Picture this: For the first time in months a small builder sells a new home. The sales price cuts the builder’s profit to the bone, but it’s a reasonable price given today’s housing market. The buyers are well qualified, and everything is going along smoothly until the appraisal comes in at tens of thousands of dollars less than the sales price. Why? The local market has been hit hard by the recession and the comparables include foreclosures and other distressed sales.
Now the builder faces a wrenching dilemma. Does he cut the home’s price to be consistent with the appraisal value and take a loss, or does he cancel the sale even though it could take a long time to find another buyer and the next appraisal could come in equally low?
Scenarios like this are playing out daily in markets across the country as the use of foreclosed and distressed sales as comparables for appraisals on single-family homes needlessly drives down home values, slows new-home sales, and puts a drag on the housing recovery.
Equally important, using foreclosed and distressed properties as comparables is affecting the availability of AD&C credit. Falling appraised values for land and subdivisions under development have led some financial institutions to stop lending to developers/builders, to demand additional equity, and even to call performing loans.
This is a complex situation with many interconnected parts. In the wake of criticism that lax appraisal standards contributed to the economic and housing crisis, appraisal standards and procedures were tightened earlier this year. But now the pendulum has swung too far, and reports of homes failing to appraise at the sales price, or even construction cost, have become more prevalent.
There’s no question that the conditions in today’s housing market are unprecedented. The practices that may have been effective in the past are no longer responsive to the realities of today’s housing market.
For example, appraisers generally are only required to inspect the exterior of a property that is being used as a comparable. But, too often, properties that have been subject to foreclosure or distress sales have issues related to deferred maintenance or internal damage that an external inspection cannot detect.
The NAHB believes that it’s time for appraisers to have regulatory guidelines that acknowledge such realities. In neighborhoods where the comps include a large number of short sales or foreclosures, appraisers should have the option of expanding the geographic area or extending the time frame for eligible sales to get a more representative picture of the value of homes sold in the area.
The NAHB has been working on this issue for some time, and we have reached out to the Appraisal Institute, which held an informational session at the fall board of directors meeting last year to help builders better understand the appraisal process. We continue to work with the Institute and other housing industry groups to address this important issue. We have also made our position clear to the regulators who set the standards for home sales.
What the market needs most is clear, concise regulatory guidance from Fannie and Freddie and the housing and financial regulators that will allow appraisers to develop realistic valuations based on sales that are truly comparable.
The bottom line is that you just cannot compare a well-constructed new home with a foreclosed home that has been vacant for months. They simply are not “comparable,” and the standards need to be adjusted to reflect that reality.