My New Blog

Well, the strange lending practices continue. What do underwriters and lenders not understand about curable functional obsolescence? Recently, I have appraised several properties which have curable functional obsolescence and the lenders are requiring the cure be completed prior to the purchase or refinance of the property. I have never experienced this in the past. How could one purchase a property with tandem bedrooms, unpermitted additions or conversions? How would one purchase an REO property, for instance, without the lender/owner curing the obsolescence? This seems ridiculous. With the market moving in the direction that it is today, these practices, by the lenders, may very well deepen the decline in the market. Will they make exceptions for their own REO properties? This has occurred several times in the past few months. I will, for an example, relate the latest incident.

The property is a 1950s era home with a GLA under 900 sf., is located in a county area of a medium sized metropolitan area of Southern California. The garage was, long ago, converted to a family room. The conversion was done in a workmanlike manner and there are no visible inadequacies. An approximate five foot section of the livingroom wall was removed for access, the garage door hinges were removed, and that wall, as well as the other walls has been drywalled, textured and painted. The floor has been carpeted.

The buyer is fully aware that this conversion was done without permits but is willing to pay the list price as it is well below the sales and listing prices of other comparable homes in the area.

Because this particular lender does not allow value to be given to unpermitted living area, I addressed the conversion as curable, functional obsolescence. I took the cost to install a door from the living room to the garage, closing that five foot space, and also considered the cost of removing the drywall from the garage door opening and to reinstall the hinges. In the sales comparison approach, I address the functional obsolescence by taking these costs under functional utility. In the cost approach, I took this amount under functional depreciation, effectively reducing the value of the home by the amount of the cost to cure. This, in theory, should protect the lender from any exposure from this obsolescence.

The lender is requiring that the garage be returned to its original use as a garage prior to lending to the property. This amazes me and the only explanation appears to be lack of education. The lenders are willing to use AVMs for values, which do no indicate functional obsolescence, curable or incurable, nor do they indicate health and safety issues which may exist in the property. They also do not reveal environmental issues which may exist. But, when an appraiser, under due diligence, inspects the property, reports the problems to the lender with a full explanation, he becomes the villain. The response I got from the manager of the broker was “why did you mention the conversion?” In other words, why did I not just look the other way (lie) and not mention it? Even if I was willing to lie (which I am not) the conversion is mentioned in the MLS.

In the past, it was only health and safety issues which were required to be corrected prior to funding. Now, some lenders do not even want these mentioned. I appraised a property with a detached garage that had been converted to living area, including a living room, bedroom and bath. The partition walls were made of chipboard. As there was not room enough for a kitchen, one had been added to the rear of the garage. This was a “lean-to” structure with chipboard floors, cupboards and countertops. There was a roof, but no ceiling. The kitchen had a gas range with no hood or vent and a sink which drained into the yard. Mold and mildew were a major concern throughout the garage. Had there been a grease fire, the whole place would have gone up and there was only one standard, three foot exit door at the front of the conversion. The place was a certain deathtrap. I appraised the property subject to removing the kitchen and converting the garage to its original use. The underwriter stated that they did not want this mentioned in the report and they wanted the report done “as is” or they could not fund the loan. As it was, I stuck to my guns, and I became the bad guy. I believe they found another appraiser to appraise the property and not mention the health and safety items because public record indicates a refinance shortly after the time that they made this request.

What is happening to the industry? Lenders won’t allow appraisers to do their jobs correctly. They are less concerned with property defects than they are with what is mentioned in the report. Is it not our responsibility to protect the lender? Is that not the purpose of obtaining an appraisal? I taught mortgage underwriting and appraisal review at a local university for a number of years and I believe my students, most of whom were connected to the lending industry, understood the process. What has happened? Is it, perhaps, that the lenders want to make the loans and let the appraisers take the fall down the road? Please relate your experiences or feel free to comment.

©2007 C.D. McCullough Real Estate Appraiser, all rights reserved.