Computer Generated Residential Real Estate Appraisals, Have They Failed?
My appraising career started in 1996 and in the early 2000’s, as a young appraiser full of drive and enthusiasm, the rumbling from large lender’s was beginning to reflect the possibility of replacing physical appraisers and appraisals with AI (artificial intelligence) generated valuations. FANNIE MAE & FREDDIE MAC implemented the UAD appraisal (Uniform Appraisal Dataset) in 2010 as an attempt to get more of a standardization for residential home appraisals making appraisal reports easier to read and interpret, along with gathering data on every lender required appraisal performed. This large database of information at the time was going to be able to also assist AI appraisals by providing the algorithm with all the information collected from the physical appraisal inspections by state licensed / certified appraisers.
This was 12 years ago, and over the past three to four years, big investment firms have also attempted to use AI algorithms to do immediate valuations for decisions regarding value of real property residential property. At this time, the rumbling from the large lender’s was getting loud and appraisers were considered a “hinderance” in the loan funding process, not to mention, an additional cost to the consumers, as their AI could value the property on a “risk” analysis basis for a lower cost and an increase in speed. Companies like Zillow, Open Door, Offerpad, etc. were all using AI to make purchasing decisions to accumulate residential home portfolios, oftentimes creating false shortages of available homes on the market as purchased homes would remain vacant to create a shortage while watching the home value increase. All this seemed great, property values were skyrocketing (partially due to the fake shortage) across the Phoenix metro area and the entire country. Unfortunately, this led to first time buyers and the typical home buyers having to pay well above market value for their home. But wait, oftentimes FANNIE / FREDDIE were allowing appraisal waivers (they already had their AI model in place with all the condition / square footage / quality ratings accumulated over the past 10 plus years from actual appraisers for their database), so why not, they are willing to assume the risk, why does a consumer have to pay for a $500 appraisal in the scheme of the process. I mean, FANNIE and FREDDIE implemented desktop appraisals, real appraisers would just sit in their office and rely on hand selected photos and measurements from others to value the house. This is a great idea, right? Not for the consumer, but for the real estate machine, now they can fast tract a sale (even if the consumer is paying well above market value) an extra week or so, and the machine can earn their fees / commissions. FYI, the commission on just a $500,000 home on the low side for a realtor is $25,000 (sure they often split that with another agent, so maybe only $12,500 each on the low side). Lender’s commission can vary from 1.5% to 3.5%, so to be on the low side let’s say $10,000, title fees vary but average approximately 1% ($5,000). An appraisal fee is $500-$600 for a typical home in a typical neighborhood (approximately 1/10 of 1%, appraisal fees are not based on home values but on complexity / time required for completion).
Fast forward to late 2022, large real estate investment companies that have relied on AI for their valuation purchasing decisions are all either out of business and/or suffer large losses reflected in their stock prices (this was happing as early as May of 2022). Now, as an appraisal company, we are seeing market dumps of real estate investment companies losing as much as 10-20% on their purchases just a few months ago. How did or does this hurt the everyday consumer? Well, these investment companies were artificially driving up prices using their AI algorithms and assuming the risk based on artificially increasing property values. Now, property values would have increased regardless, it is just the level at which it increased and the speed of that increase. The normal supply and demand curve was damaged which resulted in an excessive shortage. The consumers that had to or needed to purchase their home during this time suffered from having to compete with these companies, and oftentimes not even getting an appraisal to make an informed decision on their purchase.
Disclosure, I am an appraiser and an owner of an appraisal company, so has this hurt us as a company? The answer is difficult to answer, as we were busy during this time and have maintained our office staff during this downturn over the past six months. Residential real estate is as individual as humans, every home has its pros and cons, positives and negatives, unique characteristics, etc. Having a professional appraiser perform an appraisal on your home not only gives you information that is non-biased, not compensated on if the home closes or not, it is truly one of only a few processes in the home purchasing process that are not dependent on the purchase price of the home and/or if the home closes, only to report the property and to give an opinion of market value based on the similar sales / listings / pending sales in that specific neighborhood. In addition, the appraiser will measure the property to calculate the true livable square footage, garage square footage, provide the correct site size, and note any marketability issues the property may have (home inspectors / termite inspectors are also critical cogs in the machine that also are there to provide the lender and/or potential purchaser information to make an informed decision).
So, in conclusion, I do believe the AI model has failed, as the proof is in the pudding. I also do believe that AI has a place in the loan approval / purchasing market. It is a checks and balances on an actual opinion of market value provided by a professional, and although AI values are often way out of bounds either high or low on certain properties, they can provide valuable statistics for risk analysis. Due to the unique characteristics of every home and the differing locations (even when in the same community), differing levels of condition, upgrades, square footage, layout, etc. every home should have an appraisal so the buyer can have a non-biased opinion of market value of that individual home. History has proven over the past 26 years of my career, that Macro valuations (AI appraisals) are only useful for a range of value or a large tolerance in financial risk, while Micro valuations (individual appraisals) are useful for the individual home (Subject property).
Additional Thoughts
FANNIE MAE & FREDDIE MAC have implemented some rules and guidelines that have been beneficial to the physical appraiser, including the UAD data set to keep some conformity when reporting a property along with the recent ANSI measuring guidelines (which I have personally always wanted as a standard to protect the consumer). Appraisal waivers along with desktop appraisals, are (in our opinion) a negative in consumer protection, but as a consumer you can always request a physical appraisal from an actual state Certified appraiser for peace of mind and a thoughtfully reconciled opinion of current market value to make informed financial decisions.
by Jason Clow, owner and founder of West Valley Appraisal Services 12/04/2022 Through my 26 years of residential appraisal experience in the Maricopa County market, I have been asked countless times, “Should I get an appraisal before listing or buying a home?”. The short answer is “YES”. In this month’s blog, I will go over the pros and cons of ordering and having a private appraisal for each instance, and you can decide what is best for you.
Selling a home, why is a professional private appraisal a good idea?
Buying a home, why is a professional private appraisal a good idea (especially when paying cash)?
Think of it this way, getting a private appraisal on a property you are selling or buying is like taking a used car to a mechanic prior to selling or purchasing. Knowing the most information about the property can and will assist in making the best financial decisions regarding that property. Divorce and Estate Appraisals are some of our specialties also. These appraisals are typically performed the same way as regular market value, but often times we perform retrospective valuations based on a date of death or a date of separation, along with the current market values which is helpful in understanding the market change and / or having realistic asset valuations for important dates during those troubling times.
Jason Clow (Owner)
West Valley Appraisal Services
appraisals@wvas.email
Office: 602-717-8450
Fax: 623-349-0652
Appraisal Waivers (Risks & Rewards) by Jason Clow, owner and founder of West Valley Appraisal Services 11/16/2019
I am going to preface my blog, stating that any information, examples, etc. are regarding residential properties from my area of expertise in Maricopa County Arizona (the fourth largest county in the United States). For reference, I have been an appraiser in Maricopa County for over 20 years and a Realtor in Maricopa County for nearly 20 years.
Appraisal Waivers for residential properties really started in early 2017 for low Loan to Value (LTV) mortgages. Currently they are being used in a much wider range of mortgage products and for a larger pool of borrowers. Currently (taken from the Fannie Mae website (dated 08/07/2019). The following link shows the list of the criteria regarding qualifying for an AW (appraisal waiver):
https://www.fanniemae.com/content/guide/selling/b4/1.4/10.html
Fannie Mae has been collecting information / data from appraisers for years on all mortgage transactions that appraisals were performed to assist in the AVM (Automated Valuation Model). What is an AVM? Well it is a computer-generated appraisal to provide a quick risk assessment based on what the AVM states the value range is of a specific residential property. Basically, borrowers with good credit, good equity (based on the AVM) for refinances, and a typical down payment putting the loan to AVM value ration in a low risk scenario.
Why would Fannie Mae allow loans to be funded without an appraisal? Well the simple answer is simplification of the mortgage process, a reduction in cost associated with the loan to the consumer, and confidence in collected data from previous appraisals over the years. It is basically an accepted risk tolerance for a specific borrower.
What are the risks associated with appraisal waivers on the overall real estate market (regarding Maricopa County, but could possibly be applied to other cities and counties throughout the U.S.)?
What are the benefits associated with appraisal waivers for individuals involved in a transaction an appraisal waiver was allowed?
Below is a list of three real life examples I have personally had in the past six months regarding failure of appraisal waivers. Two are as an appraiser and one is as a Realtor.
Example 1.
I was representing a client to sell their home, so I have my Realtor hat on. As a Realtor my job and obligation is to assist my client to obtain the best sales price for their property as possible and protect the interests of my client. I am going to use false numbers, but similar % differences for reference.
I took the listing and we discussed the initial list price. This home was in a strange market with differing quality of homes located basically across main / different streets. 3,000 sq.ft. homes on one side of the street would typically sell for $500,000+-, 3,000 sq.ft. homes between the two main streets the same quality of home would typically $400,000+-, and 3,000 sq.ft. homes to the south of the main street would typically sell for $325,000+-. This is all with-in about a two-mile radius, with limited (recent sales in the middle section, but historic data coupled with current data showed these differences. The market data in the exact micro market was showing a list price of approximately $425,000 on the high end. I showed my client all the market data and they decided to list the home on the lower side of the historically superior neighborhood. So, we listed the home, with the understanding, they would be willing to lower the price after a few weeks on the market to a price point that would attract more foot traffic.
With-in the first week we had a few showings, and we received an offer. The offer was negotiated and an agreed upon sales price was made. This contracted price was well above market value; however, automated AVM’s free to the public (just google find your homes value), showed a value close to the contracted price. I told them that is due to the neighborhood on larger lots with superior community amenities, better setbacks, and better architecture and I prepared her for the appraisal process. We had a plan in place, but again, my job as a Realtor is to obtain the highest sales price available. As an appraiser, the contracted price was well above market value. Well, in a few weeks, we found out that the buyer had an appraisal waiver, and the home was never appraised and closed at the contracted price. This now created a recent arm’s length sale in this community like the historically higher priced community, just across the street. Since this sale, there has been another home that has been listed and not yet contracted. This micro market just jumped 10%. Sure, this can happen with all cash buyers also, so this isn’t the first time I have seen this, but the first time with a buyer that needed a mortgage. Who does this hurt? Well it hurts all buyers in the near future, the buyer of this house, etc. Had they had a professional appraisal; it is very possible the home could have been purchased for tens of thousands less.
Example 2.
This example is as an appraiser. Recently, I was assigned to appraise a property for a home equity line of credit. The owners / borrowers recently purchased the home with over 20% down and received an appraisal waiver. Now they wanted to get a HELOC (home equity line of credit).
As I do on all residential appraisals, I physically measured the home. I immediate noticed that the square footage of the home was off. This happens all the time, that there are large discrepancies in square footage. The home was 15% smaller than what they thought they were buying. Not only did the owner pay more than the home was worth with the marketed square footage they thought they were buying, now the home is 570 sq.ft. smaller. The market value of the home was well below what they purchased the home for just a few months ago, as there was no appraisal / measurement made on the property.
Example 3.
This example is as an appraiser. Recently, I was assigned to appraise a property for a home equity line of credit. The owners / borrowers recently purchased the home with over 20% down and received an appraisal waiver. Now they wanted to get a HELOC, very similar to Example 2.
I physically measured the home like always and performed my appraisal (and the physically measured square footage was very similar to the assessors square footage). The home was sold in average condition with minimal remodeling / updating performed in the past 15 years (this home was built in the early 80’s) but priced like a remodeled home, while the market norm and all other sales near the price point this home was purchased at were complete remodels. There was a lot of market data available in the community, and the range of sales for the same floor plan was $190,000 to $300,000 (this also including things like site size, pools, etc.). Homes that were in very average condition similar to the Subject property were selling at the very low end, while the remodeled homes with new surfaces (quartz / granite counter tops, new flooring, new bathrooms, new trim, new roofs, newer dual pane windows, etc.).
Needless to say, my appraisal utilized comparable properties in similar condition (not remodeled) and was much less than the original purchase price a few months ago, while the market was slightly increasing.
There are other examples of the damages that can be caused by appraisal waivers, as computers can’t replace professional experienced appraisers who examine all aspects of the property including but not limited to condition, quality, location, site size, site amenities, curb appeal, square footage, garages, etc.
So in summation, this is just a blog entry to try to inform any readers that in my opinion, if you are buying a home regardless of what the “public” information states or what AVM’s say the value is, purchasing a private appraisal (in an instance where you quality for an appraisal waiver) would be a small price to pay if something is not noticed or misrepresented in the buyer’s research. I also recommend always getting a home inspection on any home you purchase to find out if there are any major issues that can cause what seems like a value to be a nightmare.
If getting a private appraisal takes an additional week, so be it, when making the largest purchases in a typical person’s life, gathering information can only help the situation. Just like finding your future spouse, you don’t meet and get married in 30 days, you have an “inspection period” for better terms to determine if this is the best decision.
by Jason Clow, owner and founder of West Valley Appraisal Services 07/29/2019 Through my 22 years of residential appraisal experience in the Maricopa County market, I have been asked countless times, “Should I get an appraisal before listing or buying a home?”. The short answer is “YES”. In this month’s blog, I will go over the pros and cons of ordering and having a private appraisal for each instance, and you can decide what is best for you.
Think of it this way, getting a private appraisal on a property you are selling or buying is like taking a used car to a mechanic prior to selling or purchasing. Knowing the most information about the property can and will assist in making the best financial decisions regarding that property.
by Ray Cutler | Market
Residential real estate in greater Phoenix continues to see price appreciation, driven by modest personal pay increases and falling interest rates. Current 30-year conventional loans are 3.82% with .5 points. (Fannie Mae, June 2019)
Further, the Federal Reserve is now forecasting a drop in rates through next year with many Wall Street analysts predicting three reductions of ¼ point each over the next 12 months.
Why the change in rate forecast?
Late last year, signs of a significant slowing in the U.S. (and global) economies began to emerge. The Gross Domestic Product (GDP) had slowed, and forecasts were predicting continued slowing over the next several months. Also, the U.S. found itself in a significant trade dispute with China (and for a brief time, Mexico), and trade disputes are almost never good for global economic growth. With the economy significantly slowing, the Fed announced its intent to change its forecast of approximately three interest rate increases to taking a “wait and see” position.
Today, analysts are predicting rates in 2020 to be flat to slightly down:
(Reuters) – The U.S. Federal Reserve is done raising interest rates until at least the end of next year (2020), according to economists in a Reuters poll who gave a 40 percent chance of at least one rate cut by end-2020.
So what have these lower rates done to our housing market? Our median sales price in June 2019 is $278,000, up 4.9% year over year.
One last point, whether buying or selling, please keep in mind that our market is not monolithic. Price ranges and neighborhood locations will vary in performance, often significantly.
For the $150,000 to $225,000 range, expect annual appreciation rates to be between 6%-10%. For homes that sell for $225,000-$500,000, appreciation is expected to be between 3%-5% and those selling over $500,000 appreciation is expected to be between 1%-3%. (Cromford Report, June 2019)
Please be sure and partner with your real estate professional to determine the correct market value of your home.
Raw Data Source: ARMLS
By DAVID PAYNE, Staff Economist June 13, 2019
Short-term interest rates are headed down because of expectations that the Federal Reserve will cut the federal funds rate next month. The Fed probably will lower the rate, at either its July 31 or September 18 meeting. The central bank wants to counteract the slowdown in manufacturing caused by the trade war.
The Fed could also cut rates in 2020 if an expected economic slowdown threatens to snowball. GDP growth should slow from 2.5% this year to about 1.8% next year, but could drop more if a U.S.-China trade deal doesn’t happen, or some other negative economic shock occurs.
Mr. Trump has criticized the Fed’s 2018 interest rate increases for slowing growth and called on it to start using its tools to stimulate the economy. On Tuesday, Mr. Trump said in a tweet that the Fed should lower its benchmark rate by a percentage point, saying such a move could send United States economic growth “up like a rocket.”
He compared the Fed’s approach with that of China, a partly managed economy, saying: “China is adding great stimulus to its economy while at the same time keeping interest rates low. Our Federal Reserve has incessantly lifted interest rates, even though inflation is very low.”
“They’re in a good place,” Michael Feroli, the chief United States economist at J.P. Morgan, said of the Fed. “Growth is above trend, financial conditions are easy, so that should continue to support above-trend growth, and they believe that should support firming inflation pressures over time.”
The Fed raised rates four times last year, and has lifted them a total of nine times since 2015. In December, it projected two more rate increases in 2019. But the central bank abruptly changed tack early this year, as warning signs began to emerge that the global economy was slowing. In March, officials removed projections for future rate increases. It also announced a plan to end what is commonly called quantitative tightening, an effort to winnow the giant portfolio of bonds it amassed in the financial crisis.
Many of the risks that prodded the Fed toward patience have since faded. Shaky markets have rallied, financial conditions have eased, spending has rebounded and growth was better than expected in the first quarter.
Yet annual price increases slowed to 1.6 percent on a core basis in March, taking the Fed further away from its stubbornly elusive goal of 2 percent inflation. Weak inflation raises the risk of economy-damaging deflation, so the central bank aims to keep prices growing at a slow and steady rate.
That disconnect poses a serious policy challenge. If officials cut rates to lift prices against a backdrop of strong growth, they risk fueling financial excess and looking like they have caved to political pressures.
Should inflation slip too low for too long, on the other hand, businesses and consumers could come to expect permanently slower gains and behave accordingly. That would make it harder for the Fed to ever achieve its 2 percent goal.
Charles L. Evans, the president of the Federal Reserve Bank of Chicago, has indicated that rate cuts are possible if inflation falls too low and stays there. “Anything that’s sustainable, that looks like it’s moving downward, not upward, I would be extremely nervous about,” Mr. Evans told The Wall Street Journal in April. “I would definitely be thinking about taking out insurance in that regard.”
The full committee will not release fresh economic projections until after its June meeting, but Jerome H. Powell, the Fed chairman, could flesh out what conditions would merit a precautionary cut and explain whether such a move is becoming more likely during his postmeeting news conference.
Subtle statement tweaks could also provide the setup for a future shift. Officials could use their release to highlight lower inflation as a real risk rather than a transitory miss, said Neil Dutta, the head of economic research at Renaissance Macro Research.
“If they sound more dovish on inflation, more worried about where inflation is going, that would tee up the idea that there could be a policy response,” Mr. Dutta said.
The Fed cut rates three times total in 1995 and 1996 because inflation was slowing, so tweaking policy around the edges against a strong economic backdrop with relatively low recession risks would not be unprecedented.
“It’s one thing if the Fed is cutting because the economy is getting worse,” Mr. Dutta said. “It’s another thing if they’re just trying to reinforce their inflation target in an otherwise healthy economy.”
Still, Mr. Dutta thinks it is more likely that the Fed’s next rate move is up. Goldman Sachs economists also expect an increase, though not until late 2020.
“Fed officials would likely worry about the risks that a rate cut could appear political or unnerve markets,” Goldman’s chief economist, Jan Hatzius, and his colleagues wrote Thursday in a note. They “might mistake a cut in response to low inflation for serious concern about the growth outlook.”