The party is back – Can you spot a B.S. appraisal?

Are we partying like it is 2007 again? Hopefully no one has forgotten the last real estate groove and how badly it ended. With the market on fire in many locations throughout the country, there is increasing pressure to get transactions closed.

According to a Wall Street Journal article an estimated one in seven appraisals analyzed between 2011 and 2014 inflated home values by 20 percent or more.

Do you know how to spot a dodgy appraisal? 

Although private lenders don’t require appraisals, many borrowers will send recent assessments completed to help substantiate their property value. I’m always skeptical when I look at an appraisal (see what do Domino’s and Appraisers have in common) and I’ve recently seen a noticeable uptick in appalling appraisals.

One last week took the cake!

I was asked to complete a loan on an investment property in Northern Colorado. I am very familiar with the area, having done multiple loans in the vicinity.

For this transaction, I pulled the property history along with some fresh comparables. My value came in around $400,000. The borrower then sent me an appraisal almost double what I determined. I was concerned, to say the least.

Was I off on my value this much? 

Why is there such a huge difference of opinion in value?

As anyone in can attest, valuing property is part science and part art since there are a multitude of factors that can influence value. As a result, it is not uncommon to see small differences (typically less than 5 percent).

In the case above with such a large difference in value, one of us was clearly wrong. I began going through the appraisal to understand the logic behind the other value and see who was right.

Four items jumped off the page immediately:

1.     Are the comparables really alike?

Before reading all the “fluff” at the front of the appraisal, I cut to the chase and skip to the bottom of the appraisal and look at the pictures of the subject and the comparables. Do the properties actually look similar?  Look at the pictures above (taken out of the appraisal); is the metal barn/house on the left (the subject property) comparable to the picture on the right?  They are not even closely alike; yet, the appraiser used the brown house on the right as a comparable even though it is far superior to the barn looking property.  Before looking farther, I knew this appraiser was a bit “optimistic” in their value just from the pictures.

2.     How far apart are the comparables? 

I looked at another property in metro Denver where they sent me an appraisal for almost $1 million. I was a little concerned since the area was not the typical million-dollar area.  Before looking at the appraisal, I did a quick radius search (under a quarter of a mile) to see everything that sold in the last 18 months. The average sale price was $465,000 with the highest at $650,000. How could they come up with a value of $1 million with no supporting sales close by? I scrolled through the appraisal; the closest comparable was two-and-a-half miles away. Think of Cherry Creek in Denver when you go two-and-a-half miles from Cherry Creek you are in an entirely different neighborhood with different price points. If you are looking at a property that the closest comparable is over two miles away in a dense metro area just run! The property is too unique and should not be valued the way it is. Distance is critical when evaluating a property. The farther the comparables are the more skeptical you should be.

3. Look at the adjustments in the appraisal on the comparables. 

Basically, with an adjustment an appraiser is trying to normalize the comparables with the subject to ensure they are comparing apples to apples. For example, does one have a basement vs. one without? On the one I reviewed in Northern Colorado, some of the adjustments were 40 percent to 50 percent. This proves the comparables were not similar enough to the subject if large adjustments needed to be made. A typical adjustment should be under 25 percent; if a large adjustment is needed then a better comparable should be utilized. The larger the adjustment, the more skeptical you should be on the value conclusion by the appraiser

4. What is the property history? 

Any transactions in the last three years for the subject have to be disclosed in the appraisal (always double check with the county assessor to be certain) If the property recently sold, you should do a quick calculation to see if the appreciation is “normal” for the area. For example, I reviewed another appraisal and saw that the house sold three years ago for 250,000, now it was supposedly worth 750,000. The sale three years ago was an arm’s length sale and the house had not changed substantially, yet the value supposedly increased three times in a market that might be increasing at 10 percent to 12 percent a year recently.  Clearly this was another case of the appraiser being a bit optimistic on their values.

In hot market cycles, like we are in today, there is pressure to get the transaction closed.  Many falsely believe that value is strictly what one is willing to pay. This might work well in a fast appreciating market, but eventually the market will moderate or even decline. Why is it important for the average person to be able to spot a bad appraisal? Long and short you don’t want to be the “sucker” that buys a property with an inflated appraisal. What we saw from the last cycle is that the properties that were “optimistically” valued before the downturn took the largest hit when the market corrected. The game of musical chairs eventually stops over time. Fortunately, it is easy to spot the vast majority of BS appraisals with the four steps above. Use this information to ensure you aren’t the one with the overvalued property when the game stops.