Question: We’re buying a house. It will cost us almost $500 to get an appraisal. Given free online estimates this seems like a huge waste of money. Isn’t there a cheaper way to value houses?
Answer: I hope you’ll pay the $500 and get an appraisal when purchasing a residence. Here’s why:
At the start of April, the nation’s financial regulators issued a new rule which says banks don’t need an appraisal to finance commercial real estate transactions valued at $500,000 or less.
The new standard, said the regulators, “will not pose a threat to the safety and soundness of financial institutions.
“The final rule allows a financial institution to use an evaluation rather than an appraisal for commercial real estate transactions exempted by the $500,000 threshold. Evaluations provide a market value estimate of the real estate pledged as collateral, but do not have to comply with the Uniform Standards of Professional Appraiser Practices and do not require completion by a state licensed or certified appraiser.”
With the stroke of a pen, it became officially okay to replace licensed, trained, experienced appraisers with data and algorithms in a large number of commercial transactions.
Think about this: The new standard “will not pose a threat to the safety and soundness of financial institutions.” Okay, but what about borrowers?
Appraisal Substitutes
The situation with residential appraisals is much the same.
Since last August, Fannie Mae – with 26 million appraisals in hand – says it “may be willing to waive the appraisal for certain transactions with the borrower’s OK.”
Freddie Mac tells borrowers that it will not require an appraisal for certain transactions but home buyers – at their expense – are welcome to “obtain an appraisal of your property in order to confirm that you are not paying too much for the property.”
Lenders also don’t want liberal appraisals because higher values may create additional lender risk. However, according to the Federal Housing Finance Agency, “a number of empirical studies have shown that property appraisals tend to be biased upwards, and over 90 percent of the time, either confirm or exceed the associated contract price.”
AVMs versus the Appraisal
AVMs – automated valuation models — are quick and cheap when compared with an appraisal, and they’re getting more accurate. Valuation standards are improving because we now have access to tens of millions of appraisal reports – and there are millions more every year.
When combined with past sale reports, nearby homes now on the market, and tax records these reports provide much of the data needed to create AVMs. In addition, if a lender has required an appraisal during the past few years it’s increasingly likely that they also obtained an appraisal review, an electronic evaluation of the appraiser, the appraisal, and the property. In realty, more data.
“AVMs can scale up at a rapid rate potentially earning them the moniker of ‘weapons of math destruction’ if they are deployed on a large-scale basis,” argue Ritesh Bansal and Joan Trice writing in Appraisal Buzz Magazine. “You should be concerned if there is no independent third party monitoring the use of these models. Also, keep in mind that appraisers are licensed and subject to oversight. We are entering new ground here. Can machines be held accountable if their outputs are unreliable or at worst have been corrupted? Let’s hope that regulators employ experts in this burgeoning field rather than focus on relieving lenders of their regulatory burden. Their focus should be the ‘safety and soundness’ of housing finance.”
Appraisers may well be able to use AVMs in their practices but in the future, the demand for real estate appraisal services will inevitably shrink. While there may be the option of getting an appraisal, in practice how many borrowers will shell out $500 or so for an elective professional valuation? AVMs, coupled with appraisal reviews, are creating a massive database that in time will include virtually all US properties. Valuations will be as easy to get as haircuts – and not much more expensive.
That said, I’ll pay for an appraisal when buying a home and I’ll try to get an AVM when refinancing.
How come?
When buying a home an appraisal – an independent estimate of value – will help assure that I don’t overpay for the property, a potentially huge mistake. In a buying situation, I see an appraisal as a form of consumer protection that I want. With a refinance I’m in the home, I’m not moving and I’m not selling so I only care that the valuation is sufficient to support the loan I want. If I can get that good refinancing valuation with a cheap AVM that’s fine.
