U.S. moves to insulate appraisers from pressure to cook the numbers

Emmet Pierce

As the U.S. economy struggles to recover from the ongoing housing slump, the appraisal industry is undergoing changes designed to improve professional standards and reduce the temptation for appraisers to overvalue homes.

Critics say appraisers, pressured by lenders and other real estate professionals, often overvalued homes during the recent housing boom. They hold that such practices contributed to the recent surge in foreclosures and the meltdown of the subprime lending market.

Now Freddie Mac and Fannie Mae, the largest mortgage purchasers in the U.S., have agreed to shield appraisers from outside pressure in an arrangement with New York Attorney General Andrew Cuomo and the Office of Federal Housing Enterprise Oversight.

The recent pact settles an investigation into loan purchases made by the two mortgage giants. In part, Freddie Mac and Fannie Mae have agreed to stop purchasing loans from lenders who use in-house appraisers.

Ted Faravelli Jr., executive director of the California Association of Real Estate Appraisers, said it's unfair to blame appraisers alone for the decline of home prices. Pressure to inflate values came from all quarters, he said. Everyone from buyers and sellers to mortgage brokers and real estate agents had a stake in seeing home loans approved as prices soared between 2000 and 2005, he said.

"I think there is enough culpability to go around," Faravelli said. "All of the participants should shoulder some of the blame. Many people were complicit. Everybody had some chips in the pot."

Unrealistic appraisals that overvalue property are easy to spot during a declining market. That's not the case during a housing boom, when prices are rising rapidly.

A key tool for estimating home value is to examine recent sales of nearby dwellings of comparable size that have similar amenities, said George Dell, an appraiser based in the affluent Mission Hills area of San Diego. The key is to use houses that are actually comparable.

Recognizing the importance of accurate home values, the Federal Housing Administration recently mandated that loans it insures for $417,000 or more in declining markets must have a second appraisal for verification, said Dave McDonald, president of the San Diego Chapter of the California Association of Mortgage Brokers.

The new rule "is consistent with the overall tightening of underwriting guidelines across the board," he said. Longtime San Diego appraiser Rick Foos served on an Appraisal Institute committee charged with reviewing the Cuomo agreement and an accompanying code of conduct.

"Real estate isn't a black-and-white subject," Foos said. "You can have two competent appraisers who appraise the same property and have different opinions. Is it reasonable for what someone is willing to pay? If not, that's the time you have to raise your hand and say 'Something is wrong here.'"

Appraisers who do so often find themselves under fire from clients, he added. When you tell someone a home isn't worth an agreed-upon sales price "you are affecting the commission to a loan agent, you are affecting the commission to a real estate agent."

Dell said dealing with client pressure is part of the job. "It has been that way since I got into the business 25 years ago."

Freddie Mac and Fannie Mae recently solicited public comment on the agreement with Cuomo. Subject to modification, it is scheduled to take effect in January. In part, the agreement seeks to:

- Prevent lenders from using staff appraisers or appraisers working for companies they own or control.

- Institute a "Home Valuation Code of Conduct" designed to eliminate coercion, extortion and collusion.

- Prevent mortgage brokers from ordering appraisals.

- Create a consumer hotline to field complaints.

- Establish an "Independent Valuation Protection Institute," funded with $24 million from Fannie Mae and Freddie Mac, to monitor appraisal practices.

McDonald expects elements of the pact to be opposed by some federal agencies and lenders who want to continue using in-house appraisers. In-house appraisal departments are common among large lenders, said Todd Lackner, a San Diego appraiser.

"I worked for Bank of America for a number of years as a staff appraiser," Lackner said. "They don't want bad loans and they have to keep up their reputations."

During the recent housing boom, however, lenders were able to sell large volumes of loans to Fannie Mae and Freddie Mac, who bundled them into mortgage-backed securities for sale to investors. That meant the investors, not the lenders, were left holding the bag for loans that went bad.

In some cases, investors have held lenders accountable, said Ed Smith Jr., vice president of government affairs and industry relations for the California Association of Mortgage Brokers. That is why many lenders have left the risky subprime market.

Some analysts say it's impossible to remove all pressure from the appraisal process.

"The source of the problems is the highly incentivized nature of the mortgage business," said Sara Schwarzentraub, a La Mesa, Calif., appraiser. "What will happen is a lender will call and say, 'Gee, I see your range of value is from $550,000 to $575,000, couldn't it be $580,000?'" she said. "Or they will call up and say, 'Gee, do you have to make this comment about the condition of the roof?' Over the time it becomes a big deal."

There is broad consensus that appraisers need more training and protection from outside pressure. National education requirements for home appraisers were raised on Jan. 1 at the urging of industry trade groups.

Appraisers have always been subjected to pressure. Carlsbad, Calif., appraiser Dave Eshelman said one of the best tools an appraiser can have is a strong sense of ethics. He credits his appraiser father with teaching him to exercise good judgment.

"The mentoring process is critical," he said.

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