A good friend of mine, Mark Stockton of Valuations Unlimited, LLC , has developed a powerful research tool to aid in valuation. Mark is a sharp unassuming guy who has sold technology to Wall Street before. Here is a simple overview . It addresses the significant elements of the technology. It’s not an AVM and better yet…it actually works! His technology develops the replacement cost, market analysis, land residual analysis, assessment analysis, sale price index and rental analysis and allows the user to weight the applicability of each approach.
Here’s the second installment of his property valuation trilogy. The first installment covered ‘Sustainability ‘. This version is about “defensibility”. It was perfect timing since I just testified in court this morning as an expert witness to defend my appraisal report.
In Defense of Defensibility
By Mark L. Stockton
June 7, 2012
Can you imagine walking into an IRS audit without the slightest ability to defend the deductions you have taken to reduce your tax liability? Not on your life! If your tax return was to become the subject of an audit, you would walk into the meeting with the IRS auditor equipped with all of the support documentation required to substantiate every entry on the tax form. To do less would be to risk a ruling disallowing specific deductions and perhaps requiring you to pay some amount of tax plus penalty and interest.
The concept of defensibility is not new to any of us, nor is it confined to our tax filings. The theory has universal application for any service or product that relies to some degree on the appropriate selection of factual information, and the analytical abilities and/or opinions of one or more individuals. As this relates to the mortgage industry, a title policy must be defensible, or it is of no value. A credit report or an income statement must also be defensible in order to have any worth. It stands to reason that a real estate appraisal should be able to withstand the same scrutiny – but it generally will not.
Residential real estate appraisals are seldom defensible. Traditionally, lenders have audited appraisals for completeness (are all the boxes checked?) without giving any consideration to the reasonableness of the value conclusion. That changed – or was supposed to change – with the adoption of the Interagency Appraisal and Evaluation Guidelines in December of 2010.
Consider the following excerpt from the Guidelines:
XV. Reviewing Appraisals and Evaluations
This review also should ensure that an appraisal or evaluation contains sufficient information and analysis to support the decision to engage in the transaction. Through the review process, the institution should be able to assess the reasonableness of the appraisal or evaluation, including whether the valuation methods, assumptions, and data sources are appropriate and well-supported.
Interpret this anyway you wish; it is impossible for a lender to assess the reasonableness of the appraisal or evaluation without considering whether or not the value conclusion is reasonable. In order to accomplish that task, all of the items set forth in the provision above must be readily available and/or readily apparent to the lender.
- There must be sufficient information to support a decision making process.
- There must be sufficient analytics to support the value conclusion
- The valuation methods used must be adequate and applied properly
- Assumptions must be documented
- Data sources must be adequate
Given the lack of support documentation that accompanies a residential appraisal report, it is impossible to determine whether any of these criteria have been adequately addressed. Under these circumstances, how can anyone be expected to make a determination about the reasonableness of a value conclusion as the Guidelines require, and as common sense and prudent business practice dictate?
The appraisal process today is an abbreviated version of that which was once mandated. Generally, a single approach to value is considered – the market comparison approach. This method depends on the successful execution of two procedures:
- The identification properties that have recently sold, that are reasonably similar to the Subject property in terms of location and property characteristics, and that best represent local market conditions (“comparable properties”)
- The determination of reasonable dollar adjustments to account for the locational and characteristic differences between each comparable property and the Subject.
We know from studies performed periodically by Fannie Mae and others that a significant percentage of the time – perhaps 40% – properties identified as comparables on appraisal reports are in fact not comparable. A valuation process that begins with such a flawed premise can seldom arrive at a reasonable, defensible value conclusion. We don’t know what properties comprised the set from which eventual comps were selected, nor do we know the precise criteria used to define “comparability”. Likewise, we do not know the analytical basis for the computation of the dollar adjustments.
What do we know?
- There is insufficient information to support a decision making process
- A single approach to value is insufficient to support a value conclusion
- The valuation methods used are inadequate, even if applied properly
- Assumptions are seldom documented
- Data sources may not be adequate
The sum of our knowledge leads us to the following determination: The information supplied is inadequate to form an opinion about the reasonableness of a value conclusion, which cannot, therefore, be used in a prudent decision making process.
Unless and until the appraisal product becomes defensible, as defined in the Interagency Guidelines, lenders will be unable to comply, and appraisals will not be useful tools for lending or investing decisions.