It's been little over a month since the switch was flipped on the Home Valuation Code of Conduct (HVCC), and many builders are still unsure as to what the new rules mean for their business. However, many believe any regulatory change spells disruption.
The new code, a pet project of former HUD secretary Andrew Cuomo, was an attempt to secure the independence of real estate appraisers, who, say the code's supporters, have been under continual pressure from lenders, mortgage brokers, real estate agents, and even home builders to inflate values. Under the new code, lenders have set up firewalls between their loan departments and their either internal or third-party appraisal services if they wanted be able to sell the loans on the secondary market to either Fannie Mae or Freddie Mac.
According to a May survey of home builder executives by John Burns Real Estate Consulting, more than half (53%) of the 219 respondents indicated that they felt that the tighter standards would have a negative effect on their selling process. Three percent said the new rules would positively influence their business while 19% believed the change would have no effect. One out of four respondents admitted that s/he knew little about the code change and its implications.
The pain points for builders when it comes to appraisal issues mostly fall into three categories that add up to one outcome: further price erosion.
First, builders have complained that under the new rules, lenders are selecting appraisers from a generic pool, which is resulting in what they feel are inaccurate valuations. Prior to the code's implementation, many lenders had appraisers assigned to specific projects and submarkets. Now, builders have argued, appraisers are being assigned work on a random basis, so fewer of them come equipped with specific knowledge of the submarket or project, which in turn, is affecting appraisal values.
Tim Kane, president of California-based MBK Homes, said in his market appraisals have been coming in between 10% and 15% less than what buyers are willing to pay. "They just keep marking things down because they are afraid. That's what's happening," he said.
The second issue, for builders, is that appraisers have begun factoring foreclosures and short-sales into their comparative analyses. Many builders felt that was unfair because by mixing distress properties with true market rate properties, values would be driven down more than they already have been.
The third concern related to appraisers' obligation to indicate whether they believe the properties being assessed are in declining markets or not. Builders questioned not only whether giving a forward-looking snapshot of the markets was reasonable but also were curious to know to what extent labeling a market as in decline could negatively affect the loan's funding.
"They don't want to look bad to banks, where they put a value on a home and it goes into foreclosure in the next year," said John Young, a founding partner of Young Homes in California and CFO and secretary of the California Building Industry Association. "I think that's a little too much."
Bill Gerber, director of government and external relations for the Appraisal Institute, said that many of these concerns related to processes that were in place before the new code went into effect May 1; they are surfacing now because of the state of the market. For example, he noted that the declining market box had been part of the appraisal paperwork well before the code change and that Fannie and Freddie had issued statements that they would continue to lend on loans in declining markets, although they could reduce maximum loan-to-value calculations in conjunction with the risk in those markets.
Gerber also acknowledged that lenders likely were drawing from appraiser pools now more than ever because of the need to maintain clear distinction between loan officers and appraisers and that there are no hard-and-fast rules governing how to evaluate REOs as comps.
Takeaways from a recent conference call hosted by Josh Levin, an analyst with Citi Investment Research and Analysis, suggested that the issue over the code appeared overblown. "PCV Murcor [a national appraisal firm] argued that the HVCC was basically a non-issue and would not depress home prices," Levin wrote in a follow-up research note.
However, Gerber pointed out that the new code did have some other implications for home builders businesses. He said the new code acted as a "mortgage broker prohibition" of sorts because it effectively eliminated the role of a mortgage broker in the appraisal process. Before the new code, brokers accounted for 60% of the appraisal market; they now make up no more than 10% or 20% at most, he said.
Moreover, the change in rules was creating what Gerber called "a race to the bottom in terms of fees." Third-party appraisal management companies have been dropping their prices on jobs in an attempt to gain volume; in fact, Gerber said many of the bids were coming in at 50% of what would be considered market rate fees. The result? More underqualified and out-of-town appraisers getting appraisal jobs, something Gerber said could be what builders are seeing.
"We are in support of the code in spirit," Gerber said, "But we have to question whether appraisal quality is part of the consideration."
The proliferation of these low-quality appraisals could have increasingly serious consequences for home builders. For every appraisal appeal, appraisal review, or request for second appraisal, a closing is delayed as many as three to five days, according to Gerber. Moreover, a low-ball appraisal or a restricted cap on LTV means someone--either the builder or the home buyer--has to ante up more cash at the closing table.