Most real estate appraisals are produced using the same set of manual steps that have been used for decades, following regulations and standards that are as ambiguous as they are antiquated. Modern data science practices should—and easily can—be applied to modernize this process and vastly improve the accuracy, consistency and trustworthiness of appraisal results.

Current State

As an unintended consequence of appraisal process “reforms” in the aftermath of the the 2008 US financial crisis, residential appraisals can seem like a random dice roll, with the results being driven by the opinion (a defined term in the USPAP appraisial standards) of individual appraisers.

The impact of this is multi-faceted:

1. Appraised values of the same property can vary dramatically from one appraiser to another.
2. Lenders are expected to “trust” the numbers, which are literally (per USPAP appraisal standards) appraiser opinon.
3. When a borrower or seller attempts to invoke the appraisal “Reconsideration of Value (ROV)” process in response to a bad appraisal result, appraisers can ignore the request—or worse, retaliate by making the appraisal even less accurate.

These are not unfounded assertions. They are direct observations from personal experience—and a widely recognized reality that builders, real estate sellers, buyers, brokers, mortgage brokers, borrowers, lenders—and appraisers—struggle with every day.

Despite the fuzzy standards and historical baggage, there are many truly professional and dedicated appraisers in the US and Canada who deliver trustworthy, repeatable and accurate results using state-of-the-art practices.

That they are so exceptional is an existential problem for the appraisal profession. Let’s fix that.

How We Got Here

The 2008 US financial crisis was triggered by an avalanche of home mortgage loans made to borrowers who didn’t qualify for their mortgage. Andrew Cuomo (at that time New York’s attorney general) became famous by asserting that widespread appraisal fraud was a key driver, but subsequent investigations were inconclusive. What is clear is that the “bigger fool” market dynamics created the US real estate bubble. In the years leading up to that bubble bursting, home values increased dramatically, and Wall Street firms made enormous profits packaging up home mortgages into mortgage-backed securities (MBS), with the price of each MBS based on the underlying appraised value of the properties and the buyer qualifications asserted during the loan underwriting process. (Fraudulent applicant data and bad underwriting were conclusively found to be a root cause of the crisis.)

During a housing market bubble, as long as the home can be sold later at a higher price to a “bigger fool,” everyone makes money.

Appraisers during that era had trusted relationships with lenders, mortgage brokers and real estate firms. This makes sense; trusted relationships are a core part of the overall financial system. However, during the investigations responding to the Cuomo action a majority of appraisers reported feeling pressure—increasingly during the run-up to the crisis—to “hit the number.” Some feared that if they didn’t produce an appraisal that matched the desired value, they wouldn’t get subsequent appraisal orders. This dynamic sets the stage for a conflict of interest, and some appraisers who experienced this pressure felt like they had little practical choice other than to produce appraisals with numbers to support the amounts demanded.

Appraisers weren’t alone in dealing with such conflicts. The credit rating agencies (Moody’s, Standard & Poor’s, and Fitch) were pressured into assigning “AAA” ratings to the Mortgage Backed Securities (MBS) that Wall Street firms were pitching to hapless investors. Many of the loans in those MBS packages were made by unscrupulous loan brokers to people who couldn’t afford the payments. If the credit rating agencies didn’t “find a way” to deliver those ratings on those packages of questionable (“subprime”) loans, they got no more business.

Reform Attempts

Congress and financial regulators formed commissions and working groups to identify the root cause(s) of the financial crisis, and they pontificated, huffed and puffed with great fanfare for years. Essentially nothing happened to the Wall Street firms who were the worst actors by creating and selling garbage MBS bonds.

The credit rating agencies were sued by investors, and Congress passed some laws intended to reduce the dominance of the Moody’s/S&P/Fitch oligopoly, but those firms remain the dominant credit ratings agencies.

Appraisal Reform: Be Careful What You Wish For

One can argue that legislation and regulator action following the 2008 financial meltdown failed to create substantive changes—except when it comes to appraisals. Largely in response to the Cuomo action (which specifically focused on Washignton Mutual and an appraisal software vendor) the GSEs revised the Home Valuation Code of Conduct that became effective in 2009 and later incorporated into the 2010 Dodd-Frank legislation intended to prevent another financial crisis.

The essence of those changes severed the strategic relationships between residential appraisers and parties ordering the appraisals. This means that:

• Appraisers can have no relationship with the lender, loan broker or real estate firm ordering the appraisal.
• The appraiser to fulfill an appraisal order must be selected by a third party who is completely independent of the lender, loan broker or real estate firm ordering the appraisal.

There are other details, but these two provisions have resulted in the elimination of lenders, loan brokers or real estate firms being able to discuss the appraisal order or scope with the appraiser. This adds a level of indirection between appraisers and their clients. This does help eliminate the chance (and appearance) of conflicts of interest, but it has also created unwelcome transaction friction—particulary with the emphasis on appraisal management companies (AMCs) as the “impartial” appraiser assignment conduit—and it can drive appraiser behavior changes that distort appraisal numbers in ways that are unhealthy for the real estate market.

Unintended Consequences

Many unintended consequences seem obvious in hindsight, but they are wickedly difficult to anticipate (and prevent). An especially pervasive consequence is two edges of the same sword: Motivation.

Under the old system, appraisers were motivated to efficiently deliver appraisals that were considered credible while also meeting the desired appraised value when they could. It’s the “considered credible” piece that required not just motivation, but also deep expertise and dedication to nurturing strategic relationships. Because appraisers were dedicated to a small set of lenders, brokers and real estate agents in local markets, building this deep expertise was a natural outcome of the pre-reform system.

Under the new system, what had been a limited experiment with AMCs became an ill-conceived strategy, with the consequence that appraisers are forced to play “post office” by interpreting what the AMC believes is the appraisal order scope instead of directly hearing it from the appraisal buyer. The best appraisers figure out a way to make this work; lesser appraisers won’t (or cannot) overcome that friction, so they default to delivering appraisals that meet the minimal requirements to prevent their license being revoked.

When appraisers have to spend their time fighting against indirection and appraisal order ambiguity instead of focusing on improving their local-market expertise, should we be surprised that appraisal outcomes can be so haphazard?

Reforming the Reforms

It would be great to wave a magic wand to make appraisals, appraisers and their regulators perfect, but the reality is that the size and political inertia of US housing market and (any) regulatory process are not compatible with quick fixes. Abrupt change, in fact, is dangerous in a chunk of the economy as large as housing.

This does not, however, make this situation hopeless. Improving the appraisal process is like improving any process, in that we can try seemingly small ideas, observe the results, refine as necessary, then iterate on this process to validate changes on a small scale before applying them more broadly.

The Appraisal Science Mission

Iterate with all stakeholders of residential real estate appraisals to:

• Modernize the appraisal process*
• Improve appraisal accuracy, predictability and repeatability so that all stakeholders have a higher level of confidence and trust in the results.
• Gather data which objectively measure the efficacy of improvements to inform the appraisal community, standards bodies and regulators.

Each iteration will respond to “Show me!” with objective data.

Join Our Community

No one person or small team could possibly define solutions alone that work best for such a large and vital part of the US economy. We welcome input of all stakeholders (especially appraisers and lenders) in our Discord community. (Discord is like Slack or Teams, but cool.)

*I tagged along with my appraiser dad decades ago, and I recently had two appraisals done on our current property. I saw the tape measure replaced with laser measurement devices, and the appraisal report looks fancier, but the basic process is almost identical. Given the ocean of data available now in real time, coupled with software tools to instantly analyze that data, this is a big problem. Comps, for example, should be selected based on deterministic data, not the whims of the appraiser.