Small Talk

AVT
To: Fellow Real Estate Appraisers From: David A. Braun, SRA Date: May 12, 1995

Automated Valuation Technologies

Subject: Small talk on the industry wide uproar concerning technological change, or perhaps more appropriately, the lack thereof.
* Illustrations provided by Microsoft Clip Art.

ACCEPT THE CHALLENGE!

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Appraiser

Central Valuation Computer System

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Part I: Do Monsters Really Exist?

nxiety has reached an epidemic level in the appraisal industry. It all started with rumors of a Monstrous Computer System that was quietly being built in the basement of such mortgage giants as Fannie Mae and Freddie Mac. Have these entities, once our friends, turned against us? We have been told the creature will have the strength of ten thousand appraisers, and having read Shelly's novel Frankenstein we townspeople are not happy about it!

hile the notion of Frankenstein is easily dismissed, the warnings we heard from Richard C. Sorenson, National President of the Appraisal Institute at our December meeting held at the Club LeConte in Knoxville, are not so easily dismissed. The comment, Appraisers must find other sources of income such as the appraising ...of non-real property assets. still haunts me. The article, Systems Slicing Home Loans Costs & Time are set by Fannie Mae and Freddie Mac found on page A2 of the April 18, 1995 Wall Street Journal adds more fuel to the fire. I may be reading too much into this article, but the planned savings per appraisal mentioned of ...$300.00... seems to be very similar to the fee many users currently pay for secondary market appraisals.

any appraisers seem to be frozen much like a deer staring into the lights of an on coming car. Has anyone had dealings with a disgruntled borrower who felt that the appraiser knew too much about their property and neighborhood? On the other hand, computers can do some pretty amazing things and borrowers want to pay less closing costs. Further, the Appraisal Industry has just experienced a six month slow down... maybe an indication of things to come. So, where does this leave us? Most of us are trying to come up with short and long term plans of action. In order to do so, we must have an accurate view of the environment we are working in. Appraisers are basing future plans much more on gossip and speculation than factual information and common sense. This type of analysis is very similar to a witch hunt, and just about as productive. After all, someone once said, "Dont worry about what you cant change..." So, lets talk about what you can and should be doing.

Part II: Know Thyself:

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Y B

ou should be discarding any doubts you have about the Appraisal Industry and yourself. Our industry anxiously met, and I believe exceeded, all regulatory demands on education, training, and experience that resulted from FIRREA. During the recent unprecedented mortgage lending brought on by the lowest interest rates in fifteen years, most appraisers worked night after night and weekend after weekend. Yes, our earnings increased, but for most the primary motivation was to serve the needs of our communities and friends. You may be concerned that you are not as computer literate as you should be. Keep in mind, that the technology required to make a real difference is only now becoming available. So, if you are the typical appraiser you are well educated and trained, work hard, and are not afraid of a challenge. You have contributed as much as anyone to making the American dream of owning a home a reality. If another appraisal is never ordered, you can hold your head high! ut, folks dont retire yet. We are still needed. Perhaps our industry leaders could have been more flexible and demand driven, but I assure you they could not have worked any harder or sacrificed more. In fact, we could not be in a much better position to face this Monster. In order to make a good decision on what direction you and your company should take, lets evaluate the appraiser's role in the lending system. A good place to start is with the analogy between a mortgage loan and an automobile loan. You know the one, Why cant a $60,000 mortgage loan be closed in about the same time as a $60,000 car loan? I did some research on large automobile loans. The typical profile of such a loan is a high loan-to-value ratio with a very short term. The interest rate is about 1.5% to 2% above the 30 year fixed- rate mortgage. What is the difference between these loans? The

Mortgage loans can be closed as fast as a car loan, but they would take on much more risk.
loan-to-value ratios are similar. The terms have a similar ratio of term to expected remaining economic life. For example, a 5 year automobile loan where the expected useful life of the automobile is 12 years has the same ratio as a 30- year mortgage loan where the expected useful life is 70 years. The big difference is in the interest rate. The main determinant of an interest rate is risk. This includes all types of risk. Examples are the risk associated with the; return of the loan, return on the loan, opportunity costs (time value), etc. If the set of risks, that are associated with long-term fixed rates versus short-term fixed rates are factored into the auto loan example, there would be an even larger difference between the two rates. Mortgage loans can be closed as fast as a car loan, but they would take on much more risk. The increase in the interest necessary to offset the increased risk would knock many

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Americans out of the home market altogether and move the rest to lower priced markets. I do not know how to factor out the risk of a loan without the mortgage banker, surveyor, sales agent, home inspector, environmental expert, title attorneys, closing companies, and yes, appraisers. I do feel each of these links in the chain could be more efficient. Pointing fingers is never a good idea, so lets just be concerned with the Appraisal Industry.

he above analogy helps us focus on the role of todays appraiser. Sometimes it is difficult to see the forest for the trees. We have been estimating market value for so long that maybe we have forgotten why. We do this to help lenders manage the risk side of their loan portfolio. Remember that there are many types of risk. We deal in that group of risks that are associated with real estate markets. Usually, aspects of these risks are analyzed, or at least touched on, in a property appraisal where market value is estimated. The question is, are the benefits (dollars saved) greater than the cost (time and money) of the appraisal service? The problem, or more appropriately the challenge, is to provide services where the benefits outweigh the costs.

The Benefits of the Appraisal Service

Must be Greater than

The Associated Costs

Did you notice that we went from Frankenstein, to the Problem, to the Challenge?

t is beyond the scope of this paper to present a risk analysis, or go into the theory of probability. However, I am presenting an example calculation of how much interest reduction is necessary to pay for the dollar cost of the appraisal service in a hypothetical situation. Assume a $60,000 loan, 30 year term, 9% mortgage rate, and $300 appraisal cost. In order to convert this $300 cost that is in the present value to a rate, it must first be converted to be a part of the repayment of the 30 year loan. The difference in the payment for the above example and the payment of a $60,300 loan with all other parameters remaining the same is $2.42 ($485.19 less $482.77). In order to reduce the appraisal cost too break-even, the interest rate reduction is found by reducing the interest rate to the point that the $60,300 payment is reduced to equal the payment resulting from the $60,000 loan. This amount is approximately 0.055% or 55/100,000 (9.0% less 8.945%). This tells us that the underwriter must be willing to reduce the mortgage rate from 9.0 to 8.945 percent because of the improvement in risk that directly resulted from information, analysis, and conclusions presented in the appraisal.

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large computer network with fly by satellite inspections may be the appraiser of the future, but we should be more concerned with the problems we face now. We are perceived to be an expendable part of the lending system by many lenders and politicians (this has probably always been true). Appraisals are being replaced by tax cards on many second mortgage loans (I do not know if this meets the minimum guidelines of the appropriate regulatory agency, but if so this trend will worsen). If the income tax exclusion for mortgage interest is removed (as may result from a flat tax rate) fewer mortgage loans may be made in the future. There is a chance that the supply of appraisers is greater than the demand. If we do not improve the time aspect of our service, we will get the boot whether or not a monster computer system is ready to replace us. Just when all seems hopeless a new powerful tool is laid at our feet, the PC. If the HP-12C is a shovel, the 486 computer with a modern word processor and spread sheet is a bulldozer. The good appraiser is one third mathematician, one third investigator, and the rest artist. Computers represent the means to improve your math; organize, store and access data from your investigations; and be a whole new canvas on which you may present your artistry. Our industry was under heavy attack before the computer arrived. Do not think of the computer as a player, but rather as a tool.

Part III: What Does Your Nose Have to do With IT?

t would be simpler if all the appraiser had to do was to provide and market cost- effective services to lenders. However, we are regulated through licensing laws. The Uniform Standards of Professional Appraisal Practice (USPAP) outlines most all of the services we can provide, and tells how to provide them. USPAP is a good thing to be tied to, but perhaps you have felt a tug from another direction. This would be the Federal Financial Institutions Regulatory Agencies (FFIRA). The FFIRAs tell most of the financial institutions what the minimum valuation service is acceptable for specific loan categories. This is why you may feel like a puppet that is being operated by two puppeteers. The only way to free ourselves from this predicament is to follow a very famous puppets example. In the story of Pinocchio, the importance of the truth was graphically emphasized by the puppet's nose growing each time he told a lie. Unfortunately, real life is not so clear.

A
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number of truths are apparent. Both, the Appraisal Foundation and the Appraisal Standards Board have had a very positive influence on our profession and the well being of the general public. They have nobly responded to an assault of unprecedented change. Remarkably, they have done this without much help from the average appraiser! If it is impossible to serve two masters, who then do we serve? Should USPAP dictate our roles, or do the agencies of the FFIRA have that right? Certainly, their failure to limit the performance of evaluations to state licensed and certified appraisers was a message heard loud and clear. If a federally regulated bank becomes insolvent the FDIC is responsible to repay any FDIC insured deposits. If you hold to the adage You can delegate authority, but you cannot delegate responsibility you can see that the entity left holding the bag must have the final authority. Our profession cannot and should not dictate terms to the responsible agency. However, Our legal system is executed by means of a series of checks and balances. This is no accident or inefficiency. Our government was established with the belief in mind that Power corrupts and absolute power corrupts absolutely. Abuses do happen, such as the one which occurred at the highest levels in FHA a couple of years ago. The truth is, the general public is best served by state licensed and certified appraisers when any real property service (appraisal, evaluation, review, consulting, feasibility study, risk analysis, etc.) is performed. The Regulators should have the final authority. However, they should not have absolute authority. Certainly, something has to give, a compromise must be reached. I suggest a compromise where USPAP allows appraisers to perform most any service for large responsible entities such as the FFIRAs. This would happen under the watchful eye of an uncompromising ethics provision. In return, these entities would restrict the performance of these services to state licensed and certified appraisers. We cannot meet the needs and demands of the public if it is illegal for us to provide these services. If these services are inappropriate it is the fault of the responsible entity, not the fault of the appraisal profession.

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n analogy might make the picture a little clearer. A person buys a pair of cowboy boots (valuation product) to play basket ball in. The game officials (responsible entity) make the regulations concerning footwear. During the game that person slips resulting in an injury. The officials would be in error for letting that person play while wearing cowboy boots. They pay the medical bills for the injury and change the regulations concerning foot wear. Certainly, the shoe manufacturer (appraisal profession) is not to blame for misuse of the product. While there is only one medical and legal system in this country, there are many mortgage based lending systems. Some examples are state banks, federal banks, credit unions, FHA, VA and secondary market participants, just to name a few. To further complicate matters each of these have multiple programs. A good argument could be made for the shoe maker to stop making cowboy boots or try to modify the game regulations. However, the manufacturer is but one cog in the system. The system is counting on them to do their job. The general public would be best served by improved products resulting from a better understanding of orthopedics.

Part IV: When the Going Gets Tough...

elieve it or not, we are in a good position to meet the challenges that confront us. The appraisal Industry has recently undergone extensive restructuring. These changes resulted in USPAP, the Foundation, and a number of state agencies and commissions. We have a solid understanding of the theory of valuation and offer a wider range of services than ever before. Computer technology is just coming on line in our profession so, no one is too far behind to catch up. Furthermore, we can continue to evolve by improving existing appraisal techniques and by finding new ways to help keep the risk, and therefor mortgage interest rates low enough to perpetuate the American dream of home ownership.

e can do this by improving the tried and true market value estimate and seeking other risk management tools that we are uniquely qualified to provide. Todays appraiser can improve performance in terms of turn-around-time and accuracy by use of computer integration and automation. Computer assisted appraisals have fewer mistakes and allow the appraiser more time to better research sales information. Modern techniques such as modeling (something most of us have been doing all along, but didnt know it) are leading to the acceptance of new valuation theories and techniques. We already provide information to the underwriters to aid in risk management. I am just wondering if we could provide more?

n a day-to-day level you can expect some changes: 1. Appraisers will have to support the foundation and the professional organizations, with time and money, more than in the past. The state

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licensing agencies serve a purpose but do not allow for the collective self-improvement that our industry needs. 2. You will have to spend more money on computers, software, and training. In the range of 5% to 10% of your gross for each of the next few years. 3. You may have to join a larger, more progressive firm that can aid in the equipment and training costs. Some tips are: 1. If you are a small company share expensive equipment with another similar sized company. 2. Crawl before you walk. Start your computer training by taking very general courses. 3. Let different people in the office specialize in certain types of software (word processor, spread sheet, database, etc.). 4. If you are not a member of a professional appraisal organization join one. It is time that the lone wolves return to the pack. 5. New ideas and theoretical advances must be embraced by our profession if we are to continue to meet the needs of an ever changing economy. 6. Set goals, and develop a business plan that will achieve those goals. This is called management by objectives. An example of goal setting follows:
A) To increase your gross by 25% over the next 2 years. Means: By capturing a larger piece of the pie by offering and marketing more valuation products. To expand geographically. B) To instill more confidence in the users of the report. Means: Be more accurate in both the appraisal and the report. Improve the look of the overall report. Start a news letter discussing issues that are important to lenders. C) Improve turn around time by 25%. Means: Use computers to auto mate and integrate. Set up an inhouse photo system.

7. Develop a Corporate Mission such as the following:

To provide Lending Institutions and the General Public with Information with which to base decisions concerning Real Property.

USPAP tells us this requires Integrity, Objectivity, Independent Judgment, and Ethical Conduct. 7. Most Importantly, start today!

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Part V: Conclusion
The purpose of this paper is to point out that things are not as bad as they seem. Lenders are demanding risk analysis services that are very different from what we have offered in the past. Appraisers have a proven track record for hard work, training, and adaptation. It is ironic that many appraisers fear that they will soon be replaced by computers. It is the PC that will allow them to offer these new valuation products and services just as quickly as any large computer system can. The appraisal profession has served Americas economy nobly in the past, and we are still needed. The general public deserves, and I believe will demand, that all valuation services be performed by the existing pool of well trained and licensed appraisers. However, we must be able to perform these services in compliance with USPAP. Just as Pinocchio could not evolve into a real boy until he stopped lying, our industry cannot evolve further without accepting and adapting to the realities of our environment. Some fundamental changes will have to be made at the very foundation of our profession. An eleventh standard must be created concerning automated valuation techniques. Ethics will have to be more strongly emphasized than in the past.

es, monsters do exist! There are two types; imaginary and real. Both are created by human beings. Perhaps Huxley said it best, One of the many reasons for the bewildering and tragic character of human existence is the fact that social organization is at once necessary and fatal. Men are forever creating such organizations for their own convenience and forever finding themselves the victims of their home-made monsters.1 There may come a time when appraisers are replaced by a computer. However, this is not the time. There are some amazing similarities between the story of Frankenstein and a central computer system that would be able to generate valuation conclusions through artificial intelligence. The following passage has been included for amusement only, and is not intended to belittle any particular person, group, or agency.
Frankenstein (frngken-stn) noun 1. An agency or a creation that slips from the control of and ultimately destroys its creator. 2. A monster having the appearance of a man. [From Frankenstein, the creator of the artificial monster in Frankenstein by Mary Wollstonecraft Shelley.] Word History: The word Frankenstein has taken on a life of its own, somewhat like the monster created from parts of corpses by the Swiss student Frankenstein, whose name serves as the title of Mary Shelley's novel, published in 1818. People have persisted in calling the monster Frankenstein; in fact, the first recorded use of the name as a common noun in 1838 refers to mules as "Frankensteins." The word has gone on to refer to "a monster having the appearance of a man" and "an agency that slips from the control of and ultimately destroys its creator.

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Since most people have given the name of the novel's protagonist to his creation, Frankenstein's monster has, in a sense, destroyed its creator.2

here are a number of real challenges facing us at this time. The general public deserves for all valuation services to be performed by state licensed and certified appraisers. Many of these services are being performed by individuals with less training and experience even though most appraisal offices are operating below their normal capacities. Perhaps, the most important thing we can do is get involved with the entities that control how we provide services to our clients. This includes the Appraisal Foundation, state agencies and commissions, and professional appraisal organizations. We will have to change our day-to-day business operations to adapt to this new environment. To plan and implement the changes we must understand the environment we are working in, and what our role is in it. We must educate the public to the fact that our services are cost effective. We must find new risk management related services and present the existing ones in more useful formats. If we do not change there will come a time when we will be the problem. According to James Baldwin, People who shut their eyes to reality simply invite their own destruction, and anyone who insists on remaining in a state of innocence long after that innocence is dead turns himself into a monster.3

ost importantly we must we must have faith in ourselves and in our profession. Many of you are having a hard time developing a specific plan of action to meet these challenges. I have some very specific things in mind, but there is one thing that you must do before you can proceed:

Accept the challenge!

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Endnotes
1

Aldous Huxley, Themes and Variations, "Variations on a Philosopher" (1950) sct. 2. From Professional Office and Bookshelf. Computer software. Microsoft Office Professional 4.3/Microsoft Bookshelf 1994 Edition.
2

The American Heritage Dictionary of the English Language. Third Edition Houghton Mifflin Company, 1992. Computer software. Microsoft Office Professional 4.3/Microsoft Bookshelf 1994 Edition.
3

Baldwin, James. "Stranger in the Village." Harper's. (New York, Oct. 1953; repr. in Notes of a Native Son, pt. 2, 1955). From Professional Office and Bookshelf. Computer software. Microsoft Office Professional 4.3/Microsoft Bookshelf 1994 Edition

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