As if getting houses sold wasn't a big enough challenge, builders in what were some of the fastest appreciating markets in the country are beginning to experience more challenges–falling appraisal values and greater loan scrutiny right before closings.
Appraisals are coming in lower than sales prices because appraisers say prices have slid since the original contract was signed. In addition, some builders report lenders are scrutinizing sale prices more closely, asking for updates within a couple of days of closing, even asking builders to supply copies of HUD-1 closing statements for other, more recently sold homes in the neighborhood. They're looking for builder incentives listed on the form that effectively lower the actual sales price of the house from the on-paper sales price.
Such are the signs of a devaluating market. During the boom years, the chances of an appraisal coming in low were remote. Even if they were slightly low, lenders worried little because the market was climbing so fast that the difference could be wiped out in few months. Appraisals became almost cursory. A computer records search for comparative prices and a drive-by to make sure there was a house on the lot often sufficed.
Not anymore in markets like Phoenix, says Ann Susko, of Valley Wide Appraisal Services. "One of the biggest problems that [local appraisers] are coming up with is [for a house] that was contracted for at the end of 2005. Now when they go to do a final inspection and a re-inspection of value, it's like, 'Uh oh.' Depending on the area, the market has decreased, sometimes 30 percent."
Even in markets where values haven't fallen through the floor, lenders are starting to pay attention to appraisals again, says Keith Gumbinger, vice president of HSH Associates, a mortgage-tracking and financial publisher in Butler, N.J. "Lenders are very concerned right now, not that prices have fallen, but that they might fall tomorrow," he says. "I am not surprised lenders are taking extra steps [to discern value]. Market conditions are really shifting under a lot of feet right now."
Triggering some of those worries are some early numbers that show more borrowers are not even making the first payments on home loans, says Gumbinger. Those early indications of default make the entities that buy the mortgages from the original lenders go back to the loan originators and say, "Cover me for a piece of that" loss, says Gumbinger. If loans were written with "recourse," loan purchasers have a right to make those kinds of demands. "I bet right now more loans are being written with recourse," he says.
In addition, buyers of mortgages are beginning to take a closer look at the loans in their portfolios to determine if they have, with the housing slowdown, become uncertain investments. The recent years of easy-credit loan products allowed borrowers to buy homes with little, if any, equity, and sometimes cursory appraisals for value may have left them holding loans that are suddenly riskier investments in a slowing market.
The worst case scenario: A buyer who now owes more than the house is worth because it was purchased at an inflated value, perhaps by 20 percent, using a loan that allowed a low down payment or no down payment and was financed at an artificially low interest rate or even no interest rate.
Just how many of those homeowners are out in the market now is a matter of speculation. But Rachel Dollar, a California-based attorney and certified mortgage banker who handles fraud recovery litigation for lenders and secondary market investors, worries the fallout could be huge if those homeowners walk from their homes. Foreclosure rates will climb, resulting in more homes on the market and lower sale prices.
"I expect that there are some significant losses to be had out there," Dollar says.
Blocked on the Ballot
Voters prevent developers from gaining an easy path to prime property.
Developers gained little ground with voters in the last election season. Voters in 10 states told their elected officials in no uncertain terms that they were against state and local governments seizing private property for economic redevelopment purposes.
The ballot initiatives stemmed from a 2005 Supreme Court decision that validated such eminent domain claims, giving governments extensive leeway to seize private property and turn it over to developers for new uses. Local governments can condemn nonblighted residential or commercial areas and sell them for new private redevelopment. The seizure of property often benefits the public in the form of additional tax revenues for the local governments, but private developers also pocket the development profits.
"It was a bad day for developers," says John Echeverria, executive director of the Georgetown Environmental Law and Policy Institute in Washington, D.C., of voter sentiment. David Goldberg, a spokesperson for Smart Growth America, agrees, noting that voters made it clear they felt "that developers have too much sway over local government."
The issue is far from settled. With state legislatures all over the country debating eminent domain, future ballot initiatives and legislation that could make it harder to condemn land and make it available for new development are a strong possibility.
Mick Pattinson, president of Barratt American, a private California builder that closed about 500 homes last year, says that local governments can, in some cases, abuse their power to take away private property for development. But much of the renaissance of downtowns across the country, and in California in particular, has occurred because local governments seized infill and encouraged urban development.
"I believe that people are entitled to their property, and there should be a minimum of government interference, but we all understand that in many cities across the country there is a need for renewal," Pattinson adds.
This fall, 12 states had measures on their ballots to limit government's power to force the sale of private property for economic development. Voters in 10 of the 12 states succeeded in putting the slap down on eminent domain. Here's the roundup of where these measures passed and failed.
- Arizona passed by 65 percent
- Florida passed by 69 percent
- Georgia passed by 82 percent
- Louisiana passed by 55 percent
- Michigan passed by 84 percent
- Nevada passed by 63 percent
- New Hampshire passed by 86 percent
- North Dakota passed by 68 percent
- Oregon passed by 67 percent
- South Carolina passed by 84 percent
- California failed by 48 percent
- Idaho failed by 26 percent
Learn more about markets featured in this article: Dallas, TX.