New York Appraisals Get Shortchanged

By VIVIAN S. TOY

Published: September 25, 2009

IMAGINE the agony of a buyer when the bank’s appraiser rules that the apartment the buyer has agreed to pay $750,000 for is worth only $650,000.

What then?

The buyer has three options: move on, because the low appraisal means the mortgage the bank will give is too small to buy the apartment; scramble to come up with a larger down payment to make up for the smaller loan; or use the appraisal to try to renegotiate the price.

Real estate agents, mortgage brokers and appraisers all say that the low-ball appraisal has become increasingly common in today’s unsettled market. The problem is even more pronounced when homeowners are hoping to refinance a mortgage or get a home equity loan, because there is no current agreed-upon sale price as a benchmark, they say.

Low appraisals may reflect reality, since prices in New York City have dropped by as much as 30 percent in the last year. But agents, mortgage brokers and even some appraisers say they suspect that some appraisals are mistakenly low. They cite several reasons:

First, with sales volume having dropped by nearly 50 percent at the beginning of the year and only recently having reached more normal levels, appraisers are often hard pressed to find the comparable sales that allow them to come up with accurate appraisals.

“In a market where you have very little data points, you could have a totally unique property where there just aren’t a lot of comparables,” said Jonathan J. Miller, the president of the Manhattan appraisal firm Miller Samuel.

Second, at a time when local expertise is crucial, recent changes in national lending practices have resulted in the assignment of many appraisers who are not familiar with local markets, brokers and appraisers say. Some real estate agents say that in recent months they have fielded requests regarding Manhattan listings from appraisers from New Jersey, Suffolk County and the Hudson Valley.

Michael Vargas, a principal at Vanderbilt Appraisal in Manhattan, said that because of a major change in the appraisal process that took effect on May 1, appraisal assignments are often shifted “to appraisers who charge the least amount.” But, Mr. Vargas said, “very often those individuals are not the most experienced in your market.”

The policy change, known as the Home Valuation Code of Conduct, essentially prohibits real estate agents and mortgage brokers from ordering appraisals, and gives total control to banks and lenders. The change was intended to eliminate conflicts of interest and to prevent brokers from pressuring appraisers to come back with a specific dollar figure that might just happen to be the purchase price.

But most banks are using appraisal management companies, which are national businesses that act as middlemen and typically assign appraisals to appraisers who offer lower fees.

Mr. Miller and Mr. Vargas say that in New York, that means appraisals that usually cost $350 to $450 are often now being done for half those amounts.

The potential pitfalls are not exclusive to New York. “The least qualified and least experienced people are doing appraisals across the country,” said Jim Amorin, the president of the Appraisal Institute, a national trade group that represents 26,000 appraisers. He estimated that appraisal management companies now handle about 90 percent of the appraisal market, up from about 30 percent before May 1.

Mr. Amorin said he had heard of appraisers in California who travel 150 to 200 miles to do an appraisal.

“It’s hard to believe that they could still be in their geographically competent area,” he said. “And in Manhattan it would be even harder if you have someone coming in from the suburbs, since things can be vastly different from one side of the street to another.”

Subtleties like the inherently higher value of a second full bathroom in a two-bedroom than in a one-bedroom, or the difference between addresses on Lexington Avenue and First Avenue, can be lost on someone who doesn’t know Manhattan.

And without a stockpile of comparable sales for reference, Mr. Miller said, “you have to really know the local market, so you can go beyond the raw sales data and use all the subjective factors you can to really tell the story about a property.”

Of course, an appraiser with a 203 or 516 area code doesn’t necessarily lack expertise in Manhattan or Brooklyn. On the other hand, an unfamiliar prefix can signal unfamiliarity with this neck of the woods.

Dean Feldman, an executive vice president at Halstead Property, said that he recently met with an out-of-town appraiser for a two-bedroom apartment that had been combined from a studio and a one-bedroom.

“This person did not understand what a combined apartment was, and he kept asking me if there were two deeds for it,” Mr. Feldman said. “I had to explain that this was a co-op and it was a legal combination. It turned out fine, but I basically had to teach him.”

When the real estate market was rising, appraisals often came in higher than sales prices, as appraisers struggled to keep up with ever escalating prices. In the current down market, brokers say appraisers are now erring in the other direction — giving lower values since they know banks are reluctant to make loans.

Appraisals are one part science and, especially in a down market, many more parts art. An appraiser can use a tape measure or sonar device to calculate square footage, but how much a recent kitchen renovation is worth and what dollar figure to attach to a park view or a doorman is strictly subjective.

Appraisers readily acknowledge that two appraisers reviewing the same apartment will inevitably come up with two different values, but they add that experts in the same market are not likely to be more than 1 to 2 percent apart.

Since most banks do not send an appraisal to potential borrowers until just before or even after a scheduled closing, a buyer does not have time to challenge an appraisal that he or she believes to be too low.

“If an appraiser missed a bedroom or outdoor space, we used to be able to show them documentation was incorrect,” said Ellen Bitton, the president of Park Avenue Mortgage Group. “But now there’s no way to challenge a faulty appraisal.”

And in the current climate, banks are even less open to reconsidering decisions because most have already increased their scrutiny of loan applications and do not want any appearance of impropriety.

“The only thing you can do is prepare at the outset,” Mr. Vargas said. “Find out who is doing the appraisal and how experienced they are in the market and voice your concerns with the loan officer and if necessary, you can decline to make the appointment.”

You can ask the bank to send a different appraiser, but the bank does not have to comply, which means you risk losing the mortgage.

In most proposed sales, appraisers call real estate agents for an appointment to view the property. For a refinancing, they call the homeowners directly. Mr. Miller advised that appraisers always be met directly by the agent or homeowner.

“Humanize it and provide relevant data to the appraiser,” he said. “Let them know that the apartment across the street just sold for less than this one, but you know it was a fixer-upper.”

Charles Homet, a senior vice president at Halstead, said that “appraisals are kind of cloaked in mystery” and that most appraisers tend to be tight-lipped.

“It’s like a restaurant inspector,” Mr. Homet said. “They need to appear to be above influence. But I always make sure I have relevant comps in hand and I’m prepared to discuss as much as the appraiser is willing to listen why I think the price is supported.”

He said that in addition to recent sales in the same or nearby buildings, he also provides prices of apartments that have just gone into contract that may not yet have been put into the public record.

Mr. Feldman of Halstead said that since the market tends to “like” some buildings better than others, he makes that clear if he’s dealing with an appraiser unfamiliar with a neighborhood or a specific building. “I can point out that it’s closer to the park or to Citarella than the nearest comp, or maybe I know that a more expensive apartment a few floors higher has a much better view because it clears the town houses across the street,” he said. “I try to share as much information as I can, so they’re armed with the proper tools to make a decision.”

Melissa Cohn, the president of Manhattan Mortgage, says the new appraisal world means that to best serve clients, real estate and mortgage brokers should fully vet potential borrowers, to make sure they qualify before they even submit a loan application.

Ms. Cohn noted that because of low appraisals, new developments in particular have been susceptible to failed deals. Buyers who signed contracts a year or two year ago are likely to receive appraisals significantly lower than the prices they agreed to pay.

One of Ms. Cohn’s clients had signed a contract in 2007 for a $3.5 million condo. But as the closing date approached recently, the client’s bank denied the mortgage because the appraisal came in at $3.1 million. The client started the process all over with a second bank, and that bank’s appraiser found comparables among buyers who had closed at their original purchase prices; he came up with a $3.5 million appraisal.

“So the second appraiser’s opinion was the value was there, because people were paying those prices,” Ms. Cohn said. However, she added, purchase prices in new developments are not always actual prices, since many developers are agreeing to pay closing costs or offering other financial concessions. “It just shows you how nebulous the actual value can be,” she said.

Home Buyers Get a Reprieve

The Federal Reserve, in a move aimed at keeping interest rates low for home buyers through early next year, decided to extend and gradually phase out its purchase of mortgage-backed securities.

The Fed's action signals its belief that the economy, while in recovery, remains fragile and that housing, which has seen some improvement in recent months, has only started to pull out of its slump.

"We definitely need help from the government," says Lee Barrett, president of Century 21 Barrett, a real-estate brokerage firm in Las Vegas. "I don't think the market can make it on its own." He also hopes Congress will extend tax credits for home buyers due to expire at the end of November.

The central bank left its interest-rate target unchanged at zero to 0.25% and maintained its expectation that the federal-funds rate, or the rate banks charge each other for overnight loans, would remain low "for an extended period."

"Economic activity has picked up following its severe downturn," the Federal Open Market Committee said Wednesday in a statement after a two-day meeting. Though conditions in financial markets and the housing sector have improved, household spending "remains constrained by ongoing job losses, sluggish income growth, lower housing wealth and tight credit," the Fed said.

Treasury bonds and mortgage-backed securities rose in price Wednesday, sending yields lower. Stocks slumped. Although the Dow Jones Industrial Average briefly moved above the 9900 level following the Fed's afternoon statement, making some investors think about a possible return to 10000, it sagged late in the day and finished down 81.32 points, or 0.83%, at 9748.55. It was the biggest one-day point and percentage decline since Sept. 1.

Mainly because of heavy government intervention in the mortgage market, interest rates remain near their lowest levels in decades. Rates on 30-year fixed-rate conforming mortgages currently average 5.24%, down from a recent peak of 5.81% in June but up from the year's low of 4.84% in late April, according to HSH Associates, in Pompton Plains, N.J.

Sales have increased in California, Florida and some other areas from the very depressed levels of a year ago, largely driven by investors and first-time home buyers chasing bargains on foreclosed properties. But the market remains weak amid worries that new waves of foreclosures will add to supply as banks sort through mountains of paperwork from distressed borrowers seeking easier loan terms. Not all of those borrowers can be saved.

That leaves an unknown number of foreclosed homes -- estimated by some analysts to total several million -- to likely hit the market over the next few years. The risk that those foreclosures will depress prices further may keep some potential buyers on the sidelines. "Nobody seems to know how big that overhang is," says Tom Lawler, a housing economist in Leesburg, Va.

Data on existing-home sales for August will be reported Thursday, and Mr. Lawler is bucking the consensus in predicting a decline. He notes tax credits induced many people to buy homes earlier this year, and sales may fall in the near term now that most of those tax-related purchases have been completed.

In one sign that the housing market hasn't fully recovered, luxury-home builder Toll Brothers Inc. this week announced a nationwide sale on new homes. The specials being offered by Toll include lower prices on options, including custom tile and appliances, and mortgages with initial rates as low as 2.875%.

With so many empty houses sitting on the market, some builders say they still have no way to make a profit with new construction. "Why build new when people can go out and buy for less than it cost?" says Mark Connal, vice president of realty at Michael Crews Development, a developer and builder in Escondido, Calif.

An early end to the Fed's purchase program "could potentially have reduced the demand for housing by 10% to 20% and that could have slowed the recovery," says Glenn Boyd, head of U.S. asset-backed securities research for Barclays Capital. "This is certainly a positive and adds to our confidence in the ultimate recovery for home prices."

The Fed is about two-thirds of the way through its mortgage-purchase program, which was launched late last year to support mortgage lending, housing activity and broader credit markets. The central bank's decision to complete the full $1.25 trillion in purchases of mortgage-backed securities -- rather than "up to" that amount, as it said in August -- ended speculation that it might stop short, as a handful of policymakers have suggested. The Fed still plans to buy up to $200 billion in debt issued by Fannie Mae and Freddie Mac.

Mortgage rates were expected to rise throughout the fall and winter as the Fed wound down its program to buy the mortgage-related securities. Even if they inch up, now they're less likely to increase as sharply, given the Fed's longer time horizon that stretches to March.

"The Fed wanted to exit with as little disruption as possible to the market," says Peter Hooper, chief economist at Deutsche Bank Securities. "Doubling the length of time you're going to make the purchases allows for a pretty smooth transition."

Is it Over

Nearly one year after the collapse of Lehman Brothers sent shock waves across the globe, the world is a different place.

The investment bank's messy death intensified the deepest recession since the Great Depression. It helped open the way to a bigger role for government in managing the economy. It cast doubts in the public's mind about the wisdom of relying on markets to correct themselves.

But to a surprising degree, there are some big things that Lehman's demise hasn't changed.

On the regulatory front, Democrats' efforts to rework the rules for finance have bogged down amid infighting between federal regulators, fury among bankers and opposition from many lawmakers who believe that further expanding the government's reach will only create new problems. The all-consuming debate over health care has damped enthusiasm for tackling such complex legislation.

Meanwhile, major U.S. banks have regained their footing, and some of their swagger. Profits are off their lows. Large compensation packages are back. And so is risky business.

Companies are selling exotic financial products similar to those that felled markets and the world economy last fall. And banks' appetite for risk has grown: The nation's top five banks collectively stood to lose more than $1 billion on an average day in the second quarter of 2009 should their trading bets go sour, a record level.

Now, the federal government is locked in a kind of regulatory limbo. U.S. officials say they are committed to preventing history from repeating and have pleaded for fresh powers to do so. But today, they have few new options -- excepting another bailout -- should financial markets seize up again or a large institution totter.

"There's no fundamental change in the way the banks are run or regulated," said Peter J. Solomon, a former Lehman vice chairman who runs an eponymous investment bank in New York. "There's just fewer of them."

Washington officials say they are encouraged that financial markets and the economy appear to be healing after the turmoil. But they also say they feel an urgent need to establish new rules.

"We are under no illusion that things left to their own devices will evolve back to a healthy normal," said White House National Economic Council Director Lawrence Summers in an interview. "The concern...is that a resumption of confidence, which is a good thing, not become a return to hubris, which would be a very bad thing."

Wall Street's rebound presents a mixed bag for consumers. These banks' clients are demonstrating a renewed appetite for risk, a sign that confidence is returning to markets. But credit remains scarce for all but the healthiest borrowers and lenders are imposing new fees and higher interest rates on credit cards and other products. Corporations, too, are likely to have trouble getting credit if they can't access the capital markets or have less-than-pristine debt ratings.

Big Changes

The financial world has been on a wild ride since Sept. 14, 2008, the Sunday that Lehman toppled toward bankruptcy.

The Dow Jones Industrial Average dropped from 11,422 on Sept. 12 to 6,547 on March 9. More than 100 banks have failed. The federal government has pumped more than $200 billion in taxpayer money into banks, and the government temporarily deemed the country's 19 largest as too big to fail in a disorderly fashion.

Some of Wall Street's most notorious practices are unlikely to reappear. Banks say they've permanently abandoned housing risky assets in off-balance-sheet vehicles. Top banks have also stockpiled capital to raise their reserves to the highest levels in recent memory, providing a bigger cushion against market downturns.

Last December, at a black-tie gala in New York's Plaza Hotel, Bank of America Corp. CEO Kenneth Lewis told a crowd of bankers to expect a humbler industry to emerge from the wreckage. "We play a supporting role in the economy, not a leading role. Financial services are a means, not an end," Mr. Lewis said. "There should be some humility in that." The audience applauded.

But the mood has shifted as the Dow strengthened this year. Some of the government's rescue programs are coming to an end, and big banks are paying back funds they borrowed under the Troubled Asset Relief Program, releasing them from Washington's control.

The top five Wall Street firms -- Bank of America, Citigroup Inc., Goldman Sachs Group Inc., J.P. Morgan Chase & Co. and Morgan Stanley -- made $23.3 billion in profits in the first six months of 2009. That compared with a $6.7 billion loss a year earlier at those banks and the companies they acquired, but it fell short of the $49.8 billion they earned in the first half of 2007, the peak of Wall Street's boom.

These banks' biggest profit engines remain their trading arms, which place short-term wagers -- much of it with the firms' own money -- on stocks, bonds, commodities, currencies and other financial products and markets.

Losses at these arms in recent years crippled firms such as Merrill Lynch & Co. and Citigroup. This year, trading has generated windfalls. In the first half of 2009, the top five firms generated $56 billion in trading revenue, compared with $22 billion in the first half of 2008 for those banks and the firms they acquired, and $58 billion at the boom's peak. On 46 separate days in the second quarter, Goldman's traders pocketed at least $100 million in revenue, while losing money on two days.

Overall, the top firms are assuming greater trading risks than they were a year ago, based on a standard measure called value at risk. The $1 billion that the top five banks stood to lose on an average day in the second quarter represents an 18% increase from a year earlier and is up 75% from the $592 million in the first half of 2007, according to regulatory filings.

Wall Street "has been tiptoeing back into the pond," said Robert Glauber, who ran the National Association of Securities Dealers, Wall Street's self-regulatory arm, until 2006. "They have short memories."

Bankers' Pay

Despite a continuing outcry over bankers' compensation, large pay packages are still the norm at some companies as they lure talent and try to keep competitors from poaching employees.

In the first half of 2009, the top five firms set aside about $61 billion to cover compensation and benefits for their employees. A year earlier, the total for those firms, plus the big banks they subsequently acquired, was about $65 billion; in the first half of 2007, the figure was $77 billion. Per employee, the payouts may exceed previous years since the firms have collectively eliminated tens of thousands of jobs.

Congress earlier this year imposed restrictions on bonus payments. So instead, several companies, including Bank of America and Citigroup, opted to pay larger salaries. J.P. Morgan is planning a similar move.

The trend has caught the attention of world leaders.

"The abatement of financial tensions has led some financial institutions to imagine they can return to the same modes of action prevalent before the crisis," British Prime Minister Gordon Brown, French President Nicolas Sarkozy and German Chancellor Angela Merkel wrote in a letter to other world leaders on Sept. 3. The three leaders advocate strict new limits on bonus payments.

Regulators have told banks to avoid excessive risk, but haven't been specific, executives say. In fact, federal officials are pushing banks to quickly return to profitability, which Wall Street executives have interpreted as a blessing of vigorous trading.

Goldman and Morgan Stanley were expected to face tougher oversight after they converted last fall into bank holding companies overseen by the Federal Reserve, a move to gain access to government funding and ease concerns about their stability.

Both have dialed back their bets with borrowed money. For every dollar of trading assets on their books, the firms are holding roughly twice as much capital as they did in prior years, according to Brad Hintz, an analyst at Sanford C. Bernstein & Co. This deleveraging makes their businesses safer but less lucrative.

But much remains the same. Both firms were expected to sell power plants and oil rigs they own in their commodities-trading businesses, because commercial banks generally aren't allowed to hold such physical assets. But the banks, after a discussion with the Fed, believe they're allowed to keep them because of a provision in federal law that allows newly formed bank holding companies to retain certain long-held assets, according to people familiar with the matter.

Exotic Vehicles

Perhaps the best indicator of Wall Street's revived exuberance is its continued pursuit of exotic financial engineering. The market for credit derivatives, widely blamed for helping destabilize markets, remains vast.

As of March 31, the notional value of credit derivatives outstanding in the U.S. banking system, a widely used measure, stood at $14.6 trillion, according to the Office of the Comptroller of the Currency. That was down 8% from three months earlier, but still almost triple the $5.5 trillion level of three years ago.

Total return swaps -- a type of derivative that lost favor during the crisis -- are among the instruments regaining popularity, bankers and investors say. Banks use the swaps to provide hedge funds with low-cost financing, which the hedge funds in turn use to purchase leveraged loans or other assets from the bank. The hedge funds pledge the purchased assets as collateral for the loan. During the crisis, the swaps burned banks that seized collateral from hedge funds, only to find that the assets' values had plunged along with the overall markets.

Even collateralized debt obligations, perhaps the biggest money-loser in Wall Street history, are staging a comeback of sorts. Banks are disassembling securities produced by bundling home and commercial mortgages and repackaging them into what market experts describe as mini-CDOs. The goal is to cobble the mortgage-backed securities, seen as high-risk, into instruments more palatable to investors.

Wall Street firms defend their use of the complex products. "A structured or engineered product may be entirely appropriate for the purchaser," said Citigroup spokesman Alex Samuelson, whose bank is among those marketing new types of derivatives to investors. "They're not intrinsically bad."

The Obama administration, financial regulators and many lawmakers believe that more regulation is necessary to protect the U.S. economy from another crisis and to bolster confidence. Certain elements enjoy broad support, such as a proposal to empower government officials to take over and break up large, faltering financial companies whose failure could destabilize the economy. Many policy makers believe that such powers would have allowed the government to mitigate the impact of Lehman's collapse.

Geithner's Push

But many Republicans and some Democrats are skeptical of some elements of the proposal, such as a proposed consumer-protection agency and a plan to expand the Federal Reserve's powers to regulate the country's largest financial institutions.

In Washington on March 26, newly minted Treasury Secretary Timothy Geithner took a rough outline of President Barack Obama's financial rules to Capitol Hill. Administration officials knew it would take months for these proposals to work their way through Congress.

But Mr. Geithner argued that the government urgently needed the power to take over big failing companies. At a congressional hearing, he urged lawmakers to grant that authority "as quickly as you can."

Political support was lukewarm. Rep. Don Manzullo (R., Ill.) called the idea "radical." In June, House Financial Services Committee Chairman Barney Frank (D., Mass.) delayed an immediate vote on the issue, pending a broader review of financial regulation.

In the meantime, regulators have tried to crack down on dozens of banks, slapping hundreds with penalties that restrict their growth and direct them to raise capital. The Fed has centralized more of its supervision of large banks through top officials in Washington.

In July, FDIC Chairman Sheila Bair told a congressional panel that big banks were able to essentially "blackmail" the government because some companies were so large that officials had no way of breaking them apart if they were to falter.

Regulators know it would be difficult to break up Citigroup's complex bank holding company operations, for example, even if they wanted to. Bank of America, J.P. Morgan and Wells Fargo & Co. each controlled more than 10% of the nation's deposits -- once a firm regulatory cap -- because of acquisitions performed during the heat of the financial crisis, sometimes at the government's urging.

The Obama administration is expected to intensify its push for the new regulation regime in the coming weeks.

During a weekend summit, the world's top finance ministers agreed to create higher capital requirements for top global banks once they recover from the financial turmoil, a move that would force them, in effect, to become more conservative.

At the meeting in London, Mr. Geithner implored policy makers to continue fighting for tougher financial regulations in their own countries. "We can't let momentum for reform fade as the crisis recedes," he pleaded.