The Cost of Comparables

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Appraisals are subjective – how much is a view of Central Park worth? In one case, a woman on the Upper West Side wanted to refinance her one-bedroom co-op. Appraisals by two different banks valued the apartment at $350,000 and $400,000. Her mortgage broker, Jordan Roth of GFI Mortgage, suggested she try a new bank. The third time around, the apartment was valued at $550,000.

The home appraisal process has changed radically since the heady days of the real estate boom, when appraisals were a rubber stamp for getting a mortgage. New rules intended to rein in the industry have resulted in properties being appraised at values far lower than expected. As sellers scramble to keep deals intact, they lower their selling price, a move that can have a ripple effect for future sales in a building.

Appraisals aren’t a matter of public record and can’t be used to gauge the value of another property. But if the selling price is lower because of a low appraisal, that can affect overall values in a building. Also, for shareholders in a co-op or condo trying to refinance their mortgage, a low appraisal can undo their efforts, keeping a financially distressed resident in a tough situation longer.

Sales Report

Although some industry experts see appraisals beginning to match selling prices again, many still see low appraisals as a key factor in sales falling apart. About a third of all home sales nationwide fall through, according to a January 2012 survey by the National Association of Realtors. The association attributes that largely to low appraisals.

“It’s a big problem,” says Robbie Gendels, a senior loan officer at NCB (formerly the National Cooperative Bank). “It just seems to happen all the time.”

The rise in low appraisals began in 2009 after then-New York State Attorney General Andrew Cuomo hashed out a deal with Fannie Mae and Freddie Mac to sever a cozy relationship between mortgage brokers and appraisers. Critics of the old system pointed to lax appraisal rules as part of the reason that home values were so woefully inflated.

Under the agreement, lenders must now use an independent vendor who selects an appraiser for the bank. One unintended consequence of this agreement is that initially vendors chose the cheapest bidder. And the cheapest bidder generally didn’t have an office in Manhattan.

Instead, appraisers from far-flung corners of New York State who were much cheaper than their urban counterparts began appraising properties in the city. Frequently, they were unfamiliar with the local terrain and discounted neighborhood nuances such as the difference between Washington Heights and Inwood. People in the industry refer to the acronym for the agreement – the Home Value Code of Conduct (HVCC) – as “havoc.”

“Initially, it was a shock to the system,” says Michael Vargas, owner of Vanderbilt Appraisal Company. In one case, an appraiser who lived two hours outside Manhattan appraised an East Village two-bedroom co-op, which would have been fine had he looked at the correct unit. Instead, he looked at a different apartment and compared it to a one-bedroom. The final report had the wrong floor plan and the wrong photos. But the bank stood behind the appraisal and denied the buyer a loan.

“Logic doesn’t apply. It’s an unreal, dysfunctional situation,” says Jonathan Miller, president of the appraisal company Miller Samuel. In the case of the East Village property, the realtor called Miller asking him for advice on how to handle the inaccurate appraisal. Miller’s suggestion: go to another bank and start over. But going to another bank means the buyer foots the bill for a new appraisal, which costs between $350 and $550.

Although vendors are now choosing appraisers with a better knowledge of the local market, appraisals are still low. In a recovering market, appraisals skew low since an appraisal is a backward look. Add to that, appraisers are skittish about repeating the mistakes of the real estate boom. So, they tend to skew conservative.

Often what happens is the sale falls apart. “A low appraisal can blow up a deal,” says Jeffrey Reich, a real estate attorney with Wolf Haldenstein Adler Freeman & Herz. If a buyer needs 80 percent financing and the appraisal is $50,000 less than the selling price, the buyer will need to come up with extra cash or walk away. But if the seller lowers the price to save the deal, a board concerned with property values in other units could reject it.

Depending on how much the seller comes down from his original price, board members could have cause for concern. Because appraisers use recent sales data in a building to help determine the value of a property, if a recent sale is low, the next apartment that sells will be compared to that one.

Valuing Value

“The board needs to protect the value of other apartments in the building. They may reject the purchase price because they find it’s way too low,” says Dan Wurtzel, president of Cooper Square Realty.

Boards rarely get wind of low appraisals because the process happens before a potential sale ever gets reviewed. Often, all a board sees is a low selling price. In the case of a mortgage refinancing, if the appraisal is less than the current mortgage, a shareholder in a co-op could be unable to get a loan or be saddled with high closing costs. A board is left in the position of deciding whether to allow a now heavily leveraged shareholder to refinance. “The board wants to be comfortable that the shareholder isn’t getting himself into financial deep water and can’t pay the maintenance,” says attorney Theresa Racht, a partner at Racht & Taffae.

The appraisal process starts when a bank considers a mortgage. It calls the vendor, who taps an appraiser for the job. The appraiser then considers a variety of elements when setting a value on an apartment, including the selling price. He looks at various real estate websites for information about recent sales and current listings. When he visits the apartment, he notes features like a renovated kitchen, a remarkable view, or unusual amenities. Sometimes, the appraiser calls the property manager or the realtor for details. Other times, he calls no one.

Once an appraisal is filed with the bank, getting it changed is no easy feat. A buyer has three grounds for challenging it. He can point out factual errors; he can provide additional comparable data; or he can request that the appraiser explain his methodology, like how the floor plan was measured. But by and large, banks stand behind their appraisers.

“It’s very difficult to get an appraisal changed. You really have to show some manifest error, like looking at the wrong address,” says Reich.

There is an upside for buildings, though. The fallout from a low appraisal can shed light on the financial weakness of a potential owner. If he is so heavily leveraged that he can’t afford to put up any more cash, he may not make a good shareholder. “If someone is putting all their pennies together and is completely leveraged, then they probably shouldn’t buy that apartment,” says real estate attorney Debra Powell.

Although co-op boards (and sellers, for that matter) have little involvement in the appraisal process, there are steps they can take to improve the odds that appraisals will be accurate:

Remember the outliers. If a unit sold for an unusually low price, make a notation of that in the building’s transactions records. If there were mitigating circumstances, like an estate sale or a divorce, include that information. Be sure the property manager has the details readily available should the appraiser call. “You want to know what the story of that sale is, and you want to make sure the managing agent can communicate that to the appraiser,” says Vargas.

Package it. Assemble a standard appraisal packet for the building. Include information about comparable sales. Also include information about the building, such as amenities, qualities of the finishes, and tax abatements. “We definitely found that the appraisals came in more accurately when they used our information,” says Stephen G. Kliegerman, president of Halstead Property Development Marketing.

Know more. Request a copy of the appraisal report in the purchase application. The sale price may not reflect the appraisal, especially in the case of a cash deal. But if appraisals are low, it’s good information for a board to have on hand. And if there are any inaccuracies in the appraisal, the board can catch them. “The co-op itself may not have any clue that there was some back and forth or some renegotiation,” says Racht.

Spruce up the place. In the case of a sale, an apartment has likely been staged already. But when a property owner refinances his apartment, he often hasn’t done anything to give it a good first impression. Although a fresh coat of paint won’t affect an appraisal, cleaning up clutter and organizing the closets will help an appraiser see a property more clearly. If a resident has plans to replace any appliances, doing so before the refinance might be worth the effort. Says Vargas: “It’s always best to put your best foot forward.”