Is The Problem The Appraisal or The Property?
By Charlie Elliott, Jr., MAI, SRA

As appraisers, most of us would be less than candid not to admit that we have complaints, from time to time, about the contents of an appraisal which we have prepared. While admitting to mistakes is sometimes difficult for us humans, there are times when this is in order and when the most professional of us admit it up front and proceed to reduce the damage by correcting the mistake. While this method usually does little for our pride as appraisers, it is much easier than resolving problems where there have been no mistakes and the client thinks there have.

Occasionally, one of my loan-officer clients will contact me and make the statement that there is a problem with an appraisal. Upon investigation we learn about the problem through the eyes of the client and sometimes the property owner. This never begins with the loan officer but always from higher up. You guessed it, from the originator, even though most loan originators may not view the underwriter as being higher up, they at a minimum have more authority when approving loans are of a concern.

It usually goes something like this. The gross adjustments are too high on the appraisal, meaning that when the comparable sales are adjusted to derive a value for the subject property, the gross percentage of adjustment is over the 25% permitted by the Fannie Mae guidelines. To the untrained eye and/or the untrained mind this may appear to be a problem with the appraisal since that is where the adjustments are made. But consider this: Why did Fannie Mae develop this guideline? Now, I am going to make you a bet. It was not for the sake of the appearance of the appraisal. Nor was it just to keep the appraisers math skills up to par. It was to make the task of collateral assessment a meaningful exercise. Deep down in this process the people at Fannie know that if a property does not conform to those in the neighborhood there may be problems using the data for a true comparison in determining value. They want comparables to be similar in size, quality, location, age, condition, etc.

In some cases, this simply is just not possible. Sometimes it is impossible to find comparable sales with characteristics matching that of the subject. Some may think that this is because the appraiser did not do a good job searching the area for comparables. Sometimes this is the case, but not always. Some properties are so unique that there does not exist true comparable sales that can be used to evaluate the subject that is within 25% of the value of the subject. In such a case it is not a matter of changing the appraisal, but one of eliminating the property from consideration as collateral for a non-conventional loan. After all, that is why the appraisal was required.

Let’s take a look at an example of how such a circumstance could evolve. Consider the subject five-bedroom house with 3,000 square feet of floor space located on a quiet city street in a neighborhood consisting of other houses ranging in numbers of bedrooms from two to three and square footage ranging from 1,200 to 1,500. These homes usually sell for around $125,000 or about $90 per square foot, give or take a few dollars. You got it; the subject is double the size of the next largest house in the neighborhood. To the untrained eye, this may not present a problem, however, to Fannie Mae it does and to buyers it does. Notice I did not say sellers since they are leaving a situation not coming into one and they are receiving money not paying out hard-earned cash. We all know that the houses in the neighborhood are not comparable in size, but it is important to use comparables from within a neighborhood to project the true value of the location; right? Well, if we use comps from the neighborhood our comps will require size adjustments amounting to 100% or more. Do you think buyers make decisions using such judgment? Not hardly.

Fannie Mae knows this, too. In the above example if the square foot adjustments were to be extended without regard to any distortion created by adjustment size our subject would be worth about $270,000. Why is this a problem? Because people with $270,000 to spend on a home have options, and one of them is to go buy a home in a subdivision of homes selling at or near $270,000. Issues of social class, the type cars parked in the driveways, etc., creep into the picture and people with $270,000 to spend do not want to live in a neighborhood of $125,000 homes. Therefore, our big 3,000 square foot subject property is not worth $90.00 per square but something less, a lot less.

Perhaps the plot is beginning to thicken at this point, thus the need for gross adjustments within the appraisal in excess of 25%. For those thinking that there is something wrong with the appraisal and that it must be fixed to reflect gross adjustments below 25%, as appraisers we are very sorry. An all-expense-paid vacation to the poky for five years is not the type vacations we appraisers like to take, so the large gross adjustments stand.

If there is one area of major misunderstanding among the less experienced loan officers, it has to be that some properties simply do not lend themselves to conventional financing. That does not mean that they cannot be financed; it just means that they don’t qualify for conventional Fannie Mae financing. They can, and most often will, qualify for the broad array of nonconforming loans on the market. These are the loans that lenders many times keep in their own portfolio, meaning that they usually do not qualify for packaging and reselling in most financial markets.

And yes, in the case described above there is a problem with the property. There would be a problem with the appraisal if the adjustments were below, not above, 25%.

Charlie W. Elliott, Jr., MAI, SRA, is President of ELLIOTT® & Company Appraisers, a national real estate appraisal company. He can be reached at (800) 854-5889 or at charlie@elliottco.com or through the company’s Web site at www.appraisalsanywhere.com.