Current Policy Influences
Submitted by Ray O’Neil, GAA, RAA
Impact of Federal Level Lending and Appraisal Policy
Since late 2006 we have been experiencing a steady erosion of real estate values throughout the country. For the most part, these property value declines originated when the Federal Reserve decided to change the monetary policy of the last 20+ years. This monetary policy was inspired and built upon a model of easy credit for everyone.
The plan worked very well for many years but eventually caught up with itself. It ultimately led us to the subprime loan fiasco in real estate, runaway consumer credit purchases, as well as low priced auto leasing. The effect of our economy being built on easy credit eventually led us to over inflated prices on everything from basic consumer goods to automobiles and real estate. When the Federal Reserve changed leadership in 2006, it also changed the direction of our monetary policy. In doing so, the new regime at the Federal Reserve had determined that easy credit was no longer a good policy and that the consumer=s debt load had reached its peak.
The Federal Reserve undertook policies to begin to trim back the consumer’s debt load. One of the starting points began with denying the subprime borrowers the ability to refinance their adjustable rate loans. This abrupt policy change was geared to peel back some 10%+- of the market place that was considered to be subprime loans. This policy change was handled in the usual bureaucratic manner with a hard line drawn in the sand. The result was an avalanche of foreclosures that permeated all levels of the marketplace. Instead of adjusting the policy and assuming the foreclosure catastrophe would end at the subprime level, the momentum blew through the subprime portion of the real estate marketplace and quickly began eating away at those property owners who had real equity. Had the Federal Reserve eased up on the policy to slow the rate of foreclosure in the subprime market and allowed the market to wean itself off of these high risk loans more gradually, the foreclosure crisis we are still experiencing could possibly have been avoided. Unfortunately, this is a prime example of a policy that is put into place and that we are then stuck with regardless of the consequences.
This situation has lead to two more recent policies that were imposed on real estate loans which are horrifically affecting property values even more negatively. The first is the Home Valuation Code of Conduct (HVCC) which went into effect May 1, 2009 and the second is the 90 day comparable rule applied to declining markets.
Home Valuation Code of Conduct
The HVCC was created as a result of a lawsuit between the New York Attorney General and Fannie Mae and Freddie Mac. The lawsuit that was filed identified a lender and an appraisal management company (AMC) that were in collusion to create fraudulent loan values. They did this by selecting or pressuring appraisers that were willing to artificially raise property values in order to continue to receive assignments from the lenders. Those that would not succumb to the pressure were no longer sent work. The lawsuit was meant to eliminate this layer of fraud in the transaction. Fannie Mae and Freddie Mac for their part purchased at that time in excess of 80% of the mortgage loans that were originated. Since they were also involved directly or indirectly, they agreed to settle the suit with a hastily prepared agreement. Sadly, all this was done without properly interpreting the impact of the agreement.
The agreed upon settlement changed the way appraisal orders were to be placed between the lender and the appraiser. The theory was to place appraisal assignments on a rotation basis which sounded rational on the surface, however, it didn=t take into account the individual appraiser=s experience levels. Its implementation changed control of the existing ordering system from those in legitimate working relationships and with local market knowledge, back into the hands of the same national level AMC=s that had contributed to the filing of the lawsuit to begin with.
The HVCC was intended to separate the lender and the appraiser and it did, by extremely limiting any contact between the appraisers, homeowners, Realtors or loan officers. It restricted the contact to primarily appointment scheduling and little else. The hoped for benefit was again lost because of the extreme separation requirements and by not giving the investor of the mortgage and homeowner a more accurate unbiased valuation on the property.
The settlement between Fannie Mae, Freddie Mac and the New York Attorney General=s office at first did not allow the lenders to employ staff appraisers or own the AMC=s that managed appraisers. But instead of separating the two, the major banks through their powerful political lobbies, were able to have parts of the settlement agreement re-written. They were then allowed to continue these direct ownership relationships, thereby having an even stronger influence over the appraisers working for them.
Instead of establishing an unrelated entity insuring that appraisers are separated from undue influences, the same lenders have unilaterally reduced fees paid to appraisers and at the same time doubled the fees to consumers. The net result is that most of the more qualified appraisers have determined that they cannot afford to work for these low fees, leaving the AMC=s with mostly the less qualified appraisers. Those remaining appraisers that are now working at the reduced fees are reportedly providing substandard appraisals. The lack of appraiser experience or diligence results in many transactions coming to a complete standstill or falling apart just prior to closing.
The ultimate cost is passed on to the consumer because so many of these substandard appraisals create the need for an additional appraisal, thus costing the consumer yet an added fee for another appraisal.
The implementation of the HVCC has also created a lack of portability to the appraisal report which prevents the lender or mortgage broker from shopping the loan package to different wholesale loan buyers. The HVCC requirement of rotation appraisal ordering was also required by the wholesale loan market at an additional cost to the borrower.
Other unintended consequences have occurred due to the HVCC. Appraisal management companies are currently unregulated in most states. While the appraisers are required to abide by local state and national guidelines (USPAP), the very AMC=s who are supposed to oversee and review the appraisal process are unregulated. One ironic example of how the lack of regulation affects the credibility of the AMC method occurred when an appraiser in Florida whose appraisal license was revoked has now opened an unregulated AMC overseeing the work of licensed appraisers.
The HVCC needs to be put on hold immediately and eliminated it in its present state altogether. In its place, a more viable plan should be formulated by all of the parties. A plan is needed that is not so restrictive that normal communication between the parties is halted as is the case now.
90 Day Rule
The Amost recent comparable@ directive or better known as the A90 day rule@ was imposed on loan transactions that were deemed Adeclining markets@ in late 2007. In an effort to comply, the private mortgage insurers and underwriters have tried to interpret Fannie Mae and Freddie Mac=s lack of guidance in this area. The directive from Fannie Mae and Freddie Mac merely states that they would continue to purchase loans in declining areas but that the lender was ultimately responsible for the appraised value without any clarifying guidelines. In response, the lenders then began requiring the appraisal to have at least one comparable within the past 90 days. Eventually the lenders progressively tightened the still unwritten Fannie Mae and Freddie Mac requirements with regards to the current standards. Recently FHA adopted the standard and was the first to put in writing the 90 day comparable requirement for properties in declining markets.
The current 90 day rule requires that appraisers provide to the underwriter bracketing comparables that sold within the last 90 days. This means the highest and lowest comparable must have sold within the past 90 days. This dramatically limits the available selection of comparables by forcing the inclusion of foreclosure sales, short sales and other distressed sales perpetuating the decline in value.
One local example is in a northern suburban area with lower densities. Home values have been declining in the area for the past year at an annual rate of approximately 24%. Because of the 90 day comparable requirement, a typical 3,500+ sq ft. home of higher quality, on acreage, would have been reasonably valued at $480,000 in August. This is based on similar sale(s) that were less than 90 days old. But a few days later in September, the primary comparable exceeded the 90 day old rule. For the appraiser=s part they would still input the comparable with adjustments for the annualized rate of decline in value (see below).
Highest Value of Comparables August September Net Monthly Loss
Available Comparables $480,000 $480,000
Monthly decline rate 2% $ 28,800 $ 38,400 $ 38,400
Highest value based on
Thus beginning in September, because the $480,000 comparable has now exceeded the 90 day old limit, the highest lending value for underwriter requirements is reduced by a whopping $152,500 to $327,500. This is now the highest applicable lending value for a current sale less than 90 days old. Keep in mind, the market=s current decline rate is 2% per month. Under normal valuation circumstances the price would have declined by less than 10% from its original sale date. However, the results after the 90 day rule is applied in underwriting, are that the value drop on this particular transaction is more than 25% in just 1 month. This is 10 times the normal monthly rate of decline based on a blanket policy imposed in the market place.
This example shows the effects of the ever tightening 90 day rule. This demands immediate attention and clarification. All lending participants including Fannie Mae, Freddie Mac, FHA and PMI companies must provide clearer instructions on the use of 90 day comparables and the purchasing requirements of loans. Until these standards are corrected, property values will continue to decline at an artificially high rate as illustrated above. Both refinance and purchase transactions will continue to be lost and confidence in the marketplace will continue to decline.
The more urban areas with higher population density tend to show that the 90 day rule may have a lower impact. But applying or creating a poorly crafted blanket policy affects more than half the suburban homes at incrementally different rates. This gap becomes worse by the varying unique scenarios such as 1) lakefronts which tend to have most of their sales during the summer, 2) acreage properties described above, 3) golf front properties which are again predominately summer sales, 4) condominiums, or 5) properties just simply located in lower density areas such as the suburbs.
This is a simple reminder that real estate has always been treated as a long-term investment with a low-level of liquidity. One of the results of this low level of liquidity was to maintain and stabilize values over a long period of time. When the regulators and policymakers suggest or implement requirements for more recent comparables within 90 days, the impact of those requirements changes the valuation model of real estate to a different type of investment, more resembling stocks. Real estate as an investment cannot sustain itself with such a high level of fluctuation.
This is devastating to the consumer and to real estate values in general. A major concern is the complete erosion of confidence in real estate as a viable long-term investment. We ask that the regulators and policymakers follow up on the policies put in place and correct or modify those policies that are causing such a negative effect on the consumer.
It is estimated that over 25% of the real estate purchase offers and over 50% of the refinances are dying because of appraisal issues. Couple that with the fact that property owners have in many areas already lost over 50% of the value in their homes through no fault of their own makes this an extremely important issue. It is time to stop the public's equity from being squandered away.
The following is a recommended beginning step in regaining some common sense within the marketplace:
It is recommended that appropriate legislation and policy changes be drafted with immediate implementation stopping and preventing further artificial property value declines. This legislation and policy changes are to direct Fannie Mae, Freddie Mac, FHFA and FHA to clarify and remove the highly restrictive 90 day comparable requirement currently being applied in the appraisal of real estate in declining markets. The following changes and clarifications shall be the beginning basis for these organizations to implement clearer directives and understanding regarding the use of the most appropriate comparables:
In declining markets the most recent sales are preferred only if there is sufficient data available, however the most applicable sales comparables must be used in accordance with the guidelines stated in the AFannie Mae Selling Guide, XI, 406.02: Selection of Comparable Sales (06/30/02)@ :
Fannie Mae Selling Guide, XI, 406.02: Selection of Comparable Sales (06/30/02)
AThe appraiser must report a minimum of three comparable sales as part of the sales comparison approach to value. The appraiser may submit more than three comparable sales to support his or her opinion of market value, as long as at least three are actual settled or closed sales. Generally, the appraiser should use comparable sales that have been settled or closed within the last 12 months. However, the appraiser may use older comparable sales if he or she believes that it is appropriate, and selects comparable sales that are the best indicators of value for the subject property. The appraiser must comment on the reasons for using any comparable sales that are more than six months old. For example, if the subject property is located in a rural area that has minimal sales activity, the appraiser may not be able to locate three truly comparable sales that sold in the last 12 months. In this case, the appraiser may use older comparable sales as long as he or she explains why they are being used. The appraiser may use the subject property as a fourth comparable sale or as supporting data if the property previously was sold (and closed or settled). If the appraiser believes that it is appropriate, he or she also may use contract offerings and current listings as supporting data. However, in no instance may the appraiser create comparable sales by combining vacant land sales with the contract purchase price of a home (although this type of information may be included as additional supporting documentation).@
Additionally, Fannie Mae, Freddie Mac, FHFA and FHA must clarify the allowable use of distressed and foreclosure properties as comparables. The definition of value in the 1004 URAR form states AThe most probable price which a property should bring in a competitive and open market... assuming the price is not affected by undue stimulus.@ [Emphasis added.] The use of distressed sales as comparables in today=s declining market has become commonplace due to lenders= requirements and the lack of available arms length sales, however this practice appears to contradict the definition of value.