Residential Appraisals

Why Appraisal Guidelines are Vital During a Real Estate Market Downturn

By April 9, 2019 July 31st, 2019 No Comments
appraisal guidelines

Growing concern about an impending real estate market crash continues to loom over 2019, leaving buyers and sellers hesitant and unsure. While some experts say that the recent decline is temporary, others anticipate that the market will continue to slow down through the end of the year.

While no one can foresee the future, one thing most real estate experts can agree on is that rising mortgage rates and home prices are putting a damper on the housing market. Economic uncertainty attributed to the government shutdown, global trade tensions, and stock market volatility also play significant roles in the current market downturn.

Rising Mortgage Rates & Home Prices are Driving the Downturn

When you hear rumblings about the real estate market, it’s hard not to think of the housing market crash that occurred just over a decade ago. In the early 2000s, subprime mortgages made it possible for people with lower credit scores and/or financial difficulties to purchase homes. As real estate purchases rose for subprime and regular borrowers alike, housing prices began to rise, too.

Meanwhile, investment banks were buying up these subprime mortgages, bundling them, and selling them as mortgage-backed securities. This fueled the demand for banks to continue doling out risky loans to those who couldn’t necessarily afford them.

In an effort to curtail inflation, the Federal Reserve increased interest rates several times, going from 2.25 percent in 2004 up to 5.25 percent in mid-2006. These rising interest rates meant subprime borrowers could no longer afford to make their monthly mortgage payments and so, the bubble finally burst, wreaking havoc on the economy and ultimately precipitating the 2008 recession.  

Today, the problem isn’t overlending — it’s an increasing lack of affordable housing for low-to-middle-income buyers. Last year, fewer than 50,000 new single-family houses with less than 1,400 square feet were built. Instead, builders were drawn to the higher prices and rents that come with the construction of high-end homes and apartments — a sector that successfully bounced back after the previous housing crash.

This diminishing affordability led Realtor.com to forecast a two percent decline in home sales for 2019. “Unless there is a major shift in the economic trajectory, we don’t expect a buyer’s market on the horizon within the next five years,” Danielle Hale, chief economist for Realtor.com, has said.

Rising mortgage rates are also putting the brakes on home buying. Realtor.com predicts mortgage rates will reach 5.5 percent by the end of 2019, making the average home purchase eight percent more expensive per month than 2018. Zillow also anticipates an increase, with mortgage rates reaching 5.8 percent and home values growing by 3.79 percent in 2019.

The mortgage rate increase is due in part to the Federal Reserve’s efforts to normalize interest rates amid a strong job market, along with a ballooning federal budget deficit, according to The Washington Post.

The Experts Weigh In

Social media is notorious for inflating issues, and the topic of the housing market downturn is no exception. “I’ve been seeing a lot of posts on Facebook about another housing crash coming,” said Mark Ferguson, the owner and managing broker of Blue Steel Real Estate, in a Forbes article. “Many people assume there will be a crash just as bad or worse than the last crash we had about ten years ago.”

“There is no guarantee there will be a housing market crash,” continued Ferguson, “and even if there is, how could you know where the bottom hits?”

Ferguson makes a solid point: We can’t know for sure what’s coming, regardless of what social media says. So how concerned should we actually be? Here’s what the real estate and financial experts had to say about the facts and figures.

The National Association of Realtors predicts home sales will flatten and home prices will continue to increase at a slower pace. NAR also expects sales to increase one percent to about 5.4 million and the median home price to rise 3.1 percent to around $266,800 in 2019, and $274,000 in 2020.

Real estate brokerage Redfin, on the other hand, predicts the homeownership rate will grow more rapidly in 2019 as speculators and investors exit the market.

Real estate database Zillow.com says rising mortgage rates will drive up costs for home buyers in 2019 and create more demand for rentals. The increase will also “compound the effect of still-climbing home values, making homeownership even less affordable.”

The National Association of Home Builders forecasts new-home sales will be around 628,000, the same as in 2018. Single-family construction, including for-sale and not-for-sale homes, will increase nearly 2 percent from 2018 to about 900,000 units.

Moderate growth in home purchase mortgage originations is expected by the Mortgage Bankers Association, with refinance volume continuing to decline. MBA anticipates the 30-year fixed-rate mortgage will level out at 5.1 percent.

Bankrate.com’s chief financial analyst Greg McBride has said that the 30-year fixed rate will pass 5.25 percent before decreasing later in the year to about 4.35 percent.

Play by the Rules: Appraisal Guidelines

Taking into account everything the experts have to say, is there anything we can do about the downturn? While many factors, including those inflated mortgage rates, are beyond our control, real estate appraisers can do their part for home pricing by adhering to appraisal guidelines.

What are appraisal guidelines?

The FDIC appraisal regulations support real estate-related financial transactions. They provide federally regulated institutions and examiners clarification on expectations for prudent appraisal and evaluation policies, procedures, and practices.

The main goal of a real estate appraisal is to establish a property’s market value. Lenders use appraisal reports as assurance for the money they’re lending. If, for example, an appraisal comes in lower than the asking price of a house, the lender may choose to deny the mortgage loan. Property valuation also determines how much property taxes and property insurance to pay and are required to settle legal matters such as divorce, real estate settlement, or a lawsuit.

Appraisal requirements are designed by financial institutions and should form a valuation that meets their needs based on their risk profile, real estate lending activities, and business model — all while complying with the appropriate laws.

Appraisal reports are typically based on the evaluation of a property as well as sales data. Reports might include details about the property, comparisons of similar properties, a market evaluation, and issues of the property.  

How do bank appraisal guidelines factor into a housing market downturn?

Now more than ever, it’s vital that appraisal guidelines are followed and that banks stay true to their valuation obligations.

There are several property appraisal methods, but the most popular is the sales comparison approach used for residential appraisals. Here, valuation is determined by comparing properties with similar characteristics using recent sales or current market prices. The appraiser will use a variety of data points to decide commonalities between properties. Elements like location, physical characteristics, zoning use, and conditions of sale are all factored into the decision. Through comparing properties, an appraiser will ultimately arrive at a value.

When employing this method, it’s quite clear that valuations are supposed to match comparables in the area. However, if the appraisal is inflated in order to meet the loan requirements, it’s not an accurate assessment of market value and can be a contributing factor in rising home prices.

This, in part, is why appraisal guidelines stipulate that the appraiser must be an objective third party — someone who has no financial or other connection to any person involved in the transaction.

Should you get an appraisal review or a second appraisal?

An appraisal review is used to investigate, analyze, and verify the logic and procedures of an appraisal. The review is comprised of a series of procedures which ultimately help a reviewer formulate an opinion about an appraisal. An appraisal review is typically needed specifically as it relates to risk. That is to say, when a property or a buyer presents more risk, a lender might require an appraisal review. A review might be ordered due to red flags (such as inadequate comparables or a declining market location) or due to other potential risk factors.

If you think your valuation is not an accurate assessment of market value or if there were any verifiable circumstances that may have tainted the appraisal process, a second appraisal may be warranted. Confirming that all appraisals and evaluations comply with federal regulations and internal policies is a best practice that needs to happen prior to all final credit decisions for any financial institution. Read our blog post about second appraisals to learn more.

Appraisal Management Done Right

While we can’t say with certainty whether or not the housing market will crash in 2019, we can assure you that our team of appraisers is standing by no matter what the future brings. On average, our appraisers have 30 years of experience and can assist you with ordering appraisals, appraisal reviews, and evaluations all completed by certified appraisers. With MountainSeed, you can trust that your residential or commercial appraisal will be done correctly and on time, regardless of what the housing market might bring.