Subject: appraisal methodology...does not yield appraisal results.

There was an editorial in the Wall Street Journal 8-17-10 by a Mr. Edward Pinto who opined that changing appraisal methodology would have averted The Housing Bubble. Nonsense. Yes, there was, and still is, a problem with appraisal, but it doesn't have to do with valuation approaches. It has to do with clients' inability to read reports or take "no" for an answer.

As an example of the first, take the Tahoe bubble 1977-9. When prices started to accelerate I started putting verbiage into my reports about the unsustainability of the rapid inflation of prices and the possibility of an even more rapid decline. While accurate, it didn't put the brakes on Wells' lending. Whenever I meet old Wells types, though, they always say something like, "Weren't you the guy at Tahoe...?"

Deal-driven decision making is the main problem in mortgage lending. 'If the deal ain't made, nobody gets paid'. The corollary is that if the deal goes bad, nobody has to pay the money back. This leads, among other things, to the homogenization of approved appraiser lists. Lenders who don't ever want to say "no" obviously don't need appraisers who will.

Given that background it seems obvious to me that simply filling in a cost and income approach on an appraisal form is not going to change things. If the additional approaches don't support the preconceived loan decision, then either they're going to have to be changed, or a new appraiser who's more attuned to the process will have to be found. After all, they're only numbers. Push numbers around all afternoon. They don't CARE.

In fact, I would argue that prices are the only objective measure to which value can be pegged. Doing other approaches won't make any difference if the final reference is market prices. And, if prices aren't the referent, just what WILL the other approaches be benchmarked to? That said, when prices start to bubble, it's the responsibility of the appraiser, who will possibly notice it first, to comment. It is also the responsibility of the underwriter to read the comment and maybe reduce the loan-to-value ratio.

To say that cost or income approach would produce a different result than sale comparison is to exhibit ignorance of how they work. Both eventually refer to sales. Sales drive both land and depreciation in the cost approach. It's even more direct in the single family "gross rent multiplier" income technique. The multiplier, M, is derived from economic rent (R) and typical price (P), M = P/R. The direct relationship, of course hides many issues about R as well as P.

As for using automated valuation models, it's wonderful for property tax assessment purposes. In an adversarial situation good values can be pretty regularly obtained. In the "do-the-deal" one-way street environment, automation simply allows plausible "wall" paper to be produced faster and cheaper, almost untouched by human hands. When people start talking about the virtues of neural networks it's really time to hold onto your wallet. Neural networks, by definition, don't tell you how they come to a conclusion. (see also http://www.charlesbwarren.com/AVMs.html )

But, what about "doing the deal"? Well, it takes discipline to let your competitors do deals they will ultimately regret. The denouement of the present bubble makes it hard to argue for that discipline. Lenders who were able to bloat up big enough are now "too big to fail" (2B2F). As for Fannie and Freddie, they are now more or less officially part of the federal government, despite or because of Mr. Pinto's efforts. The liabilities attached to their business model are part of our grandkids' national debt.

There is one thing about the appraisal process that would change things: random selection of appraisers. This has been feared by the banking industry ever since FIRREA. I remember the sense of consternation in the room at an American Bankers' Association (ABA) meeting until they were reassured on the subject. In order to guarantee that some appraiser would NOT come up for assignment under random selection, the bankers would have to get his or her license revoked. While possible, it would be time consuming and not nearly as cozily confidential as informal blacklisting. "He doesn't do the QUALITY we're interested in...(wink, wink)" The take-home lesson of that 1991 ABA meeting was, "If you don't like the appraisal, reject it as non-compliant with the Uniform Standard of Professional Appraisal Practice (USPAP)." Presumably the appraiser would also find his or her phone ringing less.

So, how will doing a cost or income approach on an appraisal form change that?

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Charles B. Warren, MRICS ASA-urban real property Pleasant Hill 925.609.7241 www.charlesbwarren.com