Saturday, June 12, 2010

Appraisal Challenges: Straight from the Battlefield

The following was originally a reply to a blog on the Keeping Current Matters blog titled: The Appraisal: A True Evaluation of a Home's Worth?  Steve Harney and the KCM Crew thought so highly of my response, they posted it on his blog as a lead story and it had over 1,100 hits in 36 hours.

There are many challenges facing the real estate industry today, and one of the biggest is the abundance of foreclosures and short sales proliferating the marketplace in many areas of our country.

I have been a professional residential real estate appraiser for mre than 20 in the Chicago area, and I have never seen a marketplace like I have over the past 2-3 years.

The first issue is the Home Valuation Code of Conduct (HVCC), and the second issue is the marketplace itself. The HVCC has given the appraisal profession a major blow, and the most experienced of residential appraisers are leaving the industry. The intent and desire was to insulate appraisers from lender-pressure to direct values (push the numbers higher). The unintended result has allowed the additional layer of insulation (appraisal management companies) to seek appraisal services from appraisers willing to do the work for appraisal fees of 25% to 75% less than our fees before the HVCC was enacted in May 2009. In many cases, the quality appraisers have diversified away from the business, and this in turn is leading to less-experienced appraisers trying to survive in the most complex real estate market anyone has seen since our Great Depression. Geographic competency has become a major issue as out-of-area appraisers are going into areas they have never been to for the work.

The HVCC has caused me to completely diversify my appraisal business away from doing lending appraisals into better appraisal work where my clients truly do want to know the value of the property. (Relocation, attorneys, and other private parties for litigation, divorce, estates, trust, tax appeal, etc.)
The appraiser analyzes and interprets the market, and is an unbiased disinterested third party giving an opinion of “Market Value.” What the lender decides after receiving the appraisal report is one of the issues out there as well.

What the bank elects to do as far as making a loan is a completely different scenario. I have a relative who attempted to purchase a condominium in Florida this Spring with over 35% down, FICO scores in the high 700’s, an appraisal over $40,000 higher than the negotiated purchase price, yet two lenders (not one, but two) who approved the pre-qualification of the borrower would not make a loan on the property.
I know of another scenario where a close family friend attempted to refinance, the appraisal came back $25,000 higher than he needed to qualify, but the lender and their underwriter decided to do a desk-top review and lowered the value $50,000 below the appraised value.

My daily challenge is finding “good comparables” and in many cases, they don’t exist. The marketplace is proliferated with data of distressed sales. The definition of value in a foreclosure or short sale is going to be “Liquidation Value” – not “Market Value.” So it is indeed unfair to use comparables that sold at liquidation value in a property where market value is supposed to be estimated by the appraiser.

But what has happened, in some markets, the only homes selling are the distressed sales. This creates the new “norm.” The real estate principal of “Substitution” states that when several similar or commensurate commodities, goods, or services are available, the one with the lowest price will attract the greatest demand and widest distribution. This is the primary principle upon which the sales comparison approach is based. If competing properties are priced at $179,900, why would you pay $200,000? Food for thought.

Another concern is that as our real estate market bottoms out, and prices begin to appreciate or increase again which they are in some areas of the country, we are going to have a data pool of comparable properties supporting lower values. Really a catch-22 situation.

Tuesday, June 08, 2010

What is a Two-Flat?

Recently, I was asked to explain to a client in a different part of the country what a “two flat” was. No, it is not something you might find on your car the next morning after driving over broken glass. And it is not a musical reference (as in sharps and flat notes).

If you Google the term, a Chicago Sun Times definition states: “two-flat / too flat / n. A residential, two-story brick building with a common front entrance and separate residences on each floor. One floor is often reserved, reluctantly, for mother-in-law. Common source of extra income/aggravation for Chicagoans.”

In Chicago, we call residences with two units on one property a two-flat. In most other parts of the country, they are called 2-unit apartment buildings.

Typically, one of the two units is occupied by the owner of the property, and the other unit rented out (or used by a family member, hence the “in-law” apartment term). Often times, they are owned as an investment property, therefore not owner-occupied.

There are many things to consider with this type of property. First and foremost – is zoning allowable for multiple-family residences? Most communities with have zoning codes, and the zoning must allow for multiple-family residences. Occasionally, non-compliance to the zoning code may be “grandfathered” for the property’s type/use. In some areas, particularly once and/or currently depressed areas, lax enforcement of zoning has lead to illegal zoning situations. As a neighborhood goes through the revitalization part of gentrification, the illegal use becomes a grandfathered use.

There are three types of 2-unit residences that I can describe. Vintage 2-flats, Converted 2-flats, and Duplexed residences.  In the spirit of "a picture tells a 1,000 words," I have included some examples below.


One of the most important things to note is that this property was originally designed and built to be a two-unit building, usually one unit above the other. They often have the same exact floor plan, room and bath count, size, and two separate entrances. I saw a lot of these built in Chicago between 1900 and 1940. My grandfather and granduncle built many of these residences on the South Side of Chicago in the early part of the 1900’s.

Note the pictures below shows the steps up to the door, which show two separate entrances – one to the upper level and one to the main level. There is a lower basement level, and this is often called the “garden” apartment, and an illegal 3rd unit in a 2-flat building. Other times, the basement area has the mechanicals (furnace, boiler, hot water heater, etc.) for both units and a storage area and common laundry area. These are very common in older Chicago neighborhoods.  During the 1990's and 2000's, many of these original 2-flat buildings have been converted to condominium units.  This was at a point where the "highest and best use" of the unit changed because there was more demand and more valuable as individual condominium units than there was as an apartment.


Another type is an older single-family residence that was converted at some point to a two-unit residence. The original use of the property when built 100 years ago was a single family residence, but at some point in the property’s history, the use of the property was converted to an “in-law” apartment, or a “rental” apartment by converting the floorplan, securing a separate entrance, etc. Typically the original first floor was redesigned with bedrooms and a hall bath, and the original second floor with bedrooms reconfigured and adding a living room and a kitchen. Note the properties below, and most have two different front doors entrances – one leading to the main floor, the other to a staircase to the upper level unit.  There could be a common front door, leading to secure doors leading to each unit in the entrance.

As these properties were originally built as a 1-family home, at some point in history, the highest and best use changed, likely because of the change in the neighborhood and/or economic conditions.  Maybe the area was affluent when the properties were built, but change or deterioration in the declining neighborhood caused the "highest and best use" to be as an income producing property.  This was common in established neighborhoods during the Great Depression.


The third type of 2-unit residence is a duplex property, and typically that is a two-family residence on one parcel of land and it is side by side.  There is one tax bill, and the property owner owns both units.  Again, one is often occupied by the owner who rents out the adjoining unit. Sometimes they are mirror image of each other, other times they are not. See examples below. 

These residences were more commonly built in the 1960's and beyond.  Sometimes, these units are deeded separately, with the land split down the middle of the residence, and then we refer to them as a half-duplex.

A picture tells a 1,000 words.

Saturday, June 05, 2010

Chicago's Real Estate Market

There was a great deal of hoop-la surrounding the end of the tax credit on April 30.  If you had a contract dated by April 30, 2010, and you qualified, you could earn a $8,000 tax credit as a first time home buyer, or a $6,500 tax credit for existing homeowners who were moving up.  This was the government's attempt to spur the real estate markets, and it did work.  All of my statistics indicated the decline in sales volume stopped by the end of 2009 and began increasing again.  The real worry was what will happen after the tax credit expires on April 30.

Well, the good news is that as of today, June 5, 2010, about 36 days after the tax credit program expired, there has been 4,247 new contracts accepted for detached single-family homes in the Chicago market area, and there has been an additional 1,941 contracts accepted for attached single-family homes.

It is expected that with our Spring market in place, that the pace of real estate would continue, but the concern was at what rate.  It is clear now that our market continues on!