Tuesday, March 31, 2009

"Broker price opinions" depressing property values

While recently updating the real estate section for a San Diego economic conference in April, I came across an interesting tidbit: when retail space is located in mixed-use (residential plus retail) developments, it's been reporting higher vacancy rates and lower rents versus traditional retail centers. Why is this? Well, for starters, mixed-use projects are very complex, especially when it comes to parking. Moreover, if the stores depend on new housing units for their traffic, then weakness in housing will undoubtedly have an impact.

I mention this because when I was writing market studies for mixed-use projects, builders would almost always order an objective analysis for the residential portion only, preferring to turn to commercial brokers for an analysis of the retail space's ability to absorb space and achieve specific rental prices. But c'mon, seriously, how silly is that? Because although I'm sure there are plenty of commercial brokers who will provide an objective opinion of a specific project, how do you know if they're only telling the client good news to get the listing? If they're crossing their hearts?

If the residential sector is any example, asking a broker to provide an opinion of value instead of ordering a full-scale appraisal or a traditional market study is simply courting disaster. And these days, in an effort to get more short-sale and foreclosure listings, some agents will, for a variety of reasons, low-ball values. And some people think that's further escalating pricing declines in neighborhoods already filled with distressed properties. From Kenneth Harney's column in the L.A. Times:

Unlike standard property valuations performed by licensed appraisers -- which can run to hundreds of dollars -- BPOs often cost $50 and are performed by real estate agents who may have minimal or no appraisal training and are subject to no regulatory oversight. Realty agents defend BPOs, contending that their extensive knowledge of local market trends equips them to render accurate estimates.

BPOs have become a booming business as foreclosures and short sales have risen sharply. When banks that own foreclosed houses need to put values on them for resale, increasingly they order BPOs that can be delivered quickly at rock-bottom fees.

Short sales -- in which a lender agrees to take less than the principal amount owed by a delinquent owner, provided that the property is sold to a new buyer -- also frequently entail use of BPOs...

One problem is that selling BPOs to value houses violates the law in 23 states, according to appraisal industry leaders. In other states, BPOs may not be prohibited, but critics say they may be far off the mark in accuracy -- typically coming in below appraised values. That's partly because agents who perform the BPOs may set the value extra low to ensure quicker sales.

When BPO-valued houses are listed at fire-sale prices, they exert a downward pull on the values of other houses in the neighborhood because, under lending industry underwriting guidelines, appraisers must consider recent listing prices as well as sale prices...

Gary Crabtree, chief executive of Affiliated Appraisers in Bakersfield, says his company's research "shows very clearly" that BPOs frequently understate actual market values by as much as tens of thousands of dollars.

Why would agents lowball their BPO valuations? Crabtree contends that there are inherent conflicts of interest: "They want to sell the property fast" to make bank asset managers "look like heroes" to their bosses. They may also want additional BPO and property listing assignments from those same bank managers, yielding them commission dollars.

Many of the properties are snapped up by investors at the depressed prices driven by BPO valuations. Those sales then become "comparables" for appraisers, "which simply intensifies the downward spiral" in local property values, Crabtree said.

Are we learning lessons in this country from the past about people who will do anything for a dollar? It sure doesn't look like it.

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