Are Real Estate Appraisers Unknowingly Contributing to Rigging Capitalism?

The elites are stockpiling billions of dollars just waiting for the next recession. Since the last recession, the rich seem to be running away with all the gains while wages have barely grown. Are the rich to blame for this imbalance or is something not working as it should? Is Capitalism inherently rigged?

Analysts in the equity and bond market are crunching the risk of these assets on a daily bases. Values are indicated daily in real-time.

Professional investors like Warren Buffet are successful because they have devised an analysis called value investing. This is an investment paradigm that involves buying securities that appear underpriced by some form of fundamental analysis.

Investors like Warren Buffet don't naively trust the collective markets' forecasts that determine the present value pricing of a security at any single point in time. He is aware that globalization has created an investment environment that can significantly throw supply and demand out of balance in certain markets and asset classes. This imbalance can lead to irrational exuberance or irrational fear of the markets' forecasts that determine any asset's current price.

Instead, Buffet compares an asset's current market pricing to the asset's fundamental value. This essentially strips the collective markets forecasts of any irrational speculation or irrational fear. If the asset's market pricing is below the fundamental value, he buys. If pricing is equal or above the fundament value, he doesn't buy.

Unlike the equity market, the real estate market has not caught on to this concept. As a result, the major real estate market crashes are getting worse and worse and more frequent, i.e. the Savings & Loan commercial collapse of the late 1980s and the most recent "Great Recession" of 2007. This is leading to greater and greater income divides and hurting the reputation of capitalism as a rigged system.

Real estate appraisers are the major analysts that protect the public trust from overpriced or underpriced real estate assets based on the "most probable" selling price. The weakness of this first line of risk defense is that by law, the appraiser must only take into consideration what the collective markets' forecasts are for a specific property. This analysis will indicate the "most probable" selling price of a property based on the collective markets' forecasts.

The present value of these market forecasts is what determines the current "as is" market value of the property. Appraisers seek out recent comparable sales of similar properties to compare to the appraised property. The comparable sale prices are also the present value of the collective markets' forecasts.

If there is any irrational exuberance or irrational fear of the collective markets' forecasts associated with the comp sale price, it will then find its way into the appraised "most probable" appraised value using the traditional sales comparison approach.

The other two appraisal methodologies, the Cost Approach and the Income Approach by law also reflect the collective markets' forecasts for a specific property. Consequently, if all three approaches are used in an appraisal, the resulting values will be similar to each other.

This means appraisers are appraising properties in a vacuum. The paradox is appraisers are ethically, competently and legally doing the right thing by indicting the "most probable" selling price. The weakness of this process is that it's not uncovering the hidden risks or opportunities of this "most probable" single-point-in-time value opinion. What if hidden within this "most probable" value opinion is forecasts laced with the collective market's irrational exuberance? Conversely, maybe there are hidden opportunities in the "most probable" value opinion due to the market's irrational fear in its forecasts. This has led users of appraisal products to rightfully ask the question, "What good is an appraisal if it doesn't protect me from market cycle risks?"

Many appraisers sense this weakness and, especially after the "Great Recession" of 2007, are sensitive to "rubber-stamping" a property's selling price that's in escrow. They are now more "conservative" in their value opinions. They don't want to be thought of as a "whore" by their peers. The paradox is these types of appraisers are nevertheless unethical, incompetent, illegal and not doing the right thing according to licensing law.

As a result of these "illegal" valuations, the users of appraisal products have pressured the appraisal licensing institutions and state legislatures to lessen appraisal standards. This has also resulted in raising the requirements of even needing an appraisal. It has also led to allowing non-licensed appraisers to perform appraisals for lenders. Non-licensed appraisers are not subject to any appraisal standards, rules, punishment or liability.

So who are the bad guys exploiting this weakness? Actually nobody. You can't blame the rich, banks, appraisers, buyers, sellers, Realtors, bank examiners, bond rating companies, the secondary markets, derivatives, and especially capitalism.

The problem lies in the traditional appraisal process that is the first line of risk defense in the real estate markets. This traditional risk assessment of an appraisal only defends against an appraised value being too high or low in relation to the "most probable" value established by the collective markets' forecasts. As we have seen from past real estate collapses, the markets' forecasts and resulting "most probable" market value can be laced with the market's irrational exuberance leading to significant valuation collapses in the near future during a market cycle.

This imbalance of supply and demand can cause the "most probable" value opinion and its market forecasted ending selling price, called reversion, to significantly separate from the property's fundamental value and its fundamental reversion. This paradox can cause a well supported "most probable" market value opinion to be misleading if the underlying risk is not divulged of this value collapsing during the market cycle.

Of the three economic systems, Capitalism, Socialism and Communism, Capitalism by far is considered the lesser "evil". Capitalism works well if asset prices stay within a reasonable distance of the asset's economic fundament value and fundamental value reversion.

The "damned if you do and damned if you don't" paradox of real estate appraising is a very dangerous paradox to continue. Yet the solution to this appraisal paradox is not that hard to fix. See "The Paradox of Real Estate Appraisals."

Real estate is the world's largest and most important asset class. All the property in the world, including commercial and residential property, is worth an estimated $228 trillion as of January 2019. Unlike the equity and bond markets where losses are mainly absorbed by the investor, losses in the real estate markets have a more far-reaching negative economic impact on a national and international scale. The United States alone remains $20+ Trillion in debt from the last real estate collapse.

Many real estate markets and micro-markets in the western hemisphere are exploiting this weakness in the appraisal process. As financing becomes more prevalent loans are being made with an LTV (Loan to Value) based on the "most probable" value.

Many of these loans are being sold into the secondary markets and bundled into bond-like financial products that are guaranteed by the government. The remainder of these loans are retained by the lenders as portfolio loans by lenders.

Unlike when the equity and bond markets collapse, a real estate collapse impacts more than just the investors and property owners. As the largest asset class, real estate collapses have a significant economic impact not only to investors and property owners but to national economies in the western hemisphere. It disrupts critical financial banking infrastructures, stresses federal government loan guarantees, stresses the federal reserve, and can render a nation insolvent.

The traditional appraisal process, standards, rules, and institutions work well in uncovering the risk of a high or low appraised value in relation to the "most probable" selling price. The solution is to take the appraisal process two steps further. This appraisal reform solution can be easily implemented, follows generally accepted appraisal standards, and builds on the traditional appraisal methodologies of arriving at the customary single-point-in-time current market value opinion. This additional appraisal methodology reform also eliminates appraiser bias or lender pressure of single-point-in-time value opinions that are considered too "high" or too "low" by stakeholders. It also prevents appraiser liability if and when market values collapse during a market cycle. See "Are Appraisers Patsies?".

First, every appraised single-point-in-time final value opinion for income-producing properties needs to be clearly reversed engineered into the collective market's forecasts including the property's ending sale price or reversion. This gives the appraisal recipient bite-sized bits of the collective markets' forecasts they can better comprehend than just receiving a single-point-in-time value opinion. Modern spreadsheet technology using the yield capitalization methodology can easily accomplish this.

If the property being appraised is currently not at its highest & best use, the property's prospective value opinion when it does reach its highest & best use needs to be reverse-engineered. This prospective value is when the property is 100% complete to its H & B Use and is leased at market rents and at stabilized occupancy.

This prospective value for non-stabilized income-producing properties is currently part of the appraisal process and is commonly indicated.

Appraisers owe it to their clients in revealing all the collective markets' forecasts associated with their "most probable" value opinions. The clients can see for themselves if the collective market's forecasts are irrational, reasonable, too conservative or even clash with the client's own risk tolerance. If the client ignores these forecasts and is only interested in the current value, well, at least you've done your job.

You also insulate yourself from future liability if your client claims damages or the licensing board makes accusations against you due to significant changes in your appraised value. "You should have known" accusations are "Monday morning quarterbacking" and a weak argument if you disclosed what the market was forecasting as of the date of the appraisal.

Future changes in value also change the markets' forecasts. You have a better chance of prevailing in these situations if all the markets' forecasts are disclosed in conjunction with your opinion of value.

Secondly, the reversed engineered value opinion and its market forecasted ending reversion selling price needs to be transposed onto a value sustainability model. This model also indicates the property's fundamental value as of the same appraisal date of the subject appraised property. This fundamental value is reverse-engineered into its fundamental forecasts including an ending fundamental reversion sale price.

The fundamental forecasts are based on market rents being in alignment with the demographic purchasing power of users that buy or lease the property. Other fundamental forecasts are the all-cash yield rate forecasts that need to be in alignment with competitive all-cash yields of alternative investments with similar risks. Lastly, forecasts in the direction of the current market rents in the future need to be in alignment with the demographic's future purchasing power direction.

This value sustainability analysis isolates any of the collective markets out of balance speculation regarding the property's future reversion ending sale price forecast. When completed, this model quantifies whether the collective markets' ending sale price reversion is achievable or whether the ending sale price will end up being closer to the fundamental value reversion or worse.

If this analysis indicates the collective markets' current "most probable" sale price is significantly greater then the fundamental ending sale price reversion, the current "most probable" sale price is considered not sustainable during the market cycle.

History has proven in all previous market cycles that property values gravitate toward equilibrium or fundamental values during any market cycle. The value sustainability model quantifies a property's equilibrium line with the property's fundamental value and its fundamental reversion ending sale price during the current market cycle. This micro-market cycle is specifically tailored to your appraised property type and neighborhood-specific market.

It is not enough to simply value a property's "most probable" pricing and placing this value on a macro market wave cycle. Without quantifying the equilibrium line that's the middle point of the wave cycle, there is no context as to how stable or unstable this "most probable" value might be.

This value sustainability model indicates how stable or unstable the current "most probable" market value might be during its current market cycle. It also indicates hidden opportunities of a property's current "most probable" market value. These opportunities are identified in better than expected market forecasted outcomes, including the reversion forecast during the market cycle.

These two additional analyses of the appraisal process advising reverse engineering and value sustainability analysis might sound complicated and time consuming for the appraiser. This observation was taken into consideration when contemplating the practicality in executing this solution and implementing these risk analyses solutions into the appraisal process.

Through automation and technology, no further time, analysis or due diligence is necessary from the appraiser to complete these additional analyses into the appraisal process.

These additional analyses can be used for single-family homes as well as income-producing properties and subdivision properties. See "Critical Risks Many Appraisers Are Not Telling You".

By adding value to your appraisal company in implementing this modern technology, you are also solving the appraisal paradox and ceasing to contribute inadvertently to the rigging of capitalism.

Our team is willing to consult with you and your company regarding this important technology. We can show you how to build these models so you can automate the process.

Download our WHITE PAPER on how the value sustainability analysis specifically works. Help reform the valuation industry that better protects the public trust.



































