This piece originally appeared in the February 2023 edition of MReport magazine, online now [1].
A house is often a person’s largest asset.
Similarly, owning a home is often an individual’s greatest source of wealth. According to the Local Initiatives Support Corporation (LISC), homeownership is the primary way that low- and moderate-income families build wealth and achieve financial stability.
Homeownership is not only important for building wealth for the current generation but also foundational for passing on wealth to future generations. This is one of the many reasons why the appraisal valuation process is now under the microscope and being investigated to ensure fairness for all property owners.
Why Are Appraisals Important in Lending?
In the lending process, the value of the home is critically important. Lenders want to know a borrower’s income and their ability to repay the loan, their credit score, and the current property value, which determines the amount of equity in the home. All these factors determine the overall risk of the loan and will have an impact on the borrower’s interest rate and monthly payment.
During the market crash over a decade ago, most headlines were about home “overvaluation.” Roughly one-half of the loans being created then were cash-out refinances. Borrowers were looking to leverage as much equity as possible. Often borrowers were allowed to take so much equity out of their home that it put them in a negative equity position.
Combining negative equity with an adjustable-rate loan (pushed by subprime lenders), followed by a real estate market correction, resulted in widespread home depreciation and the “perfect storm” that helped drive the real estate market crash of 2008.
Today, the mortgage world is very different. Appraisal bias and “undervaluation,” is dominating the headlines. The Brookings Institution’s study, “Racial Disparities in Home Prices Reveal Widespread Discrimination [2],” cited several examples of racial bias, including the following:
“In Denver, a Black family in a white neighborhood was looking to make renovations and sought an appraisal for a refinance loan. The home value came in at $405,000, using comparable sales in a Black-majority neighborhood different than the neighborhood they lived in. A second appraisal was done after removing all indicators of race. That appraiser used comparable properties within their own neighborhood. The property was appraised at $550,000.”
“In San Francisco, a Black family invested $400,000 into their home for major renovations. After the work was completed, an appraisal came in with only an increase in value of $100,000 over the pre-renovation value. After removing all indicators of race, a second appraisal was completed and produced a home valuation that was $500,000 more than the pre-renovation value.”
What Can Be Done to Prevent and Identify Potential Bias?
The issue of racial bias in valuations is not new. The appraisal process is meant to be unbiased. However, there continues to be examples of bias in the appraisal and lending industry.
The good news is there are technological advancements and proactive leaders in the industry working together to combat bias.
The PAVE (Property Appraisal and Valuation Equity) Task Force [3] was commissioned by President Biden to evaluate “the causes, extent, and consequences of appraisal bias and to establish a transformative set of recommendations to root out racial and ethnic bias in home valuations.”
A few of the PAVE recommendations include the following:
- Develop data-sharing arrangements among all relevant government agencies and pursue joint strategies to make appraisal-related data more widely available, foster federal research, and better enable enforcement related to appraisal bias. I believe having public access to market data can help identify and remediate potential bias concerns.
- Develop a legislative proposal that modernizes the governance structure of the appraisal industry to improve transparency and public participation in the establishment of appraisal standards and appraiser qualification criteria, and to advance diversity in the profession.
- Define metrics that can help to identify and measure patterns of miss-valuation in the property valuation process and address potential bias in the use of technology-based valuation tools through rulemaking related to Automated Valuation Models (AVMs).
Word Search
Another way to help reduce potential bias is for appraisers to use more objective language in their reports. Using technology and automated review tools, appraisals can easily be scanned for the use of subjective words and phrases that could be considered bias related. This information can then be analyzed to determine if there is a correlation between the use of potentially biased words and appraisal valuation.
Appraisal Diversity Initiative
The Appraisal Diversity Initiative (ADI) is a nationwide program led by Fannie Mae, Freddie Mac, and the National Urban League. The goal of ADI is to reach out to diverse, talented candidates and educate them about the appraisal profession and provide resources for interested candidates to help them get on a path to success in the appraisal field. According to Zippia, the most common ethnicity of real estate appraisers is white (84.8%), followed by Hispanic or Latino (6.6%), Black or African American (3.8%), and Asian (2.6%). This Zippia study also reported that 66.5% of appraisers are men with an average age of 50.
AVM Validation
Automated Valuation Models (AVMs) have been recognized as viable alternatives to traditional appraisals under certain circumstances. In conforming neighborhoods with robust sales data, AVMs have proven to be very effective and accurate. Another benefit to AVMs is that they only consider actual market data to determine the valuation and are blind to all borrower and neighborhood demographics.
The question around AVMs is related to algorithmic bias in the data and methodology used by AVMs. There are current studies and ongoing research underway related to the topic of AVM bias. To date, there are a few AVM providers that have gone through deep analysis to determine if their AVM contains algorithmic bias. Whether being used as an appraisal alternative in certain cases, or quality control check on a broader scale, AVMs may be a tool to help identify potential undervaluation.
Appraisals are extremely important for both the homeowner or seller, buyer, and the lender. For an individual, accurate and unbiased appraisals can play a role in building and sustaining generational wealth. For lenders, appraisals are instrumental for measuring collateral risk. By actively building a more diverse population of appraisers, utilizing advanced review word search tools and AVMs as valuation alternatives, we can better address inaccurate valuations and racial bias claims that can be detrimental to a homeowners’ overall financial health.