Thursday, June 1, 2023 | The Latest Buzz for the Appraisal Industry

Once Upon a Time… A Housing Fairy Tale

This article was originally published in the latest edition of the Fall 2022 Appraisal Buzz Magazine!

To receive this subscription directly, click here.

Once upon a time, there was a rich nation which valued many things. There were many owners and “wannabe” owners. The owners wanted to be richer and the wannabes wanted to be like the owners. They all liked value. Some people even became “valuers of things.” They claimed to know value.

Value was price. It was obvious. Nothing to talk about here. Move along.

The owners needed money they didn’t have. So, they got help from loaners.

The loaners put up most of the money and became interested. The loaner-owners also wanted to be rich. They could get rich by “selling money!” (Actually, they were only renting the money, but no one wanted to hear that.) And best of all, they were not renting their own money. They were renting other people’s money (OPM), and the other people didn’t really own the money either. It was just sort of out there, all guaranteed, completely safe.

What is important is that everyone liked value, but everyone needed to have someone say the value is fair. They were able to get others to declare the value as fair, but some valued fair as high as possible. “Uppraisers” were in demand.

A few of the dealer wheelers got together. The loaners became lender benders. They found liar buyers. And they found uppraisers.

All the owners, the wannabe owners, and the loaner-helpers liked uppraisers a lot because they helped richness for all. Everything worked well so long as “value” equaled price!

Until it didn’t.

Let’s Ask – What Happened?

Suddenly, when no one was looking, value was
not price. Everyone got mad. Someone must be at fault! Someone had to pay the price! It must be the uppraisers. They caused the prices to be “too high” – until they became “too low.” The uppraisers got in trouble! And now, no one seems to know what “correct” value is. It’s either too high or too low.

How can this be? We have rules, we have standards, and we all know the exact definition of value. Don’t we? The “official unofficial” government-related loan definition of market value is clear. It says buyer and seller are:

  • Prudent and knowledgeable
  • Not affected by undue stimulus
  • Typically motivated
  • Well-informed or well-advised

Also part of the definition:

  • Reasonable market exposure time
  • Cash terms or comparable to cash
  • “Unaffected by special or creative financing or sales concessions granted by anyone associated with the sale” 

Let’s Ask – Are These Seven Requirements Even Possible?

As the last “economic meltdown” arrived, I vowed to spend much of my retirement years helping us find a way to avoid another one of these regular financially/socially destructive periods. My company mission statement became simple: “To help prevent the next economic meltdown.”

As an appraiser, I had to look at what I had spent a lifetime doing: “Find market value.” I had spent an entire career confidently knowing exactly what this meant. However, something had gone wrong, and it seemed the wrongness was destined to repeat every 10-12 years, as it always had.

It seemed a good starting point would be to understand exactly what market value is. I forced myself to look beyond habit, beyond assumptions, and beyond my support of groupthink — beyond even my certifications, licenses, credentials, and designations.

To find market value, I first had to carefully study that pesky definition. I asked a simple question: “What was really happening at the end of the 2000s?”

I bullet-pointed the “federally-related transactions” definition and began to write what seemed to be reality. The following became a slide in the core class, Stats, Graphs, and Data Science1. The reality I found was:

Dell operative definition of market value

“Market value means the most probable price which a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller each acting speculatively with exuberance and assuming the price is affected by universal euphoria. Implicit in this definition is the consummation of a sale as of a specified date and the passing of title from seller to buyer under conditions whereby?

  1. buyer and seller are avariciously motivated; biased
  2. both parties are uninformed and advised by commissioned salespeople acting in what they consider their own best interests;
  3. a reasonable time is allowed for exposure in the open market;
  4. payment is made in terms of cash in U.S dollars or in terms of financial arrangements comparable thereto; and
  5. the price represents the normal consideration for the property sold enabled by unrestricted special and creative financing provided by commissioned salespeople.”

The reality was that buyers wanted to get in on the runaway market to get rich. Do you remember the words “over-exuberance?” Some people did buy for a place to live, but even they were wrapped up in the speculative trip and the universal euphoria.

The “typical” motivation of a place to live – to raise children, to entertain, to sleep, cook, eat, and feel safe – were still there, but were overridden by urgency and not wanting to be left out. Everyone pretended all of this was normal and expected. Price is value, everyone understands!

 Let’s Pretend

Let’s pretend that buyers and sellers are well-informed and knowledgeable about the economics of real estate markets. Let’s pretend they are well advised by disinterested third parties. Let’s pretend that government policies do not impact real estate markets. Let’s pretend that the 80% or 90% loan money is all the buyer/borrower’s money. Let’s pretend that these loans are not highly leveraged investments (not legal in stocks or other markets). Let’s pretend that all the “help” we have given buyers hasn’t pushed prices up. Let’s pretend that, over the years, we have not priced houses out of the range of many people – in particular, minority groups who also have been subject to other disadvantages.

Let’s pretend that, historically, redlining and discrimination were not “official.” No exclusionary zoning, no deed covenants, and no loaning restrictions. Let’s pretend that the color-coded 1934 FHA Underwriting Handbook “residential security maps” identifying an “undesirable population” never existed, and they were never ineligible for FHA backing. Let’s also pretend predatory lending never took place.

Let’s pretend market value is market value. Market value is market price (per the “official” definition). Market price reflects all these influences and all these influences are embedded in the very definition. How can you argue with a clear definition? We can’t. But we can look at the definition and we can see what it says, we can hear the meaning, and we can feel the results. Or we can ignore all of the above and pretend that today’s market price is actually real value.

Let’s Look

Let’s apply some critical thinking on each of these official-unofficial elements of “value.” If you choose to continue reading, please note that each and every one of these elements below is defined by other subjective words, which also cannot be quantified. 

Buyer and Seller are Prudent and Knowledgeable

Most home buyers do not often experience the home-buying/home-selling process. They/we are not well-informed. Certainly not to the level we should be for our life’s greatest financial move.
We are uninformed and advised by commissioned salespeople. Ethical perhaps, but nevertheless motivated to make a commission, get a referral, and move on to the next deal.

Prudent is defined as “giving thought to the future.” Knowledgeable is defined as “intelligent and well-informed.” No doubt, perceptions of what the future holds – particularly with regard to home prices – is formed partly by personal expectations, but also by social and economic beliefs about future prices.

This sets up the two-fold nature of home buying: 1) a place for shelter; and 2) expectation of wealth gain.

“Fair” markets are defined by reasonably equal information – that there is some symmetry between all participants. Our participants comprise of:

1) Buyers 3) Agents 2) Sellers 4) Lenders

Do these market participants have equal information, equal knowledge? Sellers know the property,
buyers see the property, agents show the property, and lenders read about the property (and follow the regulatory rules given them). Each of these have different, even opposing, motives.

Question: Does this clear asymmetry (even if small), impact demand/supply long-run pressures?

Buyer and Seller are Not Affected by Undue Stimulus

Undue stimulus can be defined as unjustified or excessive incitement. What could be inducement in terms of investment in a home or its price speculation? It could be very low interest; it could
be very low risk – like if the initial down payment is small or even zero. Could any of this stimulus come from the other three participants in each deal? Is this normal or is it undue?

Buyer and Seller are Typically Motivated

“Typical” is common, regular, or expected. Again, these words seem intuitive and pleasant, yet they mislead. Do they imply “buying a home using my money?” – or do they recognize the speculative, leveraged nature of the purchase with 80% OPM? 

Buyer and Seller are Well-Informed or Well-Advised

“Well-informed” is not distinguished from “knowledgeable” above. It is not clear if there is a difference, yet we can take a second look at our participants. Buyers are informed by:

1) Their purchasing power (like how much loan they can get);

2) What their real estate agents tell them (good or bad, true or false);

3) What their loan agents suggest to them in order to make the complete loan.

There is a Reasonable Market Exposure Time

When I first wrote my “operative definition” of market value, my head dismissed this exposure time issue. My head told me that, whatever time there was, is what there was. I was wrong.

My course director, Cynthia Law, reminded me that there often was NO exposure time at all. Properties were selling before they hit the electronic MLS. In fact, many agents were dragging their keyboards in reporting the listing, preferring to get both sides of the commission if possible, or at least to let the others in their brokerage get the time advantage. No exposure time. Reasonable or not? No one ever explained “reasonableness” to me! 

Cash Terms, or Terms Comparable to Cash

I thought I was safe with this one. Until one day,
I was doing a case in a very upscale, luxury, gate-guarded project on the “Gold Coast” of Southern California. I noticed that many houses were vacant. My head dismissed this. After all, very wealthy people have several houses, and cannot live in more than one at a time.

Upon further review in looking at ownership sheets, I noticed a high percentage of the owners were Chinese nationals. It appeared (after talking to some sales agents) that some of these houses had never been lived in. These non-occupant owners were not buying a home. They were buying an asset to diversify their wealth, and as a currency hedge – relying on the American Dollar.

The optimal use, the “Highest and Best” use, was not as a residence at all. The cash equivalency translated to currency of another country — An investment or speculation of future relative cash equivalencies! Not cash “in terms of U. S. dollars” nor “in terms of financial arrangements comparable thereto.”

“Normal” Consideration, Unaffected by Special or Creative Financing or Sales Concessions

Looking back at the early 2000s, financing was fast, furious, loose, and looser. 110% loans were popular. “Liar loans,” “low-doc,” and “no-doc” loans all were common. “Special and creative” and “sales concessions” terminology were leftover words from the prior meltdown. People were giving cash kickbacks, upgrades, or second loans to make deals.

I have no idea how “normal” is defined for a consideration. Apparently, everyone assumed it means whatever is prevalent at the time (like liar loans).

So, we consider: What is “normal” consideration? “Consideration” is the money you get for the property sold. “Special or creative financing” is not defined. Nor is “sales concessions.” These are colloquial terms from three real estate crises back. They are not defined. Furthermore, the special financing or sales concessions must be granted by anyone associated with the sale. We wonder, does this mean lenders are associated, or not?

So What?

What all this means is that the industry and the entire economic system reflects on what everyone assumes is obvious: That price is value. It is not. Value is in the use, or of future gain.

What this does mean is that each and every clear point of the definition was simply not true, avoided, obscured, or simply ignored. Even as each party signed and certified to adherence. It works, but it seems to work poorly to prevent repeated economic crises.