Baking depreciation into appraisals

Wow, I missed yesterday altogether! Sorry about that. I got caught up in a tempest in a teapot discussion going on over in the National Association of Realtors Group on LinkedIn that I post to almost everyday, too. The topic seemed innocent enough - the practice, apparently just recently "discovered" by some, of appraisers baking a home's appreciation or depreciation into their appraisals.

I opined that we are were more than happy to have them bake-in 6 months of appreciation when homes were going in that direction; but, now everyone is upset when they take 3-6 months of depreciation into account when setting a value for the bank. Not fair, was the outcry. I'm not sure who thought that the appraisal process was ever "fair" or fair to whom. An appraisal is, after all, an attempt by the bank (and paid for by the bank) to assess the risk inherent in the loan. A part of the risk (and one could easily make the case that it is the biggest part right now) is how fast the price is moving with the market and in what direction. The appraisal is not done for the benefit of the buyer or the seller, but for the lender, because it is the lender who is putting the most at risk in most purchases.

So, for the last couple of years, appraisers have been under instructions from the banks on how to account for the risk fo depreciation of the assets that they are about to lend on. Initially there were instructions to take about 5% off every appraised value to account for depreciation. Now, with values dropping between 1 - 1.5% per month, many appraisers have been instructed to take 6 months worth of whatever the local depreciation factor is, as a way to factor in the risk of lost value. Even with that, many banks now find themselves upside down on loans that they made only 8-12 months ago.

So the posts fly back and forth – it’s not fair…they should do a real time appraisal…what if they miss the turn around…how can this be…oh, whoa is me, the sky is falling. I’m trying to make the point, sort of like in the movie The Godfather, that it’s not personal, it’s just business. The banks have to find a way to factor in the risks involved in real estate loans right now and asking the local appraisers to factor in 3-6 months of the current, local rate of depreciation may be the best and most fair way to do that. Those who don’t want that to happen are like the children who play hide and seek and yell out “Don’t see me”, when the child who is IT approaches. They don’t want the banks to look at what is staring them in the face. That’s what got us into this mess to begin with. But, maybe you have a different point of view on this. What do you think? Should the banks and appraisers be allowed to bake-in some amount of depreciation when valuing a home for a loan?