Racist appraisers show that America’s real estate market could be far more dangerous than most people assume.
Carlette Duffy alleges appraisers cut her home’s value by over $100,000 because she is black. Fox59 claims Duffy got three appraisals on her Indianapolis home. Duff claims the first two appraisals were $100,000 lower than the third estimate.
Duffy thinks the first two appraisers gave her home a lower value because she is black. In the third estimate, Duff asked a white male friend to pose as the homeowner and did not tell the appraiser her race. The third appraiser gave Duffy the higher price.
Are Real Estate Appraisals Bullshit?
Duffy’s allegations are frightening because they show real estate appraisals; the metric upon which lenders base mortgages, are not accurate or realistic.
Instead, Duffy’s experience demonstrate the appraisals are only the appraisers’ opinions. Worse, Duffy’s experiences show emotions and prejudices shape appraisals.
Consequently, the metric upon which we base property values could be totally unreliable. Hence, lenders and homeowners do not know the actual value of properties.
What is Real Estate Really Worth?
The implications of Duffy’s allegations are staggering. If Duffy is telling the truth, millions of American homes could be grossly overvalued or dramatically undervalued.
Zillow estimates the average home value in the United States was $281,370 in May 2021. In addition, Zillow predicts that home value could grow by 11.8% over the next year.
But what if they base home values on totally inaccurate appraisals? What if the true average home value in the United States is $181,370 or $81,000? What if home values are falling and nobody sees it?
How is poor is America?
A horrifying implication of irrational appraisals is that tens of millions of Americans could be far poorer than they think they are.
To explain home ownership is a key component of middle-class household wealth. The US Census Bureau estimates that home equity comprised 28.9% of household wealth in 2017.* Thus, the ordinary American household had around $30,056 in home equity in 2017.
They base home equity on the appraised value of the property. If the appraised value is 30% to 50% off. The ordinary household’s net worth could be $9016.80 to $15,028 lower than the Census Bureau assumes.
Thus, the $104,000 net worth the Census Bureau ascribes to the median American household in 2017 could be wrong. The median net worth could be $94,983.20 or $88,072 not $104,000.
Is Income Inequality Worse than We Assume
An obvious implication of this math is that America’s income inequality is worse than we assume. Fortune’s Ben Carlson blames the wealth gap between middle-and upperclass Americans on the middle-class’s habit of investing all its extra money in a home.
To explain, middle-class households invest their extra income in a home through a mortgage. In contrast, the upper class invest their extra money in stocks, businesses, rental properties, and other assets that either grow at a faster rate, or generate income in the form of profits, rents, or dividends.
Thus, the rich make more money because their assets generate wealth. In fact, The New York Times estimates the wealthiest 1% of American household controlled 38% of the US financial accounts that held stocks in 2019. Similarly, the wealthiest 10% of Americans owned 84% of the value in Wall Street Portfolios in 2019.
Instead of boosting the middle-class, home ownership could make the middle-class poorer. Many Americans are forgoing opportunities to build wealth through the stock market and investments to put their money in an overvalued home.
Will it be 2008 all over again?
A terrifying possibility is that Duffy’s first two appraisals were correct and the third appraisal was wrong. If that is the case, the appraiser could put Duffy in an underwater mortgage because of her imagined skinned color.
Hence, fraudulent and inaccurate appraisals could trigger another mortgage crisis resembling the one that led to the 2007-2008 financial collapse. The collapse of overvalued mortgage-backed securities held by investment banks was an underlying cause of the 2007-2008 meltdown. The legendary investment bank Lehman Brothers; for instance, collapsed because of its bad mortgage investments.
One cause of the 2008 Financial Crisis was NINJA (no-income no job) loans. The only data lenders used in issuing the NINJA mortgages was a credit score, a simple metric that did not say how much money the borrower had.
Millions of Underwater Homes
Duffy’s experience shows real-estate appraisals could be as inaccurate as the bullshit data lenders were using during the 2000-2007 housing bubble. There could be millions or tens of millions of mortgages based on grossly inflated or fraudulent housing appraisals.
One common home value inflation tactic is the one Duffy used: appraisal shopping. An appraisal shopper keeps hiring appraisers until she gets the results she wants, usually the highest number. Then she uses the highest number in the mortgage application.
Unscrupulous appraisers can satisfy appraisal shoppers by inflating home values. Thus, many mortgages exceed the value of the home. Hence, millions or tens of millions of American homes could be underwater.
A home is underwater when the sale price is less than the mortgage equity. In 2008, many homeowners walked away from underwater mortgages leading to neighborhoods full of empty homes.
The High Cost of Inflated Appraisals
The havoc appraisal inflation could wreak is vast.
For example, governments base property taxes on real estate values. If the real estate values are wrong, property taxes could be too high. In the worst-case scenario, governments cannot collect property taxes and find themselves with no revenue.
Furthermore, governments could issue bonds or borrow money based on unrealistic property value assessments. Hence, many municipalities will be incapable of paying their debts. One result of this could be cuts in government services and municipal bankruptcies.
Other horrendous effects of appraisal inflation could an increase in homelessness as ordinary people get priced out of the housing market. Another problem is that many people can no longer live in many communities as housing becomes too expensive for them.
Thus we get cities full of empty homes and condos Realtors cannot sell while people sleep on the streets or in their cars. One reason the property does not sell is that sellers cannot get a price high enough to pay their mortgages.
Finally, lenders could collapse because they hold mortgages that borrowers cannot pay off.
Is it Time to Ban Appraisals?
In the final analysis, racism is the least of the problems in the appraisal process. Fraud and inflation are the actual threats. The mortgage industry desperately needs reform and regulation.
An obvious solution is to make it illegal to use appraisals for mortgages. Force the lenders to rely on other data such as market prices.
Duffy’s experience shows human appraisers are often corrupt and unreliable. To eliminate the corruption, we could require underwriters to base mortgage amounts on the median home sales price in the market or the last price home sold for, adjusted for inflation.
Another solution is to look for better means of home appraisal, for instance, artificial intelligence. We need alternative solutions because the appraisal process is broken and a threat to our entire economy.
*https://www.census.gov/content/dam/Census/library/publications/2020/demo/p70br-170.pdf
Originally published at https://marketmadhouse.com on May 25, 2021.
