Dan's Papers -November 6, 2009

The slide of the real estate industry on the East End is beginning to show signs of traction. Buyers are looking for values and sellers are attempting to market their homes and properties to maximize the price they can command. This sounds great, but a routine aspect has leant a new dynamic to this process: the bank appraisal. At this time in our economic history, many legitimate buyers and sellers are being penalized by lax practices of the past that may have caused property appraisals to be inordinately high. Too many plum-home equity loans or mortgages that were in excess of 100% of the true value of the home have defaulted. There's hardly anyone anywhere who wouldn't admit this was happening during the real estate bubble. Perhaps the correction of these past abuses is becoming an abuse in itself. Now banks are appraising properties in double digit percentages below selling prices to cover banks or other lenders in case real estate prices experience another dip.

What this is doing is throwing a monkey wrench right in the middle of the beginning stages of recovery. One local banking official stated off the record, "It may seem wrong but look at the money banks lost, and look at the number of people at banks who lost their jobs trusting real estate agents' and mortgage brokers' appraisers." What she intimated is that there is a new standard of not only putting current market value (meaning the selling price) into the appraisal, but also of recent market trends-meaning the falling values over the last two years. Until a reliable, credible trend is documented to survive a banker's scrutiny, this high-ranking official said, "Don't expect this practice to change-the new system of accountability has consequences."

When speaking to Bridgehampton National Bank CEO Kevin O'Connor last spring, he explained BNB's success and profitability were caused by many factors but noted that "due process" on all loans was never lax at his bank. "We never changed our sound business model," he said then. So now it seems only logical that all banks are going back to basics, and at the moment, maybe factoring recent downward trends in value too much.

This isn't supporting a recovery of the real estate industry on the East End. In fact, it creates tension between buyers, sellers and real estate agents when the bank tells everyone they will appraise a home selling at $825,000 at only $650,000. "They're trying to be conservative," said Mike Davis, an associate professor of real estate at the W.P. Carey School of Business at Arizona State University. "They're not willing to call the shot on the market turning around."

Then there's the fact that appraising isn't an absolute science. "It can be a relatively haphazard process," said Sam Chandan, president of Real Estate Econometrics and adjunct professor at the Wharton School of the University of Pennsylvania. "It's not like stock markets, where there are pieces of Microsoft being traded at every moment." But if someone is willing to pay a price, is that not the value of the home? Maybe. It's been reported that real estate agents and appraisers are now blaming new rules, collectively called the Home Valuation Code of Conduct, that went into effect May 1. These rules apply specifically to mortgages sold to Fannie Mae and Freddie Mac, and were a result of an investigation by New York Attorney General Andrew Cuomo. Another complaint is that banks are using new appraisers that aren't truly up-to-date on the markets they're appraising. Some believe banks have chosen appraisers from lower-income areas to appraise homes in higher-priced residential areas in order to keep appraisals from being overpriced. This is disturbing to many agents, buyers and sellers, who now feel that government oversight must be introduced so that the buyer, seller and even the real estate agent are protected from under-appraising. As one seller said, "I, too, should have some protection on my asset. If a buyer wants to pay me $825,000 for my home, why should a bank appraiser be able to come in and say my home is only worth $700,000? That is an injurious action."

Appraisals were once tools to find the true values of homes, not mechanisms to protect banks from worst-case scenarios. Due diligence shouldn't mean compensating for past mistakes by establishing incompetent practices. The good news is that the problem is being exposed, which may cause some banks to consider how this practice is preventing the real estate market from getting stronger, thus reducing their financial risk on existing home mortgage loans.