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Low appraisals sabotage more deals

150 East 77th Street was appraised for 15 percent below contract price

Edward Milton Cisneros, a real estate agent at New York Living Solutions, was surprised recently to receive a panicked phone call from a family he is representing in the purchase of a Long Island City new construction condo. The buyers said the appraisal for their new home — a two-bedroom and studio they planned to combine into one unit — had come in far below the agreed-upon purchase price.

"I got an alarmed phone call from my buyer," Cisneros recalled. "The bank was questioning why they were paying so much."

The low appraisal threatened to kill the sale, he said. The bank would now only lend up to the appraised value, and there was no telling whether the buyers would be willing or able to cough up the extra cash needed to close the gap between the appraisal and the agreed-upon price.

Luckily, the developer was anxious to close and the two sides hammered out a last-minute deal, with the buyers paying a lower purchase price but higher closing costs.

"It stalled the closing for a few days while they tried to work that out," said Cisneros, who noted that he has encountered several tough appraisals recently. "It's a very difficult time to determine value right now."

That's truer than Cisneros may realize.

Real estate brokers all over the New York City area say that more and more appraisals are coming in unexpectedly low, disrupting sales that they expected to close seamlessly. The problem has spread rapidly in recent months, due in part to new guidelines known as the Home Valuation Code of Conduct, which went into effect May 1. HVCC is intended to prevent appraisal fraud by requiring appraisers to be selected by third parties who have no stake in the sale, but brokers say the code has unintended side effects that make it harder to get deals done.

Thanks to the new rules, an increasing number of appraisals are being conducted by out-of-towners unfamiliar with the complex and idiosyncratic New York City market, they say, leading to appraisals that come in up to 35 to 40 percent below the contract price and torpedoing deals in the process.

"It's a nightmare," said Melissa Cohn, president of Manhattan Mortgage. "We have people coming from the far reaches of the tri-state area to appraise a co-op."

Cohn estimated that HVCC guidelines, which affect mortgages backed by Fannie Mae and Freddie Mac, impact some 50 percent of real estate sales in the city.

Federal legislators have introduced a bill in Congress asking for an 18-month moratorium on HVCC, and Steven Spinola, president of the Real Estate Board of New York, said his organization is supporting the measure.

"It's an example of good intentions that didn't do what [they were] supposed to do," Spinola said of HVCC. "We're getting people doing appraisals who have no local knowledge and, as a result, are having difficulty recognizing what the market is here in New York City. It stops deals from happening, which is the reverse of what we want to do."

A low appraisal is the kiss of death for a real estate transaction, explained Steven Knobel, a partner at appraisal firm Mitchell, Maxwell and Jackson, who said he has recently seen Manhattan appraisals come in as much as 35 percent, or nearly $200,000, below the purchase price.

In those situations, the buyer must come up with more money or convince the seller to slash the contract price. Neither option is likely in the current climate, especially after the contract has already been negotiated.

"Deals just get killed," Knobel said.

HVCC was developed as part of a recent settlement between New York State Attorney General Andrew Cuomo and Fannie Mae and Freddie Mac. Intended to prevent appraisers from artificially inflating home prices, the code prevents loan officers, mortgage brokers or real estate agents from playing any role in the selection of appraisers, or even communicating with them.

As a result, lenders now increasingly rely on entities known as "appraisal management companies," or AMCs, which use automated systems to distribute thousands of appraisal orders a day to a pre-selected "panel" of appraisers all over the country.

But AMCs are for-profit companies that select their panels in part by choosing the appraisers with the cheapest rates. Because experienced New York City appraisers often charge hefty fees, critics say, AMCs often select appraisers from outside Manhattan.

At a time when it's already difficult to perform appraisals because comparable sales are scarce, many say these inexperienced players are churning out poor-quality appraisals in the complex and less-than-transparent New York market, which has no MLS.

"Unless you've been an appraiser in New York for some time, you have no idea how to understand the difference between a Park Avenue building and a York Avenue building, and that's where we're seeing a lot of the issues," Cohn said.

HVCC "is a great idea," but it's not being executed correctly, said Jeffrey Jackson, Knobel's partner at Mitchell, Maxwell and Jackson. He said he recently stopped doing work for a large AMC because it kept selecting him for appraisals in Staten Island, though the bulk of his experience is in Manhattan and Greenwich, Conn.

"Staten Island is an entirely different market, but [AMCs] can't differentiate between these areas," Jackson said.

In Manhattan, Knobel said, he has seen appraisers from as far away as Albany use walk-ups to help determine the price of an elevator building, or use post-war units as comparable sales for prewar apartments.

At one appraisal he saw, at 150 East 77th Street, the appraiser had pegged the price at roughly 15 percent below the contract price. The appraiser, it turned out, had come from Brooklyn, he said. To the automated system at an AMC, that likely doesn't seem far away, but it's a world of difference in terms of property values and housing stock.

"It's a different mind-set, a different kind of market," said Knobel. "You really want your appraiser to live in the neighborhood."

Moreover, the margin for error is much larger in New York, Jackson said, where two blocks can mean the difference between $1,000 and $2,000 a square foot.

"If you go into a market like Arizona or California where the properties are relatively homogenous, a mistake there is plus or minus 10 percent," Jackson said. "Here, a mistake is 40 to 50 percent."

Jeff Schurman, the executive director of the Title Appraisal Vendor Management Association, which represents roughly 15 AMCs, said it's up to each individual appraiser, not the AMC, to decide if they are competent to work in a specific area or not. He added that AMCs take zip codes and other geographical factors into consideration when distributing assignments, and that complaints about out-of-town appraisers are exaggerated.

"I don't think it's as rampant as some would like it to sound," he said.

While TAVMA agrees that some aspects of HVCC need to be revised, Schurman said many of the code's detractors are resentful mortgage brokers and appraisers who can no longer rely on cozy relationships they've built over the years, or who are losing business to AMCs.

"There's a group of people who really want to get rid of HVCC, and they'll do whatever they can to get rid of it," he said.

HVCC isn't the only factor impacting the appraisal process. It's no secret that in the midst of the financial crisis, banks now prefer lower appraisals because it lessens their risk.

"Banks want to discount the value an additional 10 percent so they're not feeling overextended," said Frances Katzen, an executive vice president at Prudential Douglas Elliman, who said she has had several recent appraisals come in too low. "The way they're lending now is so much more stringent, and it's not always fair and accurate."

Cohn said sales sometimes fall through because appraisals under the new system tend to take longer than they did in the past while buyers with mortgage contingencies have deadlines.

"There's no sense of urgency," she said, explaining that the real estate agents and mortgage brokers involved in the deal can't contact the appraiser to find out what's causing the holdup because the new rules prohibit them from communicating.

"It's causing tremendous delays," said Cohn, who noted that she's been waiting for an appraisal on one of her loans for almost four weeks.

She said her company now works as much as possible with portfolio lenders, who keep mortgages on their books rather than selling them to Fannie and Freddie, and thus are not governed by HVCC.

HVCC "is actually harming the real estate market more than it's helping the real estate market," she said.