Realtors vs. Appraisers

By: Thomas Inserra

Dear NAR:

I have been a NAR member since 1984.  Having completed hundreds of NAR, Realtor and Real Estate classes since then – ALL with a very positive feedback, I am writing to express my serious concerns about the recent NAR seminar “Productive Engagement with Appraisers” which fell very far short of NAR educational quality standards.

This seminar contained grossly biased, incorrect and misleading information and if seminar participants were to follow the advice rendered, they would be violating very serious federal and state laws and regulations designed to prohibit compromise of appraiser independence.  Let me be more specific in articulating my concerns.

Those who presented the seminar were attempting to address the recent rise in instances when the independent value conclusions of appraisers varied with agent value estimates or prices negotiated by buyers and sellers.  The two (incorrect) presumptions made by the presenters is that this is a “problem” rather than a reflection of market conditions and it also presumes that the appraiser’s independent and objective conclusions are “wrong”.   The seminar also gives the false impression that agents can and should negotiate values with appraisers by outlining how to do that by supplying comps designed to arrive at a higher value and also gives the false impression that agents can affect a lender’s selection of appraisers in loan transactions.

In my market area, over the past year as an appraiser our appraisal business has appraised approximately 35% of all sale transactions below the agent estimate or pending sales price.  As a result, I can confirm that this does constitute a noticeable increase over prior years.

In each of approximately 80 transactions appraised below the pending sales price, agents were notified in advance prior to completion of the appraisal and afforded an opportunity to submit Comparable sales in an attempt to support the sales price.  In each transaction - agents submitted between 2 and 20 sales for consideration with an average of 6 sales submitted for each property.  Without exception, 100% of the sales submitted (about 500 sales provided by agents) actually supported the lower appraised value and not a single sale supported the higher proposed price.  Even more disturbing, upon interview of participants in the transaction, the appraiser observed a very high increase in the number of transactions where parties to the transaction were related to or had some connection to the agents involved.   

“Price” is much more likely to equal value when transactions are truly arms-length transactions, but the large increase in transactions to related parties has likely had an effect, which naturally will increase the rate of disparity between price and value.  Given the large decline in price levels, we are finding many sellers/owners are in denial about price levels.  In one example, our appraisal contained a list of 50 sales and listings located within one mile of the subject property with all 50 having prices lower than the pending sale transaction without a single sale or listing priced at or above the pending sale.  These market facts clearly demonstrated and confirmed the pending sales prices simply was not supported with factual market data.

In my view, in nearly 100% of the cases where agents submitted Comps which they thought or had hoped demonstrated a higher value, that those sales actually demonstrated and supported a lower value indicates that the true disparity between agents and appraisers is driven by two key factors.  This suggests there is a difference in how agents price properties and how appraisers estimate “Market Value” and indicates there are two primary drivers for the difference between agents and appraisers:

1.    The difference between advocacy and objectivity/independence; and
2.    Differences between how agents are taught to value property and appraisers are taught to value property.

I was very disappointed that this seminar failed to address either of these 2 items for if the true reason is to help agents understand and cope with value disparity, the seminar clearly fell way short and by failing to address the true drivers was therefore inadequate and misleading. 

With regard to item #1:   I am disappointed the seminar failed to discuss the difference and conflicting objectives and legal requirements of agents versus appraisers and how that goes a long way to explain differences in opinion.  For example, the foundational principle of being an agent is the legally binding fiduciary requirements of an agent to be an advocate to one or more party of the transaction.  If for example, the agent represents the interests of the seller, they would be required to be an advocate for the sellers desired interest of selling the property for the highest amount possible.  Conversely, a buyer agent would be required to be an advocate for the buyer’s interest to help buy the property at the lowest possible price.  Another inherent conflict between the role of agents versus appraisers is that agents being compensated on commission only get paid if the transaction closes, so there is a natural bias and advocacy need to take action aimed at getting deals closed, even if that means the price is not truly reflective of market conditions.  

Appraisers on the other hand have the exact opposite legal requirement.  Appraisers are legally and ethically required NOT to be an advocate for their party.  Appraisers are not permitted to be purposely high or purposely low when rendering market value estimates and must be objective, non-biased and free of advocacy.   Appraisers are precluded from taking action simply to help a deal close and rather must stand firm when factual market data indicates a pending price is not supported by factual market data.  Another major distinction is that while appraisers are legally required to estimate “Market Value”, while agents typically render BPOs price estimates.  Price estimates and Market Value estimates are not the same nor is the methodology for arriving at each the same.   

I’ve attached three articles describing how the legal obligations of agents when rendering price estimates is notably different than the legal requirements of an appraiser and how to resolve the conflict between “Advocacy” required of agents versus the “Independence and Non-Advocacy” required of appraisers.  Frankly, NAR needs to do a better job of educating agents and the public about the two types of value estimates in the USA:  Advocated value estimates and non-advocated value estimates and how they differ.  There is no true “battle” between agents and appraisers because they each are fulfilling different yet important roles in the real estate transaction and increased knowledge and understanding of the difference between the two roles is necessary and thus needs to be addressed in the seminar.  Agents render Price estimates as an advocate to one or more party in the transaction while Appraisers render independent, objective and non-advocated Market Value estimates.  The seminar needs to address the conflicting duties of each to improve understanding.

With regard to item #2:  I am disappointed the seminar failed to address a notable flaw in how agents are (incorrectly) taught to value properties.  Because the role of agents is to be an advocate for the transaction, rather than taking the objective approach of looking at market data both higher and lower than their proposed transaction, 100% of the Comps supplied by agents were selected solely because they appeared to support a higher price.  The most common technique employed by agents, was simply to find the highest priced sales and listings and to send those to the appraiser, with inadequate attention to how similar that property actually was to the home being valued.  Another common technique employed by agents was to simply select those comps with the highest price/SF which invariably means smaller sized homes were selected.  There is a proven economic principle known as “diminishing marginal utility” which agents seem to be unaware.  Most agents I know when valuing a home simply take the size and multiply it by a price/Sf and that is a very flawed approach because it fails to account for diminishing marginal utility and fails to account for other differences which might exist among the properties.  Another economic concept that appears to be a mystery to agents is the concept of “contributory value”.   When making adjustments for differences between properties, agents tend to apply cost while appraisers are required to utilize market based contributory values.  For example, when valuing a brand new home a builder might want to include the full cost of a $28,000 swimming pool, while in our Arizona market the contributory value of a pool may only be a $12,000 impact on “Market Value”.  Thus, to improve the understanding of the difference between agent advocated prices and independent/objective appraised values, the seminar must address the flawed methodology employed by agents to improve the accuracy in their market based rather than advocated price estimates.

Finally, I’d like to express my serious concern about 2 inadvertent takeaways from the seminar which give the false and very dangerous impression that:

1.    Appraised values are negotiable when agents believe appraisers are low;
2.    That agents can impact or change the selection of appraisers or have the right to evaluate the appraiser’s credentials

Most appraisals are ordered by lenders in connection with a loan transaction.  Federal regulations specifically prohibit negotiation of appraised values or any contact by agents aimed at obtaining a higher value estimate.  In fact, in our state, such action under ARS 32-3633 would be classified as a Class 6 Felony.  With regard to selection of the appraiser, federal banking regulations PROHIBIT the selection of appraisers on the basis of complaints or requests of agents or parties to the transaction and specifically require the lender to make the sole selection in their best judgment.   Thus, the seminars suggestion that agents should be evaluating the credentials of appraisers and taking agent designed to affect the selection of the appraiser would also constitute illegal activity.  If the agent is successful at impacting the selection of the appraiser and the loan on that property ultimately goes bad, the agent would potentially face very serious civil and criminal charges for interfering with the independence of the appraisal process. 

Appraisers can NOT be independent if agents are permitted to have an impact on appraiser selection, nor can appraisers be independent if agents view their role as negotiating values with appraisers when appraised values differ with those of agents.  Thus, while it may not have been an intended seminar objective, perhaps an unintended consequence of the seminar is that it incorrectly attempts to corrupt the independent role of appraisers and frankly, that is not only unethical, it is illegal.

What is necessary to successfully address the variance between independent and objective appraised values is improved understanding of the important objective and non-advocate roles of appraisers and for agents to respect that role by NOT negotiating values and NOT trying to affect appraiser selection.

Finally, I would like to address a recent flawed study performed by NAR that appeared to be biased purposely to blame appraisers for declining price levels and to help mislead the public about the role appraisers play. 

As a NAR member, I took the survey in my capacity as an agent.  I was very surprised and alarmed that among all the possible answers to the survey  - they all blamed appraisers rather than market conditions.  Having a choice to indicate that this was simply a function of market forces wasn’t even an option, which means the only possible outcome of the survey was to blame appraisers since no other choices were available in the survey question.  Shame on you.

It is important to note that in our market, even disregarding distressed sale transactions, that Phoenix was #2 in the nation in the rate of value and price declines.  It is also important to note that the rate of homeownership both nationally and locally has been declining rapidly demonstrating lower levels of demand for housing than in years past.  Those decreased levels of demand along with unemployment are in fact driving price reductions.  It is also very important to note that about 40% of the homes and transactions in the Phoenix area are mortgage free and thus their final negotiated prices are unaffected by appraisals.   Thus, it is grossly misleading to the public to suggest that appraisers are to blame for declining price levels when in fact these declining price levels are the result of market dynamics and are NOT being caused by appraisers.  Appraisers are merely reporting the facts about what is happening in the market.   Shame on NAR for giving the public the false perception that declining prices and lost deals are the fault of appraisers. A more balanced and fact based approach is necessary along with one that recognizes the important role that a non-advocated party plays in confirming that negotiated prices are arms-length and truly reflective of market conditions.

NAR realized after the Great Depression that having only “advocated” values led to a dangerous and unsustainable price bubble that was found to be a major contributing factor to the Great Depression.  To help correct the abuses of advocacy and to establish “balance” and sustainability, NAR invented the appraisal profession and from 1929 to 1994 declared that it is a conflict of interest for agents to render valuations for lenders.  NAR needs to re-establish its credibility by reaffirming the need for total independence and objectivity by again stating that it is inappropriate for agent advocates to render values for loan transactions because of an inherent conflict of interest.  NAR needs to again recognize the important need for a non-advocated appraiser to ensure transactions are market supported, arms-length and sustainable because that is the only way to prevent dangerous price bubbles which lead to huge financial crisis.

As CEO of We Value America, LLC, I provide a considerable amount of expert witness testimony to evaluate the Standards of Care and conduct of agents, lenders and appraisers.  In my view, this NAR seminar inadvertently encourages unethical and illegal conduct and thus should be significantly revised, updated and corrected to meet NAR’s educational quality standards.

Thank you for the opportunity to provide feedback on NAR’s recent appraisal seminar.

Links: 
•    “Advocacy vs Independence”  http://www.appraisalbuzz.com/advocacy-vs-independence
•    “Appraiser Neutrality and Public Policy”  http://www.appraisalbuzz.com/appraiser-neutrality
•    “Anatomy of a Real Estate Bubble”  http://www.appraisalbuzz.com/Anatomy-of-Real-Estate-Bubble
•    “Anatomy of an Appraisal Fee”  http://www.appraisalbuzz.com/anatomy-of-appraisal-fee

About the Author:
Thomas Inserra has 26 years’ experience as the highest ranking collateral risk expert, as CEO or other executive roles at: 2 international banks, 2 global insurers, 2 federal agencies, and 2 international consulting firms.   He has served as a Credit Committee member of 13 financial institutions with assets of $21 billion and has reviewed tens of thousands of loan files in connection with his work during 3 major banking crisis – including 2 crisis in the USA and 1 in Asia helping both government agencies and private sector financial institutions to address losses caused by real estate loan losses.  This unique experience has allowed Mr. Inserra to identify lending patterns and common collateral risk characteristics that ultimately led to large loan losses at more than 500 financial institutions with total assets exceeding $500 billion.  As the leader of a 700 employee U.S. subsidiary of a global insurer he was accountable for managing and insuring risk exposures of a $1 trillion real estate loan portfolio for 12 of the nation’s largest banks.  He also served as CEO of a publicly traded technology company which invented and then successfully received a U.S. patent for innovative collateral risk scoring that applies mathematical risk scores similar to a FICO score to help measure real estate collateral risk exposures. 

Mr. Inserra has a BS degree from Purdue University, an MBA degree and both the MAI and SRA appraisal designations.  He has participated in more than 100 public speeches, media appearances and news interviews including ABC News, CNN, MoneyTV, BNN, National Mortgage News, Washington Post and many others including of course the highlight of his career – frequent articles published for “The Appraisal Buzz” and “Collateral Risk Network - CRN”.  Currently, he serves as CEO of We Value America LLC and Pinnacle Peak Advisors LLC advising financial institutions, government agencies, attorneys, insurers and other clients on a wide range of lending and collateral risk exposures, litigation, Standards of Care issues and expert witness services.