Series: How do I read an appraisal? Part 8

Next up in our review of the URAR 1004 (found here: https://bit.ly/2IkOwqn)

Gross Living Area is the heated, finished, living area that is totally above the grade of the soil.
Gross living area is NOT unfinished areas, unheated areas such as enclosed porch, or areas that have ANY portion below the grade of the soil. Heated garages are not living area. Heated pool houses are not living area. Unheated half finished attics are not living area and basements are not part of the GLA of the home. These are the Fannie Mae standards that appraisers must follow when performing appraisals that will be sold on the secondary market.

This is why the finished areas are divided into the “Above Grade” and “Basement” levels in the grid above. Many counties may tax you as though the finished basement level is the same as the above grade, however, Fannie Mae recognizes that the actual real estate market does not.

Functional Utility is the ability of the home to provide for its intended purpose. Examples of problems of functional utility are:

1. Captive bedrooms - having to walk through someone’s bedroom in the middle of the night in order to get to your own bedroom is not the typical intended purpose of a bedroom.

2. Having the only full bathroom be in the unfinished basement is not what the market expects from a bathroom.

3. Having a half bathroom in the back of the home and another half in the front of the home, with no full bathroom, is not typical.

4. Having the home’s water well be in a hole in the living room floor… is not typical.

5. Having a 3000 sf 1 bedroom home is not a typical function of a home

6. Having the holding tank of the septic tank be within the walls of the home, is not typical.

   Town and Country has appraised ALL of the above.

Functional utility is often those items that make you say “Wow!” or “Why?!” An appraisers job is to recognize those items and collect data to determine the impact on appeal because of those items. Sometimes these items can be cured (the cost of fixing the issue is less than the value increase) and sometimes they are incurable (the cost of fixing the issue is more than the value increase).

Series: How do I read an appraisal? Part 7

As we move down the URAR 1004 (found here: https://bit.ly/2IkOwqn) we come to a few areas that can be confused for each other. Here we’ll separate them into parts and explain how each factor separately affects value.

Site / Location / View

On their surface these three seem to be inseparable. The location of the site changes the site’s value. As does the view… how can these be three separate analysis. For this, lets address some real life examples in our coverage area.

How much does a nuclear clean up site, that has no guarantee of disclosure until 2030, affect value?

This is an external influence on the properties near the Kiskimere site in Parks Township, Armstrong County. This would be an example of a factor of location. We’ve performed repeated paired sales analysis to extract the difference in appeal from here to just a few miles away.

What happens when you have riverfront property, but don’t own the rights to use the river front?

This is the case along the Allegheny River in Armstrong County, where one side of the river owns the rights to the river front, but homeowners on the other side don’t. Each have the same view, but the location of the other side has a higher appeal.

What happens when your land is shaped like a triangle and/or is located on a cliff?

This affects the price per square foot of the subject acreage, because the utility of the land is diminished. We perform vacant land sales analysis on properties with similar characteristics in the market to determine the reduction in value to the site.

What happens if your house is built under an overpass and next to high tension wires?

Once again, we came across this in Armstrong County (do you see a trend). These are largely factors of the view. In order to analyze the influence in this case, other properties that have sold within view/hearing of these places are examined to extract impact on appeal. Other examples would be railroad tracks, locations on heavily traveled roadways, etc.

Quality / Condition

These factors are easy to confuse, so lenders have largely adopted a coding system:

Quality ratings range from Q1 - Q6

At the high end of the scale is Q1 - picture the white house. Custom everything, best materials for everything. These homes are very rare because the people with the skills needed are rare. On the other end of the spectrum is Q6 - picture a hunting shack. It barely qualifies as a home, and for part of the year might not be habitable. Most homes in our area fit into the Q4 rating, which Fannie Mae Defines as:

Dwellings with this quality rating meet or exceed the requirements of applicable building codes. Standard or modified standard building plans are utilized and the design includes adequate fenestration and some exterior ornamentation and interior refinements. Materials, workmanship, finish, and equipment are of stock or builder grade and may feature some upgrades.

Condition ratings range from C1 - C6

At the high end of the scale is C1 - brand new, never lived in. On the other end of the spectrum is C6 - this has condition issues so great that the house can no longer function as a home, holes in the floors, roof, missing water lines, no electricity, etc. Most homes in our area fall into the definition of a C4 range:

The improvements feature some minor deferred maintenance and physical deterioration due to normal wear and tear. The dwelling has been adequately maintained and requires only minimal repairs to building components/mechanical systems and cosmetic repairs. All major building components have been adequately maintained and are functionally adequate.

So, a home can be a Q1 quality while in C6 condition (in fact the White House during the War of 1812 was this when it was burnt down) - and you can have a brand new hunting cabin (Q6 quality in C1 condition).

Series: How do I read an appraisal? Part 6

Today we move to page 2 of the URAR 1004 form, and the sales comparison approach.

We’ll point out a few areas that can be confusing or unclear:

1. Number of comparable sales and listings.

   Located on the top two lines of the page: This is not the number of comparables used in the report (but it could be). This is the total number of comparables that the appraiser felt were sufficiently comparable to the subject that sold in the last 12 months that were analyzed. These homes may have a wider range of values than the buyer actually considered - however, these sales have factors that were necessary to analyze in order to develop a credible analysis. The more homogeneous the neighborhood of the subject, the more similar the comparables will be and often resulting in a tighter range. The more variable and rural the area is, the wider the range of comparables will be.

2. Sales price/Gross living area line

   This line is often misused by those who don’t understand it and is most useful in areas where homes and lots are all nearly identical. Otherwise there is wide variation and it causes confusion unless you know how to read it. This line only takes the sales price and divides it by the Gross Living Area (we’ll cover this later) - with no consideration of the number of bedrooms, bathrooms, condition, quality or ACREAGE. In other words, a 100 sf cabin on 5 acres that sold for $10,000 and a 1,000 sf ranch on a city lot that sold for $100,000 would both have the same “Price/Sq ft:” $100. Using this line alone to judge how “comparable” two properties are would be a gross error. Picking comparables is a far more complicated task than applying a single arbitrary metric.

3. Financing and Concessions

   If my home is listed for $100,000 and the buyer offers me $100,000 but asks for $5,000 back to cover their closing costs, how much is the home itself worth?

   This is a commonly confusing area of the form, but a simple example may give clarity.

   You walk into your local grocery store in search of an Apple. The apple costs $.95. You tender $1.00 to the cashier and they hand you back $.05. How much did you pay for the apple?

   Simple, right. Even though you handed over $1.00, you only paid $.95, and the grocer only received $.95. How you spend the $.05 is up to you.

   The hand in the back is raised, “But the contract price of this sale includes the concessions?”

   And here is the difference in our scenario:

   1. The bank is making a decision to determine if the value of the home is enough to cover the loan amount, NOT the market value of the home.

   2. The appraiser is determining the market value of the home - not the loan decision. We have two very different and important tasks.

      It can be confusing, but once you focus in on the buyer/seller motivations (which is what market value is based on) and not on lender banking decisions, the issue becomes more simple. Additionally, the data available would appear to support that the only valid adjustment to be made here is a dollar for dollar adjustment in the market areas that we cover (Westmoreland, Butler, Armstrong, Indiana, Cambria, and some parts of Allegheny County).

Series: How do I read an appraisal? Part 5

The improvements to the property include all of the structures added to the site. This section breaks the dwelling into a variety of sections for recording:

1. This describes the units construction and style. Effective Age is number given to the home based on the overall condition of the dwelling.

2. Simply describes the attic space and what access or finish is located there.

3. Gives data on areas of the home that are located below the grade of the soil. This includes finished and unfinished portions, and any of the common deficiencies found there. Its important to note that for lending purposes, the finished area below the grade of the soil is treated differently than what is located above grade.

4. Describes the heating and cooling of the home.

5. Describes the outer construction of the home and the condition of those elements.

6. Describes the inner construction of the home and the condition of those elements.

7. Gives a record of any amenities that may/may not be found in typical homes.

8. Describes the car storage on the site.

This portion of the form is rather self explanatory, its a simple reporting of the facts with little analysis. Sections 9 and 10 represent a more subjective portion of process.

Section 9: Asks the appraiser to describe the home’s improvements/special features/deterioration. This section is supplemented by the photograph addendum. The deficiencies we are asked to look for fall into 3 categories:

1. Safety - any deficiencies that could pose a safety concern to the occupant. These could include, a) lack of handrail/railings, b) exposed/unsafe wiring, c) tripping hazards in carpet, d) missing extension pipes on pressure relief valves on water heaters, etc.

2. Structural Integrity - we are asked to look for elements of the home’s construction that could threaten the improvement’s long term existence. Things like a) shifting foundations, b) leaking roofs, etc. The appraiser must determine that the home has a minimum 30 years remaining economic life.

3. Security - this refers to the subject’s ability to secure a loan. When it comes to loans that are backed by or underwritten for FHA/VA/USDA, additional regulations apply. For example, FHA/VA/USDA require that in homes built prior to 1978, ALL chipping and peeling paint be removed and painted on the basis of the possible existence of lead based paint. Standing water in basements automatically trigger the appraiser to require an inspection by a qualified professional. If this isn’t done, those loans can not be written for the subject.

These issues must be corrected BEFORE a loan can be made on the subject property.

Section 10 asks two questions:

1. Do any deficiencies rise to the level of affecting the livability, soundness or structural integrity of the home? This goes along with the above.

2. Does the property conform to the market area? If the market expects…

   1. 4 bedroom 2,000 sq ft homes and the subject is a 1 bedroom 700 sq ft home - it doesn’t conform

   2. Homes with a roof in proper condition and the subject has an “unplanned skylight” - does not conform

   3. Ranch homes on 3 acres and the subject is a town house with shared party wall and no yard - does not conform.

Market conformance is a subjective analysis based on data from the area and observations by the appraiser. The information reported to the lender is used to make determinations on whether to write a loan or not. The appraiser doesn’t have the final word - they merely observe and report the information available in all of the above areas.

Series: How do I read an appraisal? Part 4

How much is an acre worth? Well, it depends…

1. Is it river front or next to a nuclear waste site?

2. Is it one parcel or divided by power lines/major highway?

3. Is it sloped like a cliff or is it flat?

4. Is it a normal shaped lot or is it a foot wide and two hundred feet deep?

   (Town and Country has appraised all of the above, sometimes multiple at once)

The location of the subject specifically is addressed in the site section. This includes not only the lot size, but the other factors that can make much more impact. One of the greatest impacts on value is the Zoning. If the subject is a 2 acre parcel with a multifamily dwelling and zoning only allows single family dwellings, there is a huge problem (we have come across this scenario as well).

The appraisal process in this section requires familiarity/research of the area’s external factors, municipal utilities, zoning, topography, flood zones, and any covenants and restrictions that may limit the usage of the property - none of which are as easy as merely checking boxes.

Highest and Best Use Analysis

A property must be appraised in terms of its highest and best use. There are four tests that must be applied to a property, in order:

1. Legal permissibility

2. Physical possibility

3. Financial feasibility

4. Highest profitability

Steps three and four cannot be determined until the first two steps are analyzed. Most of the time legal permissibility and physical possibility are easy questions of zoning and building requirements, however, when they are not, they can slow the appraisal process down considerably. Sadly, sometimes an appraiser can wait for weeks for the local code enforcement officer to inform them of the legal permissibility of the subject under consideration. When homes are built that fail tests one and two, huge problems can occur.

In this case (http://massrealestatelawblog.com/2012/02/21/a-different-type-of-tear-down-court-orders-million-dollar-marlblehead-manse-demolished-for-zoning-violation/) the failure of the home to pass the first two tests cost millions of dollars and 16 years of legal problems. This is why appraisers in every appraisal must begin the process with step 1 and 2 of the HBU analysis and not proceed until they are confident that these criteria are met. It may slow the appraisal process down, but its better than a lawsuit against the appraiser and real estate agents for not disclosing this information to the buyer years down the road.

These two short lines in the Site Section of the report reflect a great deal of analysis behind the scenes, as is the case with so much on the URAR 1004. When you read through these reports, reflect on the fact that you are being given a 15 minute read through of analysis that took hours to develop, and something that can’t be merely replaced by an algorithm.

Real estate valuation is not a “by the numbers” only process. This is the fatal flaw in the current move towards algorithms.

Series: How do I read an appraisal? Part 3

Location… location… location. The three “L’s” of real estate. Location gets two sections of the first page because of this importance. The first is the neighborhood, the macro look, and the second is a look at the individual location of the subject within the neighborhood.

Depending on where the subject is located, the neighborhood may be a small development or an entire township as in the case of rural properties. Without getting too complicated, the neighborhood of the subject is the area in which the typical buyer pool for the subject property might also look for a home. Some neighborhoods are directly comparable to each other - one end of the same school district might have the same overall appeal as the opposite end, even though the distance is quite far. However, sometimes moving just a half mile in a built up area over a school district line can have a large impact on appeal. Distance isn’t everything.

The rest of the data here asks the appraiser to analyze the overall market conditions in the market. Are home prices increasing/declining? Is there an over/under supply of homes for sale? At Town and Country we analyze the prior 3 years of sales in an area to derive our opinion. If there are more homes in the market than sold in the last 2 years combined and the days on market are creeping towards 9 months, these factors may indicate a softening market area.

This section serves as a snap shot of the market area of the subject at the time of the inspection, a look back at how the market has performed in the past, and based on current supply of homes, how the market is performing currently. It also begins to provide data on the predominate trend of homes in the area and whether the subject conforms to the market… but we’ll cover that in weeks to come.

Series: How do I read an appraisal? Part 2

USPAP (the standards that govern the appraisal profession states the following:

Standards Rule 1-5
When the value opinion to be developed is market value, an appraiser must, if such information is available to the appraiser in the normal course of business:

(a) analyze all agreements of sale. options, and listings of the subject property current as of the effective date of the appraisal; and

(b) analyze all sales of the subject property that occurred within the three (3) years prior to the effective date of the appraisal.

The appraiser MUST analyze the contract, and listing history of the subject property IF available. Analysis of these factors include:

1. What the agreed upon purchase price is

2. Monetary/Personal property concessions

3. Contingencies

4. Listing history of the property

5. The above factors, and their affect on market value, if any.

There is a common question, “How can the appraiser’s opinion of value be impartial if they know the contract price?” The data shows that this question could be valid.

While most valuations fall into a bell curve around market value (which would be expected if purchase prices are to be trusted at all, the drop at just below contract prices and spike at/slightly above contract price would indicate that this does possibly skew opinions.

The Bad: Appraisers can get sucked into “hitting the number.” The bell curve in the above graph actually peaks approximately 3% lower than contract (a very interesting percentage given typical concessions) if the spike at contract price is ignored. Inside of a real estate transaction, there is only one party that is not financially compensated based on a closed sale/higher price and that is the appraiser. If this data is skewing opinions upward, then there is a possible long term problem. Agents seek higher commissions, banks want higher payments and the market begins to spiral upwards away from fair market value… and as we learned in 2008, prices can violently correct.

The Good: Good appraisers know their job and this risk. A good appraiser only addresses the contract price at the end of their analysis, not the beginning. Also, the meeting of the minds between the buyer/seller is a data point, one of many, but a data point that deserves to be analyzed and reconciled with the rest of the market. In an ideal world, a knowledgeable/informed seller prices their home reasonably, and a knowledgeable buyer makes a reasonable offer. Real Estate Agents have a huge responsibility in this - to set aside their own personal gains and inform their buyers/sellers (for more on this topic, watch economist Steven Levit’s warning: https://www.youtube.com/watch?v=pbFkw_roJqI).

Another question often asked is, “Isn’t market value just what someone is willing to pay?” After the long process of coming to an agreed upon purchase price, having an appraiser come in with a different market value opinion can be frustrating. Why would the two be different? A simple story may help us tease the two apart:

Imagine a small village within a large desert, with a faithful well at the center. Everyday the well produces enough water for the town's people, without fail. Each day a young man pulls up gallons of water and sells the gallons for $1 each. Each person in town has enough for the day, the man is compensated for his efforts and everyone is satisfied.

Now, on a certain day, a man struggles across the desert after a long journey, nearly dying. He is an adventurer, who has just found the greatest treasure known. He knows that when he gets back to civilization he will be rich beyond words. A young boy wanders out of town and finds the man. The man offers 1 million dollars for the water sack that the boy carries, and the boy gladly complies.

A couple of questions at this point:

1) What is the water worth to the boy?
2) What is the water worth to the man?
3) What would happen if the boy began demanding 1 million dollars per gallon in town?

Its a simple and almost silly story, but it gives us a simple example. To the boy, the water is still only worth $1. To the rich man who doesn't know the value of the water, its worth his very life. To the town, once the man has drank his fill, its still worth $1.

The price in one moment doesn't change the value. An uninformed buyer doesn't set the market. Just because a house is listed for 1 billion dollars doesn't mean that its worth it. Markets are made over hundreds of transactions, between informed buyers and sellers over the course of time.

The selling season sees more listings and sometimes pricing becomes more aggressive than the market can bear. Be sure to have an accurate home valuation before listing, as it can often save you time, frustration and disappointment.

Appraisals remain the most unbiased and reliable method of valuation, but the process and standards can always be improved upon. Algorithms are being tested, but are still decades away from reliability in anywhere other than homogeneous suburban areas. Town and Country takes our job seriously to “promote and maintain a high level of public trust in appraisal practice” (Preamble to USPAP) not merely “make the deal work.”

Series: How do I read an appraisal? Part 1

Whether you are a homeowner or real estate agent, there is a lot of information that is packed into a small amount of space, and it can be overwhelming. In hopes of helping educate consumers, today we start a series going through the most common form used in the loan origination process, and address it line by line. This form is publicly available at: https://www.fanniemae.com/content/guide_form/1004.pdf

Page 1: Subject - contains the basic information pertaining to the "subject" property, or the property under consideration for the appraisal. Most of this is self explanatory, however, we'll highlight one area of possible confusion: Property Rights.

If you own a property, you own a "bundle of rights" to that property, however, some of the rights to the property may already be sold away. Mineral rights are a common example - at some point in the past the mineral rights of the property may have been sold to another party - and that "stick" is no longer in your "bundle" of rights. If your lease your home to another person, you have temporarily handed that person a few sticks in the bundle (see picture below).

An appraisal first addresses what the subject is, and what property rights are being appraised. The more "sticks" from the bundle that have been sold off, the less value the remaining property may have, and the more difficult the property may be to appraise.

For more information on the "Bundle of Rights":
https://www.investopedia.com/terms/b/bundle-of-rights.asp

Southern Westmoreland County Review 2018

Mortgage Backed Securities, CDO/CLO's: Made easy

In this week’s continuation, we look back at Mortgage Backed Securities, and what they’re become.

A giant pool of money…

Mortgage Backed Securities/Collateralized Debt Obligations (CDO/CLO) are big complex ideas - but are simple when broken down. These "American Life" broadcasts discuss how money is made off of bad investments and when prices go down. And the article below discusses the CLO market as of June 2018... to quote their summary:

"As of June 30, the S&P/LSTA Index imputed default rate was 1.28%, the highest level in 2018 but still very close to the levels last seen in November 2007."

All while the housing sector of CLO's sees a decline, and the spreads are very reminiscent of Nov/Oct 2007. In short, if CLO's are any indicator, a market retraction on the order of 2008 may not make it to the 2020 that experts are predicting.

A look at the 2008 CDO market: https://www.thisamericanlife.org/355/the-giant-pool-of-money

1 year later, a look at the CDO market: https://www.thisamericanlife.org/…/return-to-the-giant-pool…

A 2018 look at the CDO market: https://www.tcw.com/…/Monthly_Commenta…/07-10-18_Loan_Review

The NYC market is currently softening, with trends similar to 2009: https://www.cnbc.com/…/nyc-real-estate-becomes-a-buyers-mar…

A entertaining look at the most damaging financial event since the Great Depression.

This movie gives a dramatic look at what we reported last week in a fun to watch, easy to laugh through, and deeply disturbing look at how bad the bad actors in the real estate market got. When you look at this in correlation to recent data that mortgage fraud is on the rise, it paints a difficult picture to look at.

The Big Short: a true story. Its well worth the watch.
https://www.imdb.com/title/tt1596363/

Mortgage fraud risk spikes in Q2 2018: https://www.housingwire.com/…/46820-corelogic-mortgage-frau…

Four financial experts who called the 2008's collapse and their thoughts on the current market: 
https://www-barrons-com.cdn.ampproject.org/…/financial-cris…

The $1.5 Trillion student debt crisis:
https://www.forbes.com/…/student-loan-debt-statistics-2018/…

2008 vs. 2020: What can we learn from the past to protect our future?

What does the housing market have to do with plot of the movie "The Producers?"

One of the lies that was told during/after the housing crisis of 2008 is that "No one saw it coming!" However, some did, and warned the world loudly. Many in the financial markets knew and made billions. In the coming weeks we will look at the macro housing market, by looking back, and looking at lessons that we can learn. Now 10 years later, real estate professionals nationwide are warning that the lessons we learned in 2008 are being forgotten, and that the odds of another financial collapse are rising, and estimated by the majority by Q1 2020.

A number of great reporters have done an amazing job at presenting this information to the public over the past 10 years. We encourage you to take a listen/read/watch at this compilation of how the housing market of the United States brought the world to its knees, in hopes that we can avoid another collapse. When banks are allowed to bet against homeowners... its a recipe for disaster. With mortgage fraud on the rise and the legislation (Dodd Frank) that aimed to restrict this behavior targeted for repeal, you have to ask why?

A deep look at the 2008 crisis: https://www.thisamericanlife.org/405/inside-job

Two former Fed Chairmen predict a crash in 2020:  https://www.forbes.com/sites/lawrencelight/2018/07/31/4-financial-savants-warn-about-the-great-crash-of-2020/#2de307cc6197

Mortgage fraud on the rise:
https://www.housingwire.com/articles/46820-corelogic-mortgage-fraud-risk-spiked-in-the-second-quarter?utm_source=dlvr.it&utm_medium=twitter&utm_campaign=housingwire

Promises of Dodd Frank repeal continue:  https://www.cnbc.com/2018/05/24/trump-signs-bank-bill-rolling-back-some-dodd-frank-regulations.html

Oakmont Borough

Buffalo Township Q1 Analysis

A new service to our customers!

Today we begin offering analysis of market areas in our coverage area. If you have an area you would like us to include, comment and we'll consider it!