The article in Consumer Reports describes appraisal inflation as a potential…
On the Tax and Legal update section on ERC’s web site, there is reference to an IRS memorandum that discusses applying penalties to appraisers who knowingly manipulate appraisals to help an individual pay less tax. Examples of appraisals done for tax purposes include estate tax, gift tax, facade easements and charitable contributions.
the IRS Office of Chief Counsel [note: pdf] discussed the possible application of section 6701 of the Internal Revenue Code to appraisers. Section 6701 imposes a penalty on anyone who aids or participates in the preparation of any return or document and has reason to believe it will result in the understatement of someone else’s tax liability.
What’s wrong with being held accountable for the value estimate? Nothing, except…
…and here’s the caveat, the person requesting the appraisal should be on the hook as well. The tax attorney or accountant is often the person trying to influence the appraiser. My problem with this IRS memo, is that the appraiser is left twisting in the wind.
The Office of the Comptroller of the Currency (OCC), the Board of Governors of the Federal Reserve System (FRB), the Federal Deposit Insurance Corporation (FDIC), the Office of Thrift Supervision (OTS), and the National Credit Union Administration (NCUA) were concerned enough on several appraisal issues that they released a joint statements in 2003 and 2005.
The October 28, 2003 statement addressed concerns over the independence of appraisers. [note: pdf].
The agencies’ appraisal regulations address appraiser independence and require that an institution, or its agent, directly engage the appraiser. The only exception to this requirement is that an institution may use an appraisal prepared for another financial services institution, provided that the institution determines that the appraisal conforms to the agencies’ appraisal regulations and is otherwise acceptable. Independence is compromised when an institution uses an appraiser who is recommended by the borrower or allows the borrower to select the appraiser from the institution’s list of approved appraisers.
The March 22, 2005 statement addressed concerns over the transferring re-assigning appraisals [note: pdf].
Highlights (Q & A Format)…
- May an appraisal be routed from one lender to a regulated institution via the >borrower?
Answer: A regulated institution cannot accept an appraisal from the borrower unless the regulated institution can confirm that the appraisal was in fact ordered by another regulated institution or financial services institution. In accepting the appraisal, the regulated institution must also confirm that the appraiser is independent of the transaction and that the appraisal conforms to the agencies’ >appraisal regulations and is otherwise acceptable.
- Can a borrower pay the appraiser directly for an appraisal that is ordered by the lender?
Answer: Since the regulated institution has engaged the appraiser for its services, the regulated institution should be the party to remit payment to the appraiser. The regulated institution may seek reimbursement from the borrower for the cost of the appraisal. However, the borrower may not recommend an appraiser to the institution or select the appraiser.
From their press release: “The Office of Federal Housing Enterprise Oversight (OFHEO) has finalized for publication in the Federal Register a regulation requiring Fannie Mae and Freddie Mac (the “Enterprises”) to report mortgage fraud or possible mortgage fraud in a timely fashion.” OFHEO is the regulatory oversight agency for GSE’s (Government Sponsored Enterprises) like Fannie Mae and Freddie Mac.
Complete text of the final regulation can be found here. [note: pdf]
Appraisal fraud is now considered within the definition of mortgage fraud. This rightfully defines those who pressure appraisers to reach a specific value or they won’t receive future business as committing a fraudulent act.
Excerpt… Â§ 1731.2 Definitions.
(c) Mortgage fraud means a material misstatement, misrepresentation, or omission relied upon by an Enterprise to fund or purchase — or >not to fund or purchase — a mortgage, including a mortgage associated with a mortgage-backed security or similar financial instrument >issued or guaranteed by an Enterprise. Such mortgage fraud includes, but is not limited to, a material misstatement, misrepresentation, >or omission in identification and employment documents, mortgagee or mortgagor identity, and appraisals that are fraudulent.
The Responsible Lending act introduced in the house this spring addressed the issue of appraisal pressure. The section of the bill to refer to TITLE IV–APPRAISAL ACTIVITIES primarily addresses predatory lending in the sub prime market.
You get the point.
This was probably in response to a rash of appraisal fraud that has been happening in then the relaxed lending guideline environment, proliferation of sub prime lending, increased wholesale mortgage origination, specifically in markets like the Poconos, which was highly publicized.
The bill provides terminology that specifically equates appraiser pressure to a criminal act. Its a giant step in the right direction but at the end of the day, we believe nothing will change to prevent overall fraud in the industry within the bill’s current format.
With 72,000+ licensed appraisers nationwide, state enforcement is limited at best. The average enforcement department for each state is something in the order of a few staff members and limited funds.
The government is currently analyzing the appraisal industry and will produce a detailed analysis. Hopefully, it will show that the lack of separation between the sales function and the underwriting function promotes fraud. In other words, those individuals paid on commission, should not decide which appraisers get the assignment.
One of the best descriptions of the current problem can be found from the think tank DEMOS.
Someone from the research staff of the House Ways & Means committee actually called me on this issue as well and I volunteered to testify. I wanted to discuss the problem of the lack of independence of the appraiser but they wanted me to name names. They completely missed the point. Its not specific individuals, its the way the industry is set up. I got the distinct impression from my conversation that the committee already knew what they wanted to hear. They went wih an appraiser from Virginia, David Lennhoff, who didn’t name names either, but basically said that the 10% rule – of – thumb adjustment is not valid.
Most appraisers who do facade easement valuations are using 10% to 15% adjustments as a guideline which originates from the now infamous original Primoli Letter [pdf] , since replaced by a revised version from the IRS [pdf] that omits the 10% to 15% verbage. Since it could be interpreted that the IRS seems to be re-writing history, I suspect that is the motivation for the National Architectural Trust to document the changes in policy by the IRS on this matter [NAT].
The Problem: Most appraisers are simply performing a valuation and making this discount. The problem is that the disclosure of whether the seller has taken advantage of the deduction is not available to the public, in a practical manner. The inability to use empirical data (because it doesn’t exist) provides the classic catch-22. You need empirical evidence to appraise the first property in your market, but yet the IRS says you can’t appraise without using empirical data. However, there is no definition as to what constitues empirical evidence. Using court cases, sales data, equity stock trends, what conference wins the Superbowl (well, thats a stretch) might be interpreted as appropriate since they are all empirical evidence.
Our firm grew disaffected as homeowners caught on to the process and pressured appraisers to appraise the properties on the high side to get a bigger deduction. We refused to do that so we stopped getting this type of work. We were openly complaining that there was a problem, but from their perspective, they do not have the ability to police the appraisers.
Who is going to say the value is too high? No one. There is no review function or policing of these reports done for any facade easement organization. It falls in the lap of the IRS agent during an audit.
The loss in tax revenue due to inflated appraisals has got to be staggering to the Treasury. Many appraisals are inflated because there is no oversight and like the wholesale lending process (mortgage brokers), the benefactor picks the valuation expert. And once again, appraisers, including good appraisers who don’t play this game, will be blamed.
Appraisers have been relegated to form-fillers. The easiest source of new business is the mortgage broker (wholesale lending) pipeline. I don’t want to stereotype all mortgage brokers because there are a number of good ones out there. The appraisers who deal with this client base are in a catch-22. Its simply common sense that an appraiser who comes in “low” on a refinance valuation or “kills” a sale, won’t get repeat business from that mortgage broker. Afterall, the mortgage broker is paid on commission. Appraiser makes number, gets more business. I often chuckle when appraisers are described as a “good” appraiser. That usually means that you “hit the number.”
Here’s a recent letter to the editor on this subject as seen in the New York Times:
July 3, 2005
A Disservice to Clients
To the Editor:
I am writing in response to the article that appeared in the Real Estate section concerning appraisals that don’t match the sales price (“When the Numbers Don’t Match,” May 29.).
Mortgage brokers who order appraisals until they get one that works for them are doing a disservice to their client, not to mention the lender.
It would be interesting to know how many mortgage brokers engage in this practice without disclosing their actions to their clients. If the appraisal comes in low and the mortgage broker orders another appraisal that makes the number, the question has to be asked why one appraiser could make the deal and the other couldn’t.
Is it possibly because one appraiser has taken sales outside the subject’s market in a higher-priced market or may have misrepresented the size or condition of the comparables?
The appraiser’s job is to provide the lender with an opinion of value supported by the market. The appraiser gets paid whether or not he makes the deal. The mortgage broker gets paid only if he makes the deal.
The appraiser does not have any interest in killing the deal. After all, when the appraiser makes the deal, he or she doesn’t have to take irate calls from the buyer, the seller, the sales broker or the mortgage broker. Plus, he doesn’t make any enemies, stays on the mortgage broker’s list of approved appraisers and remains on good terms with the sales broker.
Scott H. Gallant
Park Slope, Brooklyn
The author is a real estate appraiser and consultant.
It amazes me how flawed the structure of the wholesale lending process is. Someday during an economic downturn or future lending crises, this will come out with the wash. Until then, its status quo.
How it began…
As banks floundered in the early 1990’s during the recession, the non-revenue departments were cut back, which included…you guessed it…appraisal departments. The order and review function, which requires administrative overhead, was shifted to mortgage brokers who would bear the staffing risk. Mortgage brokers are generally paid a commission of 1 point, or 1% of the mortgage. The appraisal fee, which generally starts at $300 to $500, is either paid in the borrower’s application fee or the absorbed by the mortgage broker.
In relatively short order, the wall between the sales function and underwriting essentially went away and so did the buffer between bank loan reps driven by a commission incentives and the appraiser, who is supposed to be assessing the collateral for the lending institution.
Large appraisal factories sprang up across the country hiring trainees who would simply fill out appraisal forms and make the deals. Without inhouse appraisal departments to review these reports, they were essentially accepted at face value. Many experienced firms either shut down or moved into other areas of valuation.
Why does this matter?
Lets count the ways.
- The borrower is under the assumption that the licensed or certified appraiser is independently assessing the value.
- Lending institutions have no idea what their collateral is really worth and the implicit risk to their portfolio.
- These lending institutions are government insured.
- Guess who pays the bill in the next banking crises?