The Subjective and the Objective: Understanding the role of traditional and new real estate valuation techniques in today’s mortgage servicing and foreclosures market. By Scott Wilkinson March 2010 In today’s mortgage foreclosure and sales process, there has been an explosion of new real estate valuation options. For different price points, lenders can purchase valuation reports from both traditional and alternative suppliers – ranging from full appraisals, APOs, BPOs, inspection reports and AVM’s and hybrids of one or many of the above. Depending on your position with a lender you may have strong opinions on which, why and how you use any of the above. Or, you may be bewildred by the available choices and conflicting indication of values between them. The debate on who is the best of the APO, BPO, AVM models clouds the issue of how mortgage servicers utilize all these tools to make better, faster and more transparent decisions regarding both the real costs and customers involved in a mortgage foreclosure. This is what I hope to address today. Setting the Stage To set the context to understand why valuation are important, according to recent figures (Mortgage Daily.com 2010):

13.8% of American mortgages are in 60 day default or greater, as of January 31 2010. Over 3.9 million foreclosures were filed by American mortgage banks in 2009 resulting in over 800,000 REO registered sales.

2010 looks just as bad with a further 625,000 foreclosure filings in the months of January and February alone and a further 167,000 REOs.

More worrisome still, the average time for a REO sale has increased from 200 days in the 90’s and early 2000’s to over 260 days suggesting higher lender costs and risks associated with remarketing properties.

A Return to Normalcy? The period of volatility is expected to remain with us for at least 3 more years. First, with the lifting HAMP and HARP in the foreseeable future, we should expect a spike in loan foreclosures in late 2010 and 2011. Second, while over 9 million foreclosures have been processed in the US market through 2009 we can expect a further 8-12 million between now and 2013. Third, the return of house prices as indicated in Case-Shiller index (Figure below), also for-tells a period of price volatility as demonstrated by the 1991 recession for the next 12-16 quarters. In short, the new normalcy may be volatile market prices.

S&P/Case-Shiller Home Price Index shows volatility of average house prices in both Top 10 and Top 20 cities through January 2010, shows a stabilizing trend

in urban home prices. However, price volatility is expected to be the norm through 2013 as inventories work their way through the system.

Source: http://www.standardandpoors.com/spf/CSHomePrice_Release_033056.pdf The Purpose of a Real Estate Valuation It is worthwhile to define the purpose of a valuation in a mortgage transaction. For lenders, the purpose is to find the true market value of real estate collateral at a point of time. It is implied in this statement that for servicers and those working in the foreclosure groups, that the value of the collateral can be predictably extrapolated beyond to a future period – be it weeks, months or years. Certainly as a result of the 2008 – 2010 recession and real estate down lenders have been taught that the certainty of any party’s capacity to predict the value of collateral is in doubt. Clearly, then, getting the market value right and making the right decisions when offered a purchase on a property is critical for those dealing with the outcomes of distressed loans. Subjective Objectivity or Objective Subjectivity? Today it is an open question whether the new and traditional valuation methods are subjectively objective or objectively subjective. In truth, we are not well prepared to deal with the short periods of volatility that always occur in the real estate lifecycle. By and large, the methods we have used to define market value have been derived for periods of general market stability – and predictability. Within the current debate between Appraiser, Broker or AVM we still need to address our underlying biases to developing models that are inherently restricted when the predication of value matters most – in volatile, downward pricing markets. Therefore, we need to reshape the underlying question and ask what the industry needs to see from it’s valuation partners on a go forward basis. Our point of view is that lenders need valuation partners that support the following objectives:

Triangulation of Value

Cost Effectiveness and Flexibility

Understanding of Valuator Motives

Specialization by Value Purpose and Active Pursuit of Innovation

In periods of market volatility, the industry’s capacity to value the market price for real property is based on data points to reduce the deviation on assumed mean inherent with the presentation of the value report. Data points, sourced from reliable and objective sources, can both limit and illuminate the range of value expected to be realized in an open market transaction. Lenders cannot afford to freely source valuations without restraint. Therefore they must make choices regarding the cost of attaining data, the value of the data and how important it is to have updated data for their decision process. The debates raging in the industry are about the trade off which data sources provides the most value for the price; and, ultimately, the gaps and risks of procuring data that may be less reliable, but which is more current because it can be refreshed more often.

There are multiple touch points for valuations in the default, foreclosure and REO processes. Industry

discussions suggest as many as 8-12 valuations depending on the duration of foreclosure, client recivity, subject property issues and lender anxiety. Interestingly, many lenders report that successive valuations

increase decision “fog” rather than triangulate value.

Cost effectiveness and flexibility of valuation approaches are highly valued in the market. Debates on dogma aside, it can be readily agreed that Appraiser, Broker, Inspector and AVM model based approaches can add context to value discussions. The challenge is for line staff to align different perspectives of market value and create cohesive guidance to managers and investors on actions they need to take. And they are frequently being asked to make apples to oranges comparisons between appraisal, AVM and broker values. This is creating a level of analysis overload and fog with many lenders I have recently chatted with. Also contributing to the industry debate on valuation approaches are the perceptions of objectivity and subjectivity, and thus accuracy of valuation, of the players involved. Groups like the Appraisers have moved to define the standards and process required to create objectivity. But elsewhere in the valuation space the definition is weak and not well understood. One opportunity is for a valuations benchmark (like AV Metrics) for valuations. In the absence of third party validation, however, the individuals who source and who make decisions on valuation sources must take into account the unclear motives that derived some their data. The last factor we need to address is the lender’s propensity to look to one-stop-solutions for specialized valuation needs and lock into vendor relationships. I propose that now is the time for lenders to find ways to “date” vendors within a contained innovation stream, to test solutions and drive the vendors to address the problems impacting lender valuation decisions. The US valuation industry is undergoing a historic period of innovation. As a result there are a number of new and innovative

solutions in the market. Not all these solutions will pan out – but with the challenges facing lenders for the next three years, there is an advantage to those who can incorporate innovation to improve decision making and ultimately reduce losses. Making it Fit If we believe that BPO, Appraisals, APO’s, AVM’s inspections and assisted AVMs have their purposes, what then are their advantages and risks? What should our engage advice be to the operations staff responsible for seeing through the “fog’? When and how do we move through the valuation alternatives and make the spend decisions? First, every lender will have their own criteria. Markets, appetites and risks differ. But the common threads are:

Intelligently selecting partners based on their capabilities, including capability for generating innovation for your bank;

Proactively cascading valuation approaches based not only on apparent cost of valuation, but on complete understanding of number of valuations required in lifecycle, the real and assumed risks to be mitigated with valuation and with the operational costs of managing valuation sources;

Leveraging partners and reporting products to force value triangulation and escape data-redundancy, thus placing the burden of reconciling valuation discrepancies with capable valuation vendors;

Demanding innovation and improvements from all valuation vendors and incorporating innovation in foreclosure processes and enabling key valuation partners to be accountable for valuation approaches and costs; and,

Empowering operations staff to make decisions, rather than hide behind unattainable perfect information.

Given the volume of 8-12 million homes expected to be foreclosed and sold over the next 3 years it is pretty clear that lenders will be ordering more valuations and trying to reconcile divergent opinions on underlying market values. Therefore, the debate between appraiser or non-appraiser based valuation tools may be missing the point. The question we need to ask is who is creating lender-based valuation tools. ###. Scott Wilkinson is the VP Product and Operations at Solidifi. He is responsible for leading the development of Solidifi’s US and Canadian product innovations team. Solidifi is the “Next Generation” appraisal management company, founded on leveraging innovative technology to enable appraisers to perform highest quality work.