One (of many) curiosities of today’s residential sales market is the the low value syndrome, or what I call appraisal “creep”. In the current market we are faced with downward creep, 4 years ago we were enjoying upward creep. First, a little bit of explanation, then how it works:

• Mortgage loan approvals really involve 2 separate approvals, an examination of the borrowers ability to repay, and the value of the property used to provide security if the borrower does not repay. When money was flowing (like in 2005) obtaining a loan approval was easy for almost anyone that wanted a loan to buy a home. If the borrowers credit was good, all the borrower needed was an appraisal that made the the lender comfortable with advancing the money. Residential appraisals are heavily weighted in favor of recently sold properties that are comparable with the subject property (that is the property the borrower wants to buy). The process is simple; find 3 recent sales that are comparable to the subject, make a few adjustments, and justify a value. If the value is equal or greater then the amount the buyer and seller have agreed upon, the loan is made, if not, then choices have to be made or the sale falls.
• So where does the creep start? Let’s say the buyer and the seller have agreed upon a price of $250,000. The comparable process indicates a value of $248,000 based on the most recent sales. But money is easy, lenders want to make loans, and appraisal is not an exact science. So the appraiser “stretches” just a little (it really isn’t cheating, because there is flexibility in the process), and offers an appraisal of $250,000. The loan underwriter does a quick review and grants the loan.
• Next week, a similar home is sold in the neighborhood, for $251,000. A different appraiser, selected by a different lender, looks at the the 3 best most recent comparable properties, one of which is last weeks sale at $250,000. The value on this appraisal is, say, $249,000. The “stretch” is applied, and the new appraisal is delivered at $251,000.
• With many buyers in a super heated market, appraisal values “creep” up quickly. With consumer demand high, sellers can ask top dollar, and many times receive more than they are asking. If the buyer and seller agree on the price, and money is easy, everyone (buyers, sellers, Realtors, lenders, appraisers, and underwriters) involved in the process has a tendency to “stretch”. Little, tiny, perfectly legal, moral, and ethical “stretches” are compounded quickly, and perceived property values move up fast. Until it stalls.
• Then we have downward creep. Same process in reverse, made much worse by the discounts offered on foreclosed property. So the buyers $250,000 purchase of 3 years ago has difficulty appraising today at $250,000. The most recent 3 comparable properties will only produce a value of maybe $240,000. So even though a buyer is more than willing to pay $250,000 for a home in great condition, the poor condition foreclosure sales make it impossible for the appraiser to justify the $250,000 sale, the deal falls, and maybe the market has another foreclosure from a seller that simply cannot sell at a price greater than the loan amount. Then the market is involved with downward “creep”. Until it stalls.
• And there is a downward stall. It happens when the number of properties entering the market is less than the buyer demand. At that point, the market starts moving upward.

Tomorrow we will discuss the “Perfect Storm” that has today’s housing market in a tailspin, what to do about it, and how to avoid it.