AVMs to Finally Replace Appraisers?
By Isaac Peck, Editor
Since the 1990s, there have been those in the appraisal industry who’ve warned that appraisers would soon be replaced by automated valuation models (AVMs). Rapid technological innovation would quickly render the appraisal profession obsolete and properties would be appraised by computer algorithms combined with “big data.”
Despite decades of gloomy predictions, the appraisal profession and appraisers have proven to be resilient. Rank-and-file appraisers, who are overwhelmingly small business owners, continue to faithfully serve as a cornerstone of the U.S. real estate market by providing unbiased and independent opinions of value for homebuyers who, in many cases, are making the single largest investment decision of their lives. But today, some are saying things may be different.
Fannie Mae and Freddie Mac have both begun implementing their own appraisal waiver programs where an automated appraisal alternative will be accepted in lieu of a traditional appraisal. While the full extent and effects of such programs remain to be seen, this is an issue that appraisers will want to follow closely.
As part of its new Day 1 Certainty™ program, launched December 2016, Fannie is offering Property Inspection Waivers (PIWs), which is an offer to waive the appraisal requirement for refinance transactions that meet specific criteria. In its Fact Sheet explaining the change, Fannie writes that the PIW “provides a lower-cost alternative to an appraisal, while eliminating the expense of appraisal-related delays in the origination process.” The Fact Sheet also clarifies that “the majority of refinance transactions will not receive a PIW offer, which means they will require an appraisal by a qualified residential appraiser to establish the market value.”
Those properties that will qualify for the PIW on refinance transactions include one-unit properties, including condominiums, principal residences, second homes, and investment properties. The PIW will extend to limited cash-out refinance transactions up to a 90 percent LTV/CLTV for principal residences and second homes, and up to 75 percent LTV/CLTV for investment properties.
Fannie’s Fact Sheet is quick to note that purchase transactions and the “majority” of refinance transactions will not be eligible for a PIW. Additionally, for a PIW to be offered, a prior appraisal must be found for the subject property in Fannie Mae’s Collateral Underwriter (CU) data, and that appraisal must be associated with one of the same borrowers on the recent loan casefile. The Fact Sheet explains that, “DU will compare the address for the subject property to the property addresses found in CU. When a property address match is found, DU will then compare both the first and last names of the borrowers on the loan casefile to the borrowers associated with the prior appraisal. When a borrower name match is found, DU will then use the information from the prior appraisal todetermine if the loan casefile is eligible for the PIW.”
Fannie’s Fact Sheet also explains why it will not offer an appraisal waiver on purchase transactions, indicating that Fannie relies “on data captured from a full interior and exterior inspection on purchase transactions to power the CU model with up-to-date property and transaction data across the entire country. Having this data on purchase transactions enables us to confidently offer more PIWs on subsequent refinance transactions and offer freedom from representations and warranties on property value.”
Zachary Dawson, Fannie Mae’s Director of Collateral Policy & Strategy, reports that PIW rates historically have been a few percent of the agency’s total loan production, but this could increase to around 10 percent. “Our enhanced PIW program started on December 10, 2016, so delivery volume is still ramping up at this time. We are seeing it used at rates of around 20 percent on limited cash-out refinances thus far,” Dawson confirms.
In terms of how it will affect appraisers, Dawson says the impact should be minimal. “When you spread the incremental number of PIWs offered as a result of this change across the roughly 50,000 appraisers we see work from each year, it’s not a significant reduction of assignments for each appraiser.”
Freddie’s Appraisal Alternatives
Freddie Mac appears to be going a step further with proposed changes to its Loan Advisor Suite, promising that by spring 2017 it will be offering a “no-cost appraisal alternative,” which will include first-purchase transactions, and stating that this new program will eliminate steps to speed up the process and reduce borrower costs.”
Out of the $909 billion in single family loans purchased by Fannie Mae and Freddie Mac in 2016, Freddie’s share is roughly 43 percent. Combined together, Fannie and Freddie currently hold about 45 percent of the $10.2 trillion in outstanding single-family residential mortgage debt.
In an interview with Working RE, Lisa Tibbitts, Director of Public Relations at Freddie Mac, offered additional insights into Freddie’s approach. “Our new Loan Advisor Suite features include a no-cost automated collateral evaluation (ACE) that is designed to help reduce costs for consumers and lenders,” says Tibbitts.
In explaining why Freddie believes it will be able to accurately value homes, Tibbitts reports that Freddie “has over 40 years of historical data to draw on. When we combine all this historical data with advanced analytics, we believe we can produce accurate valuations. Appraisal accuracy is something we’re very interested in,” argues Tibbitts.
In terms of what kinds of properties Freddie will offer ACEs on, Tibbitts is quick to stress that appraisers will remain “absolutely vital to the great majority of loans,” but indicates that ACEs will be used on “properties where Freddie can easily leverage data and models.” Tibbitts reports that Freddie hasn’t yet released information on the specific conditions that would trigger the use of an ACE, but emphasized that it will be used mostly where there is a homogenous stock of housing. “When we have properties that are unique, with no others like it, that’s when appraisers are absolutely needed and where appraisals will be most valuable,” says Tibbitts.
Tibbitts argues that there is a backlog of appraisals in some cities within the U.S., and a main benefit to Freddie’s new program is that it may help alleviate the current shortage of appraisers and provide cost reductions to borrowers. “The key to reducing backlogs is not using appraisers in areas with homogenous housing stock,” argues Tibbitts.
When asked to reconcile the fact that most appraiser shortages/backlogs occur in rural areas where Tibbitts concedes appraisals are necessary, and that there is typically an abundance of appraisers in sprawling cities where homogenous subdivisions are most common, Tibbitts says only that Freddie Mac believes appraisers are the lynchpin of the housing market. “Our program will only cover a subset of loans and appraisers will absolutely remain vitally important in the great majority of home purchases. To suggest otherwise would be irresponsible,” says Tibbitts.
Scott Reuter, Freddie Mac’s Chief Appraiser and Director of Valuation, is a second generation appraiser, holds a Certified General credential, and has over 30 years of experience in valuation and risk management. Reuter leads a team of 10 Certified appraisers and reports that he and his team will be monitoring the accuracy of the automated tools to test their results. “As we begin the initiative, we’re going to sample data from the portal and order independent desk reviews of properties, with all of that information going through an internal review team. We can then refine the systems and improve our models. This will ensure that whatever we do from a valuation process perspective aligns with our view of quality,” says Reuter.
In terms of what Freddie is hoping to accomplish by offering automated collateral evaluations (ACEs), Reuter says the goal is to better serve the public. “An appraisal is part of a risk decision. If there is a subset of loans where we can make that risk decision without an appraisal by leveraging responsible innovation, then we should do that. Our charter calls on us to provide liquidity; it doesn’t say ‘order an appraisal on every single property.’ While the ACE is something that goes counter to my appraiser DNA, I understand it and for a small subset of the safest loans, Freddie’s goal is to better serve the public,” Reuter reports.
When asked why Freddie is choosing to offer ACEs on purchase transactions, going a step further than Fannie Mae’s initiative which only offers waivers on select refinances, Reuter says that the decision will be based on a variety of factors. “A purchase transaction brings together an independent buyer and seller at an arm’s length. They have agreed on a variety of things, including market value, independent data points, and the property’s valuation. Properties go through a tremendous amount of rigor. So in areas where we have very rich or robust analytics on a county or MSA level, and the buyer is bringing 20% down or more, then it might be appropriate to offer an ACE,” says Reuter.
For appraisers worried about the end of a profession, Reuter argues that is not the case. “We will overwhelmingly still need to order, grade, score, and consume appraisals. Our data systems are modeled off of appraisal data, so it won’t work without appraisals. But, that doesn’t mean we will need appraisals on 100 percent of loans,” Reuter says.
A good comparison is a local accountant who prepares tax returns, according to Reuter. TurboTax and other “Do-It- Yourself” tax software undoubtedly took work away from local accountants and tax professionals, but many people, even small business owners like appraisers, might still need the services of an experienced accountant. “What that local accountant has lost, due to new software and technological innovation, is the 20-something year old’s return, the college students, and the part-time workers. Simple tax returns can now be done by taxpayers, but there is still a demand for tax professionals. Some appraisers are upset that the cookie-cutter appraisals may not be in such demand in the future, but demand for appraisal services will continue on more complex assignments, rural areas, and where we don’t have sufficient data. We expect a significant majority of the mortgage loans to require traditional appraisals,” argues Reuter.
These latest changes by Fannie and Freddie prompted the Appraisal Institute (AI) to write a letter to Freddie Mac’s regulator, Mel Watt, Director of the Federal Housing Finance Agency, warning that Freddie Mac’s decision to waive appraisals for first-purchase transactions is especially risky because these are “transactions with the highest risk to the agency.” Unlike refinance transactions where previous appraisal information is typically on file, the AI points out that purchase transactions “generally have less information available to the agency” and that forgoing an appraisal omits valuable data such as the appraiser’s interior inspection, the condition of the property, and more.
AI’s letter also makes an important point that appraisal alternatives or “waivers” are nothing new. Leading up to the real estate crash of 2007- 2008, Fannie and Freddie were issuing appraisal waivers en masse. After the GSEs were taken into conservatorship back in 2008, it was discovered that as many as 30 percent of mortgage loans held by Fannie and Freddie had received such waivers, according to AI. Even after the crash, a separate report from the Government Accountability Office reports that Fannie and Freddie only required appraisals for 85 percent of the mortgages they purchased in 2010 and 94 percent in 2009. In other words, the GSEs have long used AVMs or waivers as alternatives to appraisals and the practice dates back to the early 2000s.
However, AI warns that Freddie’s latest move to use these tools for firstpurchase transactions is especially foolish. “Freddie Mac’s decision to veer away from fundamental risk management practices appears to harken back to the loan-production driven days in the years leading up to the 2007-2008 financial crisis…which turned out to be disastrous for the entire economy,” the AI warns.
Future for Appraisers
Appraisers have responded to Fannie and Freddie’s new changes with a mix of shock, outrage, indifference, and a few “I told you so’s.” Richard Hagar, SRA argues that while change is coming to the industry, appraisers are and will remain an integral part of the valuation industry. “AVMs are not going to take over the job of an appraiser any time soon. Houses change, some get larger, some remodeled, some add an accessory dwelling unit (ADU), some have massive interior damage, while others burn down. County records rarely or very slowly reflect those changes,” Hagar says.
Another reason that appraisers will be needed well into the future is that automation gets stale quickly when fresh data stops flowing in. “AVMs need lots and lots of current data. They need appraisers to feed the beast with updated information regarding the condition of the subject property, surrounding uses and market changes. Without appraisers submitting updated information, the accuracy of the AVMs begins to degrade within six months,” says Hagar.
In terms of valuing commercial property, Hagar says the accuracy of AVMs gets even worse. “AVMs fail miserably when valuing most commercial properties. The primary value component of commercial properties is the income and it takes humans to coax monthly income amounts out of most commercial building owners. Can you imagine some machine calling up an owner of a multi-million dollar shopping complex and asking for the monthly income and vacancy factor? Human interaction and in-depth market research are needed to uncover vital commercial data, so an appraiser’s expertise on the commercial side is indispensable,” argues Hagar.
While AVMs won’t replace appraisers, Hagar notes they are by no means “useless” (as some appraisers argue) and their use can be expected to continue in the future. “AVMs have a place in a valid business model when it comes to providing yearly updates on the value of a block of loans held by banks, Fannie Mae and most private lenders.
Many of these institutions have hundreds of billions of dollars’ worth of mortgages, and regulations require banks to compare existing loan balances on a portion of mortgages against current property values. AVMs do this quickly and reasonably for the dollars spent,” says Hagar.
Instead of being made obsolete, the most notable change that technology is bringing to the appraisal industry is actually a sharpening of skills and an improvement to appraisal practices, suggests Hagar. “Technology, increased access to data, and the many tools that are now at an appraiser’s disposal increase the value that appraisers bring to the table, but it also means that more is demanded of appraisers. If appraisers fail to provide accurate market analysis, fail to properly measure the subject, fail to inspect the comparables, fail to provide support for their adjustments and keep using the same old ‘rules of thumb’ that we were using back in the 1990s, then big data is going to be flagging these appraisals and questioning their utility,” says Hagar. “If the descriptions and accuracy of an AVM and appraisals are equally poor, then which one is better? The AVM is of course, since the bank can obtain results for $50 in five minutes.”
The solution, according to Hagar, is for appraisers to embrace technology to improve their practice. “We appraisers are no stranger to change. The practice of appraising real estate continues to evolve and it should come as no surprise that more is now being required of appraisers than ever before in terms of support, techniques and data analysis. If appraisers fear that the increased use of AVMs will replace us, then we should up our game, and provide a product that is better than the output of a computerized AVM. Appraisers who are willing to adapt and leverage technology to improve their techniques will see it pay off in spades. The real estate industry will long have a need for professional appraisers who are masters of their craft and provide up-to-date, supported, and market driven opinions of value,” says Hagar.
About the Author
Isaac Peck is the Editor of Working RE magazine and the Director of Marketing at OREP.org, a leading provider of E&O insurance for real estate appraisers, inspectors and other real estate professionals in 50 states. He received his Master’s Degree in Accounting at San Diego State University. He can be contacted at Isaac@orep.org or (888) 347-5273.