“Coming Soon?” Try, “Already Here”: Appraisal-by-Algorithm

When Appraisals Don’t Matter (and When They Do)

[Editor’s Note:  The views expressed here are solely those of Ross Kaplan, and do not represent Edina Realty, Berkshire Hathaway (“Berkshire”), or any other entity referenced. Edina Realty is a subsidiary of Berkshire.]

“Federal regulators have proposed loosening real-estate appraisal rules so a majority of homes can be bought and sold without being evaluated by a licensed human appraiser.  The proposal . . . potentially opens the door for cheaper, faster, but largely untested property valuations that are based on computer algorithms.”

–“Home Appraisals Go High-Tech“; The Wall Street Journal (11/30/2018).

Take human beings completely out of the appraisal equation, and what would it look like?

We already know: Zillow.

At least in my experience, Zillow’s erratic, dartboard-like appraisals (known as “Zestimates”) occasionally get it right, (very) often get it wrong . . . and sometimes aren’t even remotely in the ballpark.

That’s especially likely when a home’s floor plan, condition, and/or updates — as opposed to objective data like foundation size and finished square feet — depart from the norm.

The Role of Appraisals

All of which begs the question: “So what?”

So what if the Smiths think their $400,000 home is really $550,000, or the Johnsons believe they own a $350,000 home, when it’s likely in the high $200’s, max?

Who gets hurt?

The candid answer, at least most of the time: “no one.”

As long as the Smiths and Johnsons faithfully pay their monthly mortgage (or don’t have a mortgage); the housing market is rising (or at least placid); and no one is planning on moving . . . their home’s fair market value is a moot point.

Seeds of Next Financial Crisis

Remove one (or more) of those conditions, however, and suddenly appraisals — make that, accurate appraisals — matter a LOT.

When they’re inflated, and borrowers can’t — or won’t — make their payments, their homes suddenly aren’t homes anymore.

They’re the banks’ collateral.

And if that collateral isn’t sufficient to make banks whole if/when there’s a wave of foreclosures . . . wanna guess who’s ultimately on the hook?

Short-Term Savings vs. Long-Term Costs

So, yeah, I can see the allure of $100 computerized appraisals vs. appraisals that cost triple or quadruple that.

But, in a serious downturn, such relatively nominal, short-term savings could easily be swamped by gargantuan, long-term losses — losses ultimately borne by taxpayers.

Call it, “penny wise, pound foolish . . . times a couple trillion or more.”

See also, “Underwriting-by-Algorithm: How Long Till Computers Replace Human Loan Underwriters?“; “Zillow CEO Sells Home For 40% Less Than “Zestimate”; and “Why Realtors Hate Zillow.”

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