Two sides to appraisal technology debate

February 10, 2005

Part 3: Appraisal inflation: Real estate's dirty little secret

By Jessica Swesey
Inman News

Editor's note: Bending the numbers on home valuations is often referred to as appraisal inflation, and appraisers say it's common for colleagues to do this in order to satisfy clients and stay in business. Appraisers nationwide say commission greed among their clients is feeding the corruption. In this three-part series, we examined the problem and what the industry is doing to try to stop it.

Paul Robertson, 31, will serve 15 years in an Arkansas prison for manipulating real estate appraisals on properties in Benton, Ark. Robertson's scheme was using appraisal software to defraud lenders to grant home loans on empty lots, according to Robert Herzfeld, prosecuting attorney for the Saline County Prosecutor's office.

To orchestrate the scheme, Robertson purchased new appraisal software and gave to an appraiser he contracted to work with him. According to Herzfeld, Robertson, who owned and operated a Benton home construction business called PAR Homes, made copies of the software on his own computer so he could alter the appraisals before sending off to lenders.

"He'd alter it on his copy of the software. In some instances, he'd literally cut and paste a picture of the home and put it on a (picture of) a vacant lot," Herzfeld said.

By forging the market value of homes and sometimes non-existent homes, Robertson caused some victims to end up with a mortgage worth more than their home's real value, while others were left with nothing or fell into foreclosure.

"There will be repercussions on this for the next several years – having a significant impact on this community for a long time," Herzfeld said.

Not all appraisal technology is misused, but the lack of regulation over who's using what raises questions about the real value of homes being appraised this way. In many cases, appraisal technology has made the lending process more time and cost efficient. But like all technology, it can be manipulated, corrupting the data that eventually is used in another home appraisal.

The most common appraisal technology tools are automated valuation models, known as AVMs, which increased in usage during the mortgage refinance boom of the last few years. AVMs are statistical algorithms that gather information surrounding a property, and return a value estimate based on the data from properties in the area.

Appraisers say AVMs can be dangerous because of the inherently unique value of individual properties.

Michael Ela, president of C&S Marketing, a company specializing in decisioning and risk assessment tools for lenders, noted the pros and cons of AVMs.

"The beauty of them is that they are painfully objective. They really don't have biases because they are just bringing in a bunch of data," he said. However, "models can be fooled," he added. "If you have a bunch of bad data going into them, they can render inaccurate values so it's important that there be some sort of litmus test."

Mortgage fraud schemes have resulted in artificially inflated property values in many markets, which messes up the raw data going into some AVMs. If the AVM can't recognize these values as artificial, they get factored into the next property appraisal, resulting in an inaccurate value.

"That's the risk of the AVM," Ela said.

Also, AVMs aren't suited for all types of properties. They tend to work well in homogeneous neighborhoods where all the houses are similar, but can miss factors unique to some properties that would affect their value. These include items like landscaping or interior details like crown molding and customized wood floors, or proximity to busy streets and freeways.

AVM creators have spent decades trying to make the models as accurate as possible, and the geographic searches and information they collect are not easily manipulated, Ela said.

On the other hand, the objective stance of an AVM also can result in a more accurate value than a traditional appraisal. Ela said there are "too many topics at conferences to deny that appraisers do come under pressure" to meet specified values on homes.

Some appraisers willingly bend numbers on home valuations to satisfy their clients and get more work, a practice known as "appraisal inflation." In its most destructive form, appraisal inflation can assist predatory lending practices and can play a role in flipping schemes, in which properties are fraudulently assessed to win a high loan amount and then resold for even higher prices. Exaggerated appraisals can lead to inflated home prices, increasing the risk of loan default and foreclosure and placing homes out of reach for some prospective buyers.

AVMs in some cases could help eliminate this problem, but if they are misused, they could end up contributing.

Many lenders have started using screening tools before deciding whether to use an AVM or a traditional full appraisal, according to Ela. These tools can assess the risk in an area for things like high foreclosure activity and proximity to influencers like freeways and golf courses. Lenders have wised up because "you might fool one of the tools, but the likelihood of fooling them all is small," Ela said.

Another risk area in appraisal technology is the potential for hacking electronic appraisal reports. Jonathan Miller, CEO of Miller Samuel, an appraisal company based in Manhattan, said about 70 percent of the appraisals his company performs now are delivered electronically as PDFs.

The company also enables clients to log onto a special area of its Web site to view special reports which are kept on the site for six months.

"We're dealing with issues of encryption, making sure the appraisals can't be hacked," Miller said.

Miller noted the surge in AVM usage over the last five years and increasing inaccuracy in the data being pulled for the AVMs. "I was talking to a national lender who said in eight out of 10 AVMs they use the data is not accurate."

Miller thinks there is a use for AVMs in the marketplace, but he feels there is an overconfidence in them in some cases. AVMs work well for some properties, but not all. And Miller disagrees with the idea that the centralization of data can remove appraisals at the local level.

"I think where we'll see problems in technology is when we have a down cycle because the flaws in this automated information will be exposed," he said. However, he thinks the depth and quality of AVMs will continue to grow.

Tony Salvitti , a licensed appraiser and past president of the Pennsylvania Association of Mortgage Brokers, said he has appraised properties that an AVM calculated a much higher value for because it couldn't consider that some of the physical characteristics of the property needed to be updated.

There are instances where an AVM works and instances where it doesn't, he said. "One flaw that can never be erased by the computer is the physical characteristics of the property," he said. "It doesn't necessarily pick those sales that are comparable from a physical standpoint."

Copyright 2005 Inman News

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