Distresses Sales as Appraisal Comps

Over the past 5 years, home values have been devastated due to short sales and foreclosures. In Nevada, prices seem to fall lower with each new, distressed sale. Now legislation is being proposed in Nevada, Illinois, and Missouri that would exclude or restrict the use of foreclosures and short sales when determining the values of neighborhood homes.

According to a story by Joy Leopold in today’s DSNews, “Industry participants have expressed reservation at the idea of barring distressed sales from consideration when appraising properties, saying such actions would cause homes to be appraised for more than they are really worth.

According to the Appraisal Institute, “Elimination of foreclosures and short sales as comparables would result in an artificial market and would mislead lenders as to the true value of their mortgage collateral.”

Furthermore, the institute notes that under the Uniform Standards of Professional Appraisal Practice, all federally related transactions are required to consider all sales for appraisals, including short sales and other distressed sales. Most residential lending transactions fall into this category.”

I agree all sales need to be considered, but that is the point. We have seen a 180-degree turn around on the part of real estate appraisers. Between 2003 and 2005, homes were being appraised for well above any available comp due to the appreciating market. Now, in a depressed market, it is CYA, limiting comps to distressed sales.  Both practices are wrong!

The role of the appraiser is to determine Fair Market Value. Fair Market Value is “the probable price at which a willing buyer will buy from a willing seller when (1) both are unrelated, (2) know the relevant facts, (3) neither is under any compulsion to buy or sell, and (4) all rights and benefit inherent in (or attributable to) the item must have been included in the transfer.” FMV is generally the basis for tax assessment and court awards. Sellers of foreclosures and short sales are under compulsion to sell. Adjustments should be made when using these as the value basis.

All sales need to be considered, including homes that are not a short sale or foreclosure. The practice of ignoring non-distressed sales will continue to drive home values down. The role of the appraiser is interpreting the market. When an appraiser only considers distress sales, he or she is setting the market.