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Should Distress Sales Be Used as Comparables?

Written by on Monday, 04 April 2011 7:00 pm

A recent article in the Appraisal Institute's internet publication, Appraiser News Online, notes that four states are considering legislation that would affect the manner in which appraisers may treat the sale of distressed properties such as foreclosures and short sales.

The pending legislation in Maryland is both broad and vague. It states that in cases of duress or unusual circumstances "such as a foreclosure sale or short sale", the appraiser is to "consider" the property's history such as being sold at auction or as a short sale. Moreover, the appraiser is to, once again, "consider" the seller's motivation, such as a bank seeking to liquidate undesirable assets, or a homeowner seeking to avoid foreclosure. No instruction is given as to how such consideration is to proceed.

The Illinois and Missouri legislation are both direct and restricted to foreclosures. The latter says that appraisers must comply with the Uniform Standards of Professional Appraisal Practice (USPAP), "provided, however, when a property in the subject area has been foreclosed, an appraiser shall not utilize the foreclosure price as a comparable property when developing an appraisal." In Illinois the proposal reads that an appraiser may not "use as a comparable sale the sale price for a residential property that was sold at a judicial sale at any time within 12 months after the date of the judicial sale… ." The Illinois law would sunset after 5 years.

Nevada's pending law covers both short sales and foreclosures. However, it contains a broad exception. The text reads, "Except as otherwise required by federal law or regulation, an appraiser shall not include as a comparable sale in an appraisal:

1. A short sale; or

2. A sale of property which was the subject of a foreclosure sale… ."

The reference to federal law points to a problem raised by the Appraisal Institute publication. They note that appraisers are required to comply with USPAP in federally related transactions, and "The standard mandates that appraisers 'must analyze such comparable sales as are available.' Further, the standard cannot be voided by a state or local government." Hence, appraisers may find themselves having to decide whether they will violate federal or state regulations.

Leaving aside the question of jurisdictional conflicts, it is relevant to ask the larger question: should residential appraisals use distress sales (i.e. REOs and short sales) as comparables, and, if so, should they be treated differently than non-distress sales? It is not an easy question.

In a normal market (remember those?) it is widely thought that using distress sales as comparables is inappropriate because such sales are atypical, they do not reflect what is going on in the market. That can hardly be said of the market today or of the past few years. In many areas distress sales comprise 30% - 40% of total activity. Indeed, since whenever it was that the Great Recession began, in some markets distress sales have been almost the only comparables available. Nor, regrettably, can it be said that all this is about to change. Only a week ago, CoreLogic reported that the "shadow inventory" (properties at least 90 days delinquent, in the foreclosure process, or already repossessed but not yet on the market) consists of 1.8 million homes. Now, that is down 11% from a year ago, which is good news; but, knowing the general unlikelihood of successful loan modifications, it means that there will still be a sizeable number of distress sales in the foreseeable future.

While it may be appropriate and realistic to use distress sales as comparables in this market, it is most important that they be used accurately. Many are in poor condition, and the cost of rehabilitation needs to be factored into the price. Similarly, many short sales actually cost the buyer more than is recorded in the sale price. When a buyer winds up paying for such things as negotiator fees, unpaid association dues, and demands by other lien holders, those items also should be reflected as part of the actual price paid for the property.

Discovering the extent of factors such as those just cited is not easy. It takes time and extra work. Appraisers should do it, and they should get paid for it.

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  About the author, Bob Hunt

Individual news stories are based upon the opinions of the writer and does not reflect the opinion of Realty Times.