This post first appeared in the SPECIAL EDITION: Cirios Trends: A Decade in Flux

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Whew.

After all that intense discussion of economics, home prices and interest rates, we would like to finish up this special edition of Cirios Trends with a bit of levity.

Photo by Roy Delgado.

Please do not hesitate to contact Cirios to discuss any of the topics covered in the previous pages. In the interest of space we recognize that all topics may not have been explored to their fullest, and there is nothing we enjoy more than scintillating macroeconomic discussion surrounding real estate.

By ANDREW JEFFERY

This post first appeared on Minyanville.

Americans finally get it: Home prices are falling.

This may seem like a preposterous statement, what with the entire global financial system in disarray after the collapse of the US housing market, but we Americans are stubbornly optimistic people, content to ignore calamity as long as we possibly can.

A study released this week by Zillow, a real estate information website best known for its wildly inaccurate estimates of property valies, shows Americans have finally succumbed to the notion that home prices aren’t going up anymore. 57% of homeowners polled believe their own home lost value during 2008, up from 38% who felt that way just 6 months earlier.

Interestingly, when asked about the future, respondents were upbeat: Only 30% estimate the value of their house will decrease in the next 6 months. Of course, their neighbors aren’t so lucky: Forty-seven percent believe home values in their local markets will fall during the same time period.

Zillow has become something of a cult phenomenon in the past few years, as it  allows homeowners to go online and see how much their house is “worth.” By its own admission, Zillow’s values are merely estimates based on amalgamating sales data from nearby homes, comparing bedroom counts, living area, lot size and other salient characteristics.

What few people realize, however, is that Zillow’s valuation algorithm isn’t just used by John Q. Homeowner: Every big lender in the country uses a similarly opaque formula to price real estate.

Wells Fargo (WFC) – now the biggest US home lender in the country after its acquisition of Wachovia – holds tens of thousands of mortgages on its books, each backed by a unique house. It’s impractical to regularly review each home for a fresh value, so Wells and other big banks like Citigroup (C), JP Morgan (JPM) and Bank of America (BAC) rely on analytics firms to provide property values churned out by what are called Automated Valuation Models, or AVMs.

AVMs rely heavily on recent sales data to drive their valuation estimates. This works reasonably well in a vanilla market, one where home prices move uniformly in a single direction - namely up. Even rapidly rising prices are well accounted for, since liquid markets provide reliable, normal data sets upon which calculations can be made.

AVMs are a bit behind the curve in an appreciating market, offering a conservative estimation of a home’s value. But in a declining, choppy, illiquid market like the one we’re in now, AVMs fall apart.

As sales volume dries up and prices gap down, transactions that are even 3 months old become woefully out of date. Even in distressed markets that are now seeing frenetic buying activity, active listings — and therefore true market prices — are well below all but the most recent sales.

By using AVMs to value housing assets, banks are constantly underestimating losses in a declining market. Unfortunately, there isn’t much of an alternative.

Small, independent valuation firms offer the most reliable estimations of value, but they specialize in local markets by definition, which limits the scale with which huge lenders can effectively use their results to evaluate nationwide portfolios of loans.

Next time you laugh at Zillow’s estimation that a home that just sold for $250,000 is really “worth” between $315,000 and $375,000, remember that your bank is looking at the same data. No wonder they keep asking Uncle Sam for so much money.

By ANDREW JEFFERY

This post first appeared on Minyanville.

Increasingly, US real estate is becoming a tale of 2 markets.

In low-income neighborhoods, overbuilt suburbs, and other areas besieged by foreclosures, home sales are through the roof.

Data released this week by MDA Dataquick, a real estate information service, show December 2008 sales in Southern California’s hard-hit Riverside and San Bernardino counties up a whopping 300% from a year ago. Southern California as a whole has seen transactions spike more than 50%, while pockets of the San Francisco Bay Area are showing similarly robust numbers.

Prices, however, continue to plunge.

Foreclosure sales are driving distressed markets, and since repossessions disproportionately affect lower-priced homes, data are being skewed downward. Record-low interest rates, bottom-fishing investors and relentless marketing efforts by the National Association of Realtors are all spurring renewed buying activity.

Lenders are so overrun with new business that Wells Fargo (WFC), which plans to cut over 10,000 jobs as it absorbs recently purchased Wachovia, is hiring hundreds of temporary workers to handle mortgage applications, according to MortgageDaily.com.

Meanwhile, buyers are on strike in high-end markets, and supply is creeping towards materially unhealthy levels.

Jumbo loans – those not guaranteed by the government via Fannie Mae (FNM) and Freddie Mac (FRE) – are nigh impossible to get, leaving would-be buyers of expensive homes in the lurch. Transactions are down in some of California’s — and indeed the country’s –  most prestigious markets, leaving a host of recently minted real estate millionaires wondering if they’re next to get stuck in the subprime slime.

Conventional wisdom among real-estate professionals is that these well-to-do areas are in “wait-and-see” mode. This attitude, while comforting to the rich, is dangerously naïve.

Transparent, real-time sales data is carefully concealed from the buying public by the country’s real estate brokers; it tells a very different story. In these illiquid high-end markets, inventory is building, forced sales are on the rise, and prices are starting to head south.

And contrary to popular belief, value drops aren’t just taking place in far-off exurbs where palatial Toll Brothers (TOL) McMansions litter flattened hilltops. Established neighborhoods — many close to job centers with top schools – are seeing home prices fall for the first time in decades.

These high-priced markets, particularly because of the troubles in the jumbo loan market, have become dangerously illiquid. In many neighborhoods, just a handful of homes are currently listed for sale. If one seller gets antsy, loses his job or otherwise jumps at a low-ball offer, the entire market can gap down. The new, lower price sets the bar at which potential buyers begin their negotiations, putting sellers at the whims of their skittish neighbors.

Due to dramatic appreciation during the boom, many wealthy homeowners are sitting on huge equity cushions. While not something they often complain about, this could encourage quick sales, as sellers don’t need to hold out for the absolute highest price like their poorer, more levered neighbors on the other side of the tracks.

All this adds up to an increasingly bifurcated market. The most distressed areas are currently going through the final, violent throws of a real estate collapse for the ages. The process could still take months to run its course and some communities, sadly, may never recover.

Previously strong areas, on the other hand, are just now beginning to feel the pinch. Many, after decades of unfettered appreciation, have a very, very long way to fall.

By RYAN TAYLOR

What exactly does an appraisal mean?

Perception doesn’t always equal reality. The perception is that an appraisal represents the most accurate value of a property. The reality is that it’s a value provided by a licensed professional, given the purpose and functional use of a property on a given day. The key in that statement is “on a given day.”

While appraisals are indeed very thorough evaluations of a property, they’re not always the most accurate valuation, since they often don’t take into account all the inputs required to derive the current and future value of a home.

An appraiser uses three separate approaches to derive a property’s value:

(1) Sales Approach
(2) Cost Approach
(3) Income Approach

The Sales Approach is similar to comparative market analysis, or CMA, performed by a real estate broker. The appraiser examines comparable (ie, similar) sales and listings from the last 6 months in order to come to a value conclusion. Typically, sales are weighted more than listings, since sales are actual transactions and represent a home’s true resale price, while a listing is simply what a seller hopes to get.

Comparables must conform not only with respect to the subject property itself, but also in neighborhood characteristics. 3 bedroom, 2 bath, 2500 square foot homes on opposite sides of town often sell for very different amounts. Comparables should be within 1-mile of the subject property, but this rule is far from set in stone, as certain neighborhoods dictate a narrower — or wider — radius of comparison.

In the Cost Approach, the appraiser examines the dimensions of the property and structure to determine how much it would cost to duplicate the same home on an identical lot. This is often referred to as “replacement cost.” While this is a useful method for certain types of properties, it’s rarely the most accurate for residential real estate — especially in a volatile market such as we’re currently experiencing.

In the Income Approach, the appraiser determines how much income can be generated from the property and a value is derived from this number. The appraiser usually projects into the future and assumes some ongoing stream of income, discounting the value of that cash flow for the time value of money.

The concept of the time value of money assumes (basically), that most investors would rather receive a lump sum payment now than many smaller payments over time, since inflation causes money to be worth less in the future. Of course, all bets are off during deflation, but that’s another topic for another day.

More often than not, the value of a single family residence is reached through the use of the sales comparison approach.

In reality, the sales comparison approach is effective in providing a well researched value, but it fails to utilize all necessary inputs. While comparable sales are very important to the value of a home, the comparable listings can be — and sometimes are — more important.

We like to view comparable listings as an upper bound for a property’s value, especially in a declining market. For example, if all comparable sales sold 3 months ago for $500,000 and there is a comparable listing is now on the market for $450,000, the listing is far more important than the sales. To ignore the listing and rely on the sales would be inaccurate.

Equally important is the concept of affordability, which is rarely used by appraisers. If there have been very few comparable sales in the past three months, affordability will be increasingly important when trying to understand how much buyers can afford. Weak demand indicates few willing and able buyers in the market, so evaluating prevailing income levels in a particular area help determine whether values are set for small declines, steep declines, or may be approaching stabilization.

Finally, mortgage and credit market conditions — especially now — are very important to the value of a home. In today’s lending world, you need a down payment, good credit and a strong employment history to get a loan. There are plenty of areas where the qualified buyer pool is very shallow. Appraisers don’t put a lot of weight into this fact. 3 sales in the last 6 months means a very different thing if last year there were 30 during the same time period, or just a handful.

While the sales approach does have value, it could be more comprehensive.

A crucial point to understanding appraisals is that the value is today’s value, saying nothing for tomorrow. The reality is that this is an appraisers job; they are not forecasters.

In the current market place, the appraisal can, and some would argue should, be considered irrelevant 30 days after the completion date. When markets can drop upwards of 5-10% in a single month, an appraisal that’s a month old isn’t worth the paper it’s printed on.

However, since the appraisal is still considered by the housing industry to be the most accurate representation of a home’s value, always look at the completion date to determine what lenders and investors believe a home to be worth on a given day. Whether you like it or not, this is the value on that day.

Is the process of reaching an appraised value the most defined valuation process in today’s marketplace?
Definitely.

Is an appraisal the most accurate process to determine the true value of a single family residence? Maybe.

Is an appraisal a projection of what the value of the property will be in the future? Absolutely not.

This morning’s property’s is located in Stockton, CA — what more needs to be said? Guess the value by adding a comment at the bottom of this post.

(Click for a large image)

Home Details:
- 1740 West Lane, Stockton, CA 95205
- 3 bedrooms
- 1.5 bathrooms
- 1,224 square feet
- 0.23 acres
- Built in 1951
- Recent sale: 4/6/06 for $300,000

“This 1/4 lot with a huge backyard w/ alley access. RV access and storage. Must see!! Do not disturb occupants - sold as is, sellers not providing any reports or clearances.”

Good luck!

–

From time to time, Cirios Real Estate posts a home listed in California as its “House of the Day.” We then post a valuation assessment completed by our team of property value experts. We encourage our readers to post comments and participate in a discussion about the home’s value.

Cirios Real Estate has no buying or selling interest in any of the homes we evaluate, they are posted here for the benefit of our community. This analysis is a broker’s opinion of value and is not to be construed as an appraisal.