to “land” a new client or generate an income stream. Some how we are no longer in business. Just my 2 cts.

1

Last month’s articles sparked a lot of debate. Here are some responses from

our readers.

do you have something to say? www.livevalmag.com8

voices oF vaLuation

voIces oF valUatIon 8LVM LVM LVM LVM LVM LVM LVM LVM LVM LVM LVM LVM LVM LVM LVM LVM LVM LVM LVM LVM LVM LVM LVM LVMLVM LVM LVM LVM LVM LVM LVM LVM LVM LVM LVM LVMLVM LVM LVM LVM LVM LVM LVM LVM LVM LVM LVM LVMLVM LVM LVM LVM LVM LVM LVM LVM LVM LVM LVM LVM

7

The Appraisal “Review”BOBInteresting story. I am a Certified Residential appraiser and have been a desk review/reconciliation specialist since 2005. I recently responded to an ad for reconcilers. A few days later I received a phone call from the company’s President. At that time I was told that part of the job was to travel to India from time to time to train people as reconcilers. I took a pass.

3The Low Purchase AppraisalAnOnyMOUSI agree, the article is well said. I would like to add when I discuss value to Realtors I make a point that a part of establishing the value of a property is that there is a knowledgeable buyer - would that buyer make the purchase if the market indicates a lower value? Many of the buyers are not exposed to what has sold and rely on information provided by their agent, which is based primarily on what is currently on the market.


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DIrectory 2

do you have something to say? www.livevalmag.com8

50 | LVM

A friend recently sent me some information about the manic and impotent blunderings of the transportation Security Administration (tSA). While reading, I realized there is a near-perfect analogy between the TSA and AMCs’ increasingly insane demands on appraisers.

It has been noted that those demands are merely a response to past failures. Such demands may have been beneficial had they been instituted several years ago, but they are now just a response to a threat that no longer exists – or at least no longer exists in the same form. In short, they are “fighting the last war.” (Google “Maginot Line” for a classic example.)

While the TSA pursues a “check every passenger down to their skivvies” strategy, with minimally skilled and low-wage employees empowered to do all kinds of things that would have been unthinkable just five years ago (even after 9/11), the AMCs pursue a strategy of “zero defects” – blasting every report, regardless of its source, with multiple levels of overlapping and, sometimes, contradictory oversight; with minimally skilled and low-wage employees empowered to make all kinds of demands that would have been unthinkable just five years ago. In both cases, they are intensely focused on the bark of a single tree instead of the health of the forest. The TSA, it seems, pursues a ham-fisted, one-size-fits-all approach – one that is horribly ill-suited to countering the threat against which they are deployed. Likewise, the AMCs / lenders have arrayed a massive arsenal of “solutions” to find every tiny little “flaw” in individual reports – instead of identifying and engaging only those appraisers/appraisal companies that have proved reliable over a number of years, then relying on the judgment and local experience of those “best in class” appraisers/appraisal companies. Very much like the TSA’s tender mercies that have encouraged those who can to pursue alternative travel options, the enhanced QC reviews and picayune demands of the AMCs and lenders are driving those appraisers who can – including those with the most experience – to abandon the AMC segment of the market.

In both cases, the chosen strategies are highly bureaucratic and needlessly wasteful, creating an adversarial relationship between the users and providers of the underlying services, and have little chance of being successful in the long run. How many attacks on large jets have gone undetected over the past five years – until they failed to

detonate? Yet the TSA pursues the same destined-to-fail strategies, apparently believing that “eternal reliance on the incompetence of your adversary” is a sufficient strategy. We can only guess how many appraisal reports with critical flaws have been passed through the enhanced scrutiny of today’s AMCs, but if my recent review engagements are any indication, those enhanced procedures have not accomplished much (although the reports with critical flaws do tend to include a lot of pointless gibberish designed to “check a box” on the AMC’s enhanced QC checklist). In both cases, the employees operating the levers of the machine are: fairly low on the skills meter; minimally compensated; assigned to an impossible task; NOT empowered to employ any degree of common sense, and required to employ strategies that are ill-suited to the stated goals. The best and brightest seem to believe that if they just write enough rules and procedure manuals, their checklists can imitate a meaningful eyes-on review. Whatever could possibly go wrong with such a system? While there is ample evidence available indicating an unfortunate and diminishing oversupply of poorly trained and/or unethical appraisers, the AMCs/lenders would be far better served to identify those who are reliable and afford them the respect they have earned instead of treating all “passengers” as if they are uniformly blank slates that can be made equal through application of ever-more oppressive (and wasteful) QC requirements – requirements which very rarely have anything to do with the central purpose of the appraisal. In both cases, we would all be better served if the powers that be, were looking for the terrorists/incompetent appraisers instead of assaulting the dignity of every passenger/appraiser to no avail. 6

FredHoltsberry

Reactionary Insanity – Fighting the Last War

For whatit’s worth

For WHat It’s WortH }

}


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