Matrix Blog

Guest Appraiser Columnist:
Martin Tessler, CRE

Fee Simplistic is a regular post by Martin Tessler, CRE whom after 30 years of commercial fee appraiser-related experience, gets to the bottom of real issues by seeing both the trees and the forest. Marty has never been accused of being a man of few words and his commentary can’t be inspired on a specific day of the week.
…Jonathan Miller

The Wall Street Journal article of June 9th entitled, “Appraisals Roil Real Estate Deals” should be required reading for anyone who has opined to an opinion of home value. For those who missed it, the article details the swing of the pendulum from the high flying days of pre- 2007 when appraisers could not come in with values or, should I dare say, “numbers” high enough to justify a loan. In comparison, today’s lending world has swung 180 degrees to the low end of the pendulum where no value can presumably be low enough. The article goes on to portray the “usual suspects”- house values that have plummeted from the sky high years to todays’ nadir with some added color such as:

• A Fairfield County CT appraisal that came in at $50,000 below the contract price necessitating either a new appraisal or renegotiation.
• A JPMorgan Chase home equity line of credit predicated upon a 2,650 sq ft Manhattan duplex appraised at $1.475 MM in 2005 being reduced due to the bank’s estimate coming in at $600,000. The borrower then was able to produce a new appraisal that valued the property at $1.8MM. A spokesperson for the bank said that they use “an automated appraisal system on our portfolio” and that they encourage borrowers who feel that if their valuation is too low to order an outside appraisal and will reimburse them if it supports their claim.
• Banks requiring appraisers to use sales comps that closed within the past 90 days with some asking for at least one sale within 30 days.
• Agreement by the appraisal industry and Fannie/Freddie to adopt the Home Valuation Code of Conduct intended to prevent loan officers, mortgage brokers or real estate agents from selecting appraisers. This is to shield them from pressure on coming up with pre-ordered values, a major issue raised by NY State Attorney General Cuomo and on several postings in Matrix/Soapbox last year.

A significant issue not quelled by the Code is that it allows if not encourages lenders to outsource the selection to appraisal management companies or AMC’s who will charge the appraisal firm anywhere from 30%-40% of the fee for administration, overhead and, pardon the sarcasm, quality control. Exacerbating the problem is that lenders can own stakes in AMC’s. Thus, the conflict of interest is ever present.

Reports are prevalent that AMC’s shop around for the lowest appraisal fees that frequently end up on the desks of appraisers who are geographically distant from the subject property’s market, are not fully familiar with the local market and thus present sales that are not directly relevant.

It is obvious that AMC’s are clearly conflicted if owned either partially or fully by a lender. They are recipients of profits generated by a company that is not arm’s length from their fiduciary role where they require the borrower to buy the service. As for tools such as JPMorgan Chase’s “automated appraisal system” these are only rough guides to average or ranges of value from a large data bank of properties and extreme care must be taken in applying such macro data to a specific property or micro set. It is therefore not surprising that Chase allows for an independent appraisal although I’m not sure that it allows the borrower to select the appraiser as the article implies and, if so, it’s a violation of FIRREA if not the Code.

If no reforms of the Code are made to disallow AMC’s from ownership by lenders it is my opinion that history is doomed to repeat itself in the next frenzied lending cycle. Let’s get the stake ready now.

Tags: Appraisal Management Companies, Martin Tessler, AMC, Fee Simplistic

3 Comments

Guest Appraiser Columnist:
Martin Tessler, CRE

Fee Simplistic is a regular post by Martin Tessler, CRE whom after more than 30 years of commercial fee appraiser-related experience, gets to the bottom of real issues by seeing the both the trees and the forest. Marty has never been accused of being a man of few words and his commentary can’t be inspired on a specific day of the week. View his earlier handiwork on Soapbox.
…Jonathan Miller

Having recently attended the Counselor’s of Real Estate (CRE) Mid-Year Conference at the Waldorf Astoria I came away with one speaker’s astute findings on where the market is likely heading. Robert White, Jr. CEO of Real Capital Analytics wins the cigar for the most astute commentary on where we are in the marketplace and for not belaboring the obvious: * US commercial property prices are down 21% from ‘07’/08 peak to October ’05 pricing levels * Sellers are adjusting slowly to pricing changes while investors are in no hurry to buy * Banks are not dumping REO assets as it would jeopardize their capital base * Troubled assets are increasing by $6-$8 billion monthly in foreclosures but deeds are not changing hands due to capital base problem * Sales are rare but offerings are growing as sellers head toward distress

What does this mean to the appraisal world and how are we to gauge the market in the absence of sales and financing?

One must take into account that we are readjusting to a frenzied market that extended over many years fueled by easy credit and low interest rates. A new market reality will be evolving over time (if it is not already underway) that will replace the mindset created by the financing bubble best summed up by an article in the Wall Street Journal of April 6th entitled, “From Bubble to Depression”.

In the article the authors note that “Bubbles can arise when some agents buy not on fundamental value but on price trend or momentum” (emphasis added). There is no question that the market through mid 2007 acted in this manner and appraisers were ethically and legally bound to implement this reportage in their valuations.

What this portends to the appraisal world is that valuations stemming from discounted cash flow analyses is that most emphasis will be placed on income in place compared to projected income based on assumptions of growth in rents or lowered cap rates.

The caveat to appraisers is: “watch those assumptions”.

It will no longer be: “tell me the value you need and I’ll tell you what assumption you need to get there”.

Tags: Martin Tessler, Fee Simplistic

Comments Off on [Vortex] Fee Simplistic: Staying Ahead of the Curve – What’s Next?

Fee Simplistic is a regular post by Martin Tessler, CRE whom after 30 years of commercial fee appraiser-related experience, gets to the bottom of real issues by seeing the both the trees and the forest. Marty has never been accused of being a man of few words and his commentary can’t be inspired on a specific day of the week.

…Jonathan Miller

From illiquidity to insolvency, to default, to unemployment, to declining demand for space and consumer spending, to falling rents, growing vacancies and overall economic gloom coupled with looming mortgage refinancing in the face of a continued credit market freeze-up. Is it time to realize that this might well be the perfect storm? What lessons have we learned? It does not take Advanced Appraisal 501 to have foreseen that the frenzied market produced by low interest rates, CMBS securitization that off-loaded risk, easy credit and lax underwriting standards, if not their complete absence as in the residential sector, was a disaster waiting to happen (archival Soapbox postings would confirm).

The appraisal world however, true to its role in reporting what the market was experiencing as of the valuation date, could only report back market metrics of sales prices/square foot, going-in cap rates, cash-on-cash yields, expected investor yields, rental growth, and vacancy trends. And if the appraisal lived up to its fundamental requirements, it would include a section on supply and demand metrics for the particular use of the subject property. Anecdotally, I can count on the fingers of one hand the number of appraisal reports reviewed in my previous financial institution days that truly measured supply and demand factors in apartment sale and rental scenarios, shopping center appraisals where share of the market sales ratios were calculated, office space supply and absorption vs. employment growth. This is not to say that these metrics were not presented in the appraisal report but the manner of presentation was generally “boilerplate” filler to convey the feeling that these factors were being addressed.

We have gone from a capital driven market back to what will be prevailing supply and demand metrics in the specific geographic market of the subject property. In essence we will be forced to return to market analysis as the basis of valuation rather than rely on the frenzied deals of the past created by easy credit. Nowhere is this more evident than in an overview of the capital markets where in 2007 commercial property sales generated $500 billion in financing that declined to $150 billion in 2008. For 2009, loans projected for maturation refinancing total between $80-90 billion. The present closure of the securitization market will mean that valuations are going to have to be dead-on in their opinion of value and absent bonafide market analysis measuring supply and demand the appraisal will likely not be worth the paper it is written on.

This brings to mind the question of estimating value in a market that is virtually shut down and is stuttering along to find itself in volatile economic circumstances. Should the FIRREA/USPAP protocols be amended to mandate that every appraisal look at a downside risk scenario? Thus not only would the appraisal report the opinion of value as of the date of value but it would also include the lower end of value if economic and market assumptions did not pan out. If investors and lenders are exposed to the downside would it enable a thawing of the credibility and credit freeze prevailing today? My opinion is-yes it would at least help.

The Wall Street Journal, in a recent article reporting on the mezzanine debt that financed the acquisition of the John Hancock Tower, quoted a lawyer specializing in real estate that “tranche warfare” is starting in the battles over who will sustain losses or retain equity from overleveraged debt and how these are going to be battles never previously encountered. The article went on to point out how mezzanine debt was sliced and diced among different investors similar to the tranching of CMBS debt. Compounding the problem is the fact that if there was a default an appraisal was to be undertaken to determine which investors retained equity and who were wiped out. Needless to say, arguments over the appraised value have started. A major factor contributing to the cash flow shortfall was that in the two year period from the time of the purchase vacancy in the building went fro 0 to 15%. Whether this was on the radar screen of the appraisers or attributable to the market would have been something that turned up in a definitive market analysis. This will be a very interesting period for lawyers if not appraisers who may well discover that the slicing and dicing may well have produced values (or prices) greater than the sum of the tranched parts.

All hands on deck man your battle stations

Tags: Soapbox Blog, Martin Tessler, Absorption, Fee Simplistic

2 Comments

Fee Simplistic is a regular post by Martin Tessler, whom after 30 years of commercial fee appraiser-related experience, gets to the bottom of real issues by seeing the both the trees and the forest. He has never been accused of being a man of few words and his commentary can’t be inspired on a specific day of the week.

…Jonathan Miller

For those who saw former Fed Chairman Alan Greenspan’s testimony before Congress on Thursday October 23rd it was almost a mea culpa but no cigar. When queried by Congressman Waxman as to why he did not intercede with regulations to prevent the banking world from continuing its underwriting and issuance of CMBS & CDO sub-prime bonds and their toxic derivative permutations Mr. Greenspan answered that he believed the market would prevail to correct abuses as Wall Street would act to protect its shareholders. Those of us who dealt with the investment banking community knew that it was really the year end bonus pool that governed Wall Street’s actions and not stockholder interests.

The failure of the Fed and the SEC to act in a situation absent loan underwriting standards coupled with off-balance sheet securitization where the underwriters and lenders had no “skin in the game” defied logic and economic reality much less common sense. You did not need a PhD in economics to understand that disaster was lurking around the corner which FEE SIMPLISTIC called attention to on several postings. It was all based on an underlying assumption that the market would be on a perpetual rise and values would escalate so why worry?

All of this pales against more astute commentary from my country weekend neighbor who is employed by a major equity buyout firm. As we were discussing the state of the real estate market this past July I commented on the Blackstone Group’s purchase of Sam Zell’s Equity Office Properties portfolio back in early 2007 and how they immediately sold off groups of properties to other investors at substantial markups. FEE SIMPLISTIC (May 2007) noted it was like buying wholesale and selling at retail. One of the buyers at $7.25 billion for 8 midtown Manhattan buildings was Macklowe Properties who ended up having to surrender title because they could not sustain the debt service. My neighbor commented that the “smart money” guys that he worked for in the buyout firm always said, “when Sam Zell is selling you don’t want to be buying”.

So the question is: after all these years of listening to the former Fed chairman spout his inscrutable prognostications about the economy, the credit markets and interest rates should we have been listening and watching Sam Zell?

And the corollary is: will the recessionary cycle end when Sam Zell starts buying again?

Tags: Soapbox Blog, Martin Tessler, Fee Simplistic

3 Comments

Fee Simplistic is a regular post by Martin Tessler, whom after 30 years of commercial fee appraiser-related experience, gets to the bottom of real issues by seeing the both the trees and the forest. He has never been accused of being a man of few words and his commentary can’t be inspired on a specific day of the week.

…Jonathan Miller

My inclination in most of my Fee Simplistic blogs is to resort to satire in targeting the inconsistencies, foibles and malpractices that have proliferated in real estate lending including appraising. The recent demise of IndyMac Bancorp Inc., however, forces me to turn serious and throw the forum open to soliciting views and opinions on a particular appraisal incident that was only a minor blip in the bank’s implosion but looms large in appraisal management and, most of all, integrity for those of us who still hold to it.

Prior to the bank’s takeover by the FDIC it had been calling on borrowers to make up the difference if a gap existed between market value and the loan-to-value ratio established at inception. A particular incident involved a lawsuit filed by a builder in Los Angeles County Superior Court in April claiming that IndyMac did not act in good faith when it tried to call in a loan where personal guarantees were involved in a 900 acre Joshua Ranch tract in the Antelope Valley north of LA. The background was as follows:

• In May 2007 the property was valued at $82 million by the bank, and
• In December 2007 the property value was appraised at $17 million-an 80% decline- with the appraisal estimating that an 18 year absorption period would be needed to sell 539 houses on the tract
• The builder claimed that IndyMac just wanted out of the loan because of their precarious position and thus wanted the borrower to pay off the difference between the $17 million appraised value and the $27 million loan balance.

Ignoring the bank/builder argument on loan payoff what struck me was the severity of the free-fall in appraised value over a 7 month period assuming the appraisal was arms-length and FIRREA compliant with no lender influence or pressure. It, however, and raised the following questions:

1. Did the bank use the same appraiser in December as in May? If not, did the last appraisal employ any assumptions that were substantially different than the earlier appraisal?
2. Assuming the same appraiser, did the market tank that severely in 7 months or did the first appraisal miss the market dynamics as the sub-prime and loan delinquency downturn was already underway prior to May; did the bank review the earlier appraisal to note any discrepancies between the previous and current market conditions or any major changes in assumptions that would have generated such a major decline in value?
3. Assuming the same firm again for both appraisals did they indicate where and why the market had changed in such drastic fashion from their previous appraisal? It has been a long standing policy in assignments that I have directed that reference be made to any previous appraisal completed within a year prior to the valuation date.
4. If a new appraiser was selected, was it because the original appraiser could “not hit the number” that IndyMac needed to declare a call on the loan?
5. Did IndyMac’s appraisal group compare any of the facts or assumptions between the two reports to support the drastic change in value or were ethical considerations thrown to the wind not to mention FIRREA and USPAP?

Tags: Soapbox Blog, Martin Tessler, Absorption, USPAP, Fee Simplistic

1 Comment

Fee Simplistic is a regular post by Martin Tessler, whom after 30 years of commercial fee appraiser-related experience, gets to the bottom of real issues by seeing the both the trees and the forest. He has never been accused of being a man of few words and his commentary can’t be inspired on a specific day of the week.

…Jonathan Miller

Anyone who read the Monday (July 21st) Wall Street Journal could not escape the front page article on Superior Bank and their disastrous subprime lending which eventually ended up in an FDIC takeover. The FDIC operation was even more egregious as they continued the subprime lending while operating the bank until they could find a buyer. During the FDIC operation Superior funded more than 6,700 subprimes with a face amount of over $550 million and then sold most of the loans to another bank. The loan pool was a classic example of the subprime/credit implosion pandemic still spreading globally: lending to unqualified borrowers, lack of or poorly documented income verification and-last but not least-inflated appraisals.

Underpinning the inflated appraisal factor was the brief story of a retired high school teacher in rural Georgia near Athens who fixed up and added to a ramshackle house with a tin roof located next to a trailer park and who refinanced it with Superior in 2001 with a $120,700-20 year mortgage at 10.75% compared to a 7% rate for those with good credit. The bank’s appraisal valued the house at $142,000 and relied on 3 comps that were in “well attended” condition. The comps were located many miles away in neighboring counties and two were located close to the center of Athens where locational factors generated higher property values. Although not a true indication of market value, county records indicated fair market value for assessment purposes at $84,000 with the bank selling it at auction in 2005 after foreclosure for $76,000.

So where does the FDA’s side effects warning listed for all prescription drugs come in for application to appraisals?

• First: All appraisals should have an EXPIRATION DATE: WARNING: Do not use this appraisal more than __ months after (list valuation date) as market conditions will likely have changed. See your bank or CDO or MBS trustee or contact SOAPBOX.
• Second: Similar to drug interactions, the location of the comps used to arrive at market value should be highlighted so that their effectiveness can be measured as in: APPRAISAL COMPS INTERACTION: WARNING: The comparables used in this appraisal were located: within walking distance; within the defined neighborhood; within the outlying county; within the SMSA; outside the SMSA;-(choose one of the above). U.S. Government advisories indicate that there is an inverse relationship to the effectiveness of the listed comps and the distance from the subject.
• Third: PREVIOUS CONTAMINANT INDICATIONS: WARNING: This appraisal was undertaken under TOTAL ANTISEPTIC & CONTAMINANT-FREE conditions. The value indicated has been arrived at independent of any outside contact or interference from a mortgage broker, lender, investment bank, underwriter, rating agency, or other influencing factor. This may or may not apply to the fee or future assignments.

Moral of the Story: Keep Diogenes on the job looking for honest appraisers.

Tags: Soapbox Blog, Martin Tessler, Fee Simplistic

3 Comments

Fee Simplistic is a regular post by Martin Tessler, whom after 30 years of commercial fee appraiser-related experience, gets to the bottom of real issues by seeing the both the trees and the forest. He has never been accused of being a man of few words and his commentary can’t be inspired on a specific day of the week. In the first of a series, Marty looks at what’s cooking in sub-prime and observes that everyone is now washing their hands after the infection has spread. …Jonathan Miller

Sharing an elevator, a civilian neighbor of mine (“civilian”: neither in real estate, law, nor finance) reading the morning paper asked me if I could explain to him in non-technical terms what the sub-prime mess was all about and how it came to infect the entire economy. As this was a question that could not readily be answered by arrival in the lobby I told him that I would have to give it some thought but that I would definitely get back to him with an explanation.

I called him a few days later and asked him if he remembered the story of Typhoid Mary. He recalled that she was the cook who harbored the typhoid bacteria but did not outwardly manifest the disease back in the early 1900’s. He recalled how she cooked for a Long Island banker’s family and how several family members came down with typhoid and that it was quite a number of months before the illness was traced to her and how she was later isolated but continued cooking and spreading the disease among those with whom she came in contact.

“So where does Typhoid Mary come into this”, he asked? I told him to imagine that she was a gourmet cook that was able to concoct delicious meals that we’ll call “sub-prime” and which revolved around highly questionable combinations of ingredients that tasted great to the investment banking community on Wall Street. The bankers said that if it tasted this good they could sell it to the public and make billions notwithstanding the toxic ingredients that would create problems later on.

So the investment bankers set her up in business and she got rave reviews for her sub-prime meals which are so low in price that they not only kept coming back for more but word spread internationally and they opened franchise operations all over the world and everyone could not get enough of sub-prime. However, nobody paid attention to the fine print in the back of the menu stating that meal prices are going to rise but “not-to-worry” because the people who had already dined will gladly give up their place to those who have not sampled the cuisine and they will go on to newer sub-prime establishments being built by the investment bankers who are now launching a haute cuisine line of restaurants called “Derivatives”. “Derivatives” traced its origins back to Typhoid Mary’s ingredients but its higher order of culinary evolution took basic ingredients and strained, extracted and refined them further to the point where there was only a minute trace of the flavor that people thought they were savoring but had no idea of what they were eating and really did not care.

“Derivatives” was so popular in the investment banking community that they spun off boutiques for even higher haute cuisine dining called “SIV’s”, “CDO’s”, “ALT-A’s”, “Tranches”, “RMBS’s” and “CMBS’s”. Wall Streeters claimed they discovered the new El Dorado and doled out billions in bonuses to their exclusive fraternity, the Investment Bankers. Unbeknownst to the dining public, however, was the fact that all of these new culinary establishments had one thing in common, the cooking and recipes all traced back to Typhoid Mary and her dormant but lethal bacillus, “ILLIQUIDUS-ILLSOLVENTUS” from the Latin “to go broke”. Also, the scientific community was unaware of the fact that this particular bacterial strain acted in a cyclical manner and took several years to mature before striking its lethal blow.

One day, after several thousand “sub-primes” were operating around the world a 911 call went out from one that a customer was experiencing severe abdominal cramps and shooting pains. The diagnosis came back that it was nothing to worry about as the diner was merely experiencing an upset stomach but at the same time other diners at other restaurants were experiencing the same symptoms all over the globe. Frantic calls were sent to the Wall Street headquarters to find out how to treat the outbreak but word came back that each diner assumed their own risk and, besides, all the funds that would have been held in reserve for 911 emergencies were already disbursed in spent bonuses.

Calls for help to the Communicable Disease Center in Washington were met with skepticism by the Wall Streeters who said it would be better not to have government intervention as the body will build its own defenses against the outbreak. As of this writing several franchise operations have closed their doors due to the outbreak and there is some discussion of applying massive dosages of steroids and human greed hormone. The doctors however are uncertain as to whether the disease is indeed bacterial or viral and treatment is under discussion. “We have seen outbreaks like this before such as the S&L crisis, the high tech crisis and we will deal with it-and let’s not forget the tulip crisis too”, said a member of the Administration.

Stay tuned for further developments.

Tags: Soapbox Blog, Martin Tessler, Fee Simplistic

Comments Off on [Fee Simplistic] Investment Banking Culinary School: Typhoid Mary And The Spreading Sub-Prime Infection – An Allegory

Fee Simplistic is a regular post by Martin Tessler, whom after 30 years of commercial fee appraiser-related experience, gets to the bottom of real issues by seeing the both the trees and the forest. He has never been accused of being a man of few words and his commentary can’t be inspired on a specific day of the week. Marty, by way of Greenspan, and using the longest blog post title in the history of modern real estate, discusses supply and demand forces and the concept of buying low and selling high, or was that buying high and selling low?_ …Jonathan Miller

For those of you who read Alan Greenspan’s four column Wall Street Journal Opinion article of December 12th entitled, “The Roots of the Mortgage Crisis“, I wonder how many were elucidated by his macro-economic “gobbledygook” of the current situation. After spending some 1,500 words on the origins of the mortgage crisis as being too much savings from global accounts resulting in “equity premiums (that) were inevitably arbitraged lower by the fall in global long -term interest rates”. In other words we had too much money chasing deals. Mr. Greenspan then goes on to his final summation after more doctoral dissertation nomenclature that would be infinitely more palatable with a glass of scotch or bourbon. With this as background we are finally told by the former Fed chairman that the “The current crisis will come to an end when the overhang of inventories of newly built homes is largely liquidated, and home price deflation comes to an end”. In other words Mr. Greenspan has discovered the Law of Supply & Demand.

Surprisingly, there’s no mention of the flim-flam mortgage brokerage, underwriting/rating agency, CDO bond issue bonfires in which the financial world was enjoying roasting its rich gourmet marshmallows and for which it is now suffering severe dyspeptic cramps. There’s also no mention of the failure of the Fed’s actions in adding liquidity at the discount window and the Federal Funds Rate to move the large institutions into the lending mode. It is here that I, having no econometric pedigree to compete with Mr. Greenspan, offer my own version of the reason for the credit shyness by the banking world.

Back in the 1990’s and prior to the world of securitization the banks kept their mortgage lending on their balance sheets. Every quarter the banks (or at least the one I had worked for) would schedule CSR (Credit Surveillance Review) meetings comprised of the lending and appraisal teams that would review each borrower’s debt and the status of where the real estate collateral stood in the current market. As the collateral was reviewed a summary of each account’s loan to value would be brought up and a “mark to market” application would be made. Where a downturn indicated that a write-down would have to be taken the credit side would generally indicate the extent of the reserve and if the write-down was substantial it would be an orchestrated write-down of “X” dollars this quarter and “Y” dollars the following quarter. With securitization this process was done away with-enter the rating agencies whose livelihood depended on their bonhomie with the underwriters and bond issuers.

If you read the daily financial pages you will see how the write-downs by the big Wall Street firms are playing out. Each month there is another announcement of how the firms had underestimated the previously announced write-down and how they have discovered that additional write-downs and reserves would have to be revised upwards. It has already cost the CEO’s of Merrill Lynch and Citigroup their jobs and there are others such as Countrywide and WaMu that are teetering on the brink. They are all playing this game and it is no wonder that the banks are reluctant to lend when they are still grappling with the extent of their losses and write-downs and cannot expose their Tier 1 capital and balance sheets.

When I was in graduate school studying city planning at the University of Pennsylvania I lived in a rooming house across from the Wharton School on Locust Street. One of the Wharton seniors who lived directly below me would delight in imparting to me the wisdom he gathered after 4 years. “Marty”, he would say, “buy low, sell high, and remember its short term liquidity, long term solvency-follow that and you won’t go wrong”.

Somehow Mr. Greenspan left this out of this Wall Street Journal article but then again-he’s an NYU grad.

PS-I always used to study with the radio on usually listening to the old Tin Pan Alley tunes which probably should be incorporated into Economics 101.

Tags: Soapbox Blog, Martin Tessler, Radio, Fee Simplistic

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Fee Simplistic is a regular post by Martin Tessler, whom after 30 years of commercial fee appraiser-related experience, gets to the bottom of real issues by seeing the both the trees and the forest. He has never been accused of being a man of few words and his commentary can’t be inspired on a specific day of the week. In this post, applies a caffeine-induced response to the issue of “undue stimulus”.
…Jonathan Miller

How many of us who think we can quote the definition of “market value” remember that it includes the phrase, “and assuming the price is not affected by undue stimulus”? As appraisers, were we, the past several years, reporting values or were we reporting “prices” generated by a frenzied market? The repercussions from the subprime implosion that has affected the credit markets for even standardized commercial real estate transactions should make us pause to take stock.

Data reported in the 2006 annual report of “Inside Mortgage Finance, Mortgage Market Statistical Annual, Top Subprime Mortgage Market Players & Key Data” revealed some startling statistics on the run-up in subprime mortgages and their Siamese twin mortgage backed securities. The magnitude of the subprime market can be readily understood by the following parameters.

• Between 2001-2003 subprime mortgage dollar value ranged from $190-$335 billion and comprised 8.5% of all mortgage origination value. Between 2004-2006 subprime dollar value increased to $600 billion (peaking at $625 billion in 2005) or 20% of total mortgage origination value.
  
• In 2001 the dollar value of subprime securitizations amounted to $95 billion which peaked at $507 billion in 2005 and leveled off at $483 billion in 2006. This represented an increase in subprime securitization value market share from 50% in 2001 to 80% in just 5 years.

To bring this into a more comprehensible perspective, Merrill Lynch’s participation in this frenzy cost their stockholders a $7.9 billion writedown and their CEO, Stan O’Neal his job. And so the question is: was the run up in the housing market attributable to “undue stimulus”, or the low interest environment that spawned the subprime world?

I have always been a firm believer in letting the facts speak for themselves when it comes to reporting the sales market but I have also been a firm believer that market value does not sit off by itself when it comes to mortgage or bond underwriting. Nothing lasts forever including the value of a property and that’s why appraisals always have a date of value. Understanding the dynamics of the market, we know that all cycles must come to an end-the question is when?

Concluding to and reporting market value is only one part of the equation when it comes to securitization and in the final analysis the buyer of CDO or CMBS bonds had better heed the Latin saying “caveat emptor” and if they do not understand Latin at least read the prospectus that accompanies the offering. High yields come with high risk and nobody should be shedding tears for the investors holding these bonds but the clueless homeowners who are at risk of foreclosure are another story.

Yes, it was “undue stimulus” caused by the easy or no credit history verification chicanery on the part of the originators that hoodwinked many innocent single family borrowers and fed a voracious market that could not gobble up the volume of loans fast enough to securitize and sell to investors who thought the cycle would go on ad infinitum. No appraiser worth his three approaches could have stood in the breach and claimed, “no this frenzy is not market value-it is undue stimulus”. The only ones able to do this would have been the underwriters and rating agencies who could have said that their experience on subprime loan failure rates was insufficient to assess the true risk and thus they would have to build in a higher premium to account for this. But this would have cut into their business model and it obviously would not have been managing their customer’s expectations.

One final thought. The losses on Wall Street so far for the subprime debacle have totaled $27 billion which is about $10 billion shy of the 2006 year end Wall Street bonus outlay. I haven’t heard the bondholders asking for disgorgement which just proves that everyone should master Latin.

Tags: Soapbox Blog, Martin Tessler, Appraisal Pressure, Fee Simplistic

1 Comment

Fee Simplistic is a semi-regular post by Martin Tessler, whom after more than 30 years of commercial fee appraiser-related experience, gets to the bottom of real issues by seeing the both the trees and the forest. He has never been accused of being a man of few words and his commentary can’t be inspired on a specific day of the week. This week Marty gives everyone a headache because the problem with underwriting is not a quick fix. …Jonathan Miller

Without attempting to belabor the obvious it should be apparent to all of us who toil in the various niches of the world of real estate that the sub-prime implosion and its impact on the credit markets calls for: major surgery or, for those with a different outlook, some over-the counter aspirin palliative. For those who remember my previous posting calling for companion legislation to FIRREA, namely FURREA-FINANCIAL UNDERWRITING REFORM & RECOVERY ENFORCEMENT ACT-it should be mentioned that there is already some legislative sparks as noted by President Bush’s call for relief to those homeowner’s who suffered from the flim flam come-ons of the mortgage originators but who have a decent credit history (speculators and investors need not apply). The fact that Sen. Chuck Schumer endorsed Bush’s proposal (an extreme rarity in this political climate) and which involves FHA, FNMA and FREDDIEMac marching to the rescue brings no comfort to this corner as it does nothing to remove any of the past industry practices that brought this problem on with the continuing phenomenal growth of securitization.

The problem is manifold and does not only stem from the non-verification of credit and income, along with introductory low interest rates and optional payment modes allowed borrowers but also has its roots in legislation that allows the financial industry to “game” the mortgage/credit markets by off-loading risk and mortgage portfolios from the originator/lender/packager underwriters and banking institution balance sheets to bond investors who are more likely to pull the trigger on delinquent borrowers and sell off their holdings at discount rather than wait out the market as banks formerly did up through the late 80’s before the advent of securitization. For those with institutional banking experience such as the writer you may recall the people who were in “workout”in the late 80’s through the early 90’s-a vanished undertaking in today’s world of securitization and maybe even a lost art as well.

Also for those of us who are in the lowest rung of the securitization “food chain”, namely appraising, I’m sure we all have stories of phone calls and other nagging requests for lowering fees, making the value, jiffy-quick turnaround times, and other horrors which the readers of Soapbox probably know by heart. Until Congress recognizes that having fixed the lowest rung-fraudulent appraisals coupled with banking institution lending back in 1989 with FIRREA it still needs to regulate a financial market that controls the originating, assembling, tranching of risk and underwriting and sale of the bonds collateralized by these mortgages. Not the least of this regulation awaiting enactment is the fact that the sellers (a/k/a Wall Street) retains and pays the appraiser and the rating agencies. Talk about conflicting interests-is it any wonder that a recent “Sounding Bored” by blogmaster Jonathan Miller addressed the issue of compressed or low appraisal fees (no relation to compressed cap rates).

We may have separated the appraisers from the borrowers under FIRREA but we have not separated the bond issuer/sellers from the appraisers and the rating agencies. Clearly. Congress must address this issue or else we will have history repeating itself probably about 20 years from now when all of the executives responsible for today’s crisis have either been downsized or retired and a new cadre of investment bankers is at the helm with no institutional memory.

Getting back to Bush and Schumer seeing eye-to-eye on the FHA, FNMA & FREDDIEMac Rangers coming to the rescue is the equivalent of taking an aspirin for temporary relief. It will help the poor honest home owner with decent credit who was enticed into a wrongful loan and that is certainly valid and it will leave the investor/speculator licking his wounds and bank account and that is as it should be. But what is called for is transparency in the marketplace, the removal of conflicting interests, and keeping the professional inputs of appraisal and risk rating at arm’s length from the people doing the hiring and paying the fees. For those of you who remember Economics 101-Gresham’s Law where bad money chases out good money-you may want to keep in mind that Wall Street at year end 2006 doled itself $36 billion (yes-with a”b”) in bonuses and that’s after congressional campaign contributions. Do you think $36 billion is “good” money or “bad” money? And the appraisers are complaining about “compressed” (a/k/a low) fees give me a break, Chuck.

Tags: Soapbox Blog, Martin Tessler, Fee Simplistic

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Fee Simplistic is a semi-regular post by Martin Tessler, whom after more than 30 years of commercial fee appraiser-related experience, gets to the bottom of real issues by seeing the both the trees and the forest. He has never been accused of being a man of few words and his commentary can’t be inspired on a specific day of the week. In this post, he ads a new acronym to our tool box while giving us a lesson in how we got here. Great, great stuff.” …Jonathan Miller

One of the few advantages of being an “old fogey” with 30 years of real estate counseling experience notched on the belt is that if you hang around long enough you will see history repeating itself in cyclical aspects of real estate finance-roughly every 20 years. My career started back in the early 70’s when the REIT world imploded as the result of mostly borrowing short but investing long at a time that the economy underwent something the economists called “stagflation” following the first oil crisis. It was a time of double digit inflation, a stagnant economy and it also featured a phenomenon called “disintermediation”- a PhD word that denoted the massive withdrawal of deposits from fixed interest savings accounts that resulted in the devastation of real estate financing and many REIT’s. Somewhat similar to today’ subprime and hedge fund world of investing it was a time of money chasing deals.

Recovery from stagflation culminated in the mid-late 80’s when Wall Street and the real estate markets hit its stride with a booming stock market-think Gordon Gekko a/k/a Michael Douglas’s “greed is good” and the unscrupulous S&L bankers and their crooked appraiser cronies. As banks hemorrhaged loan write-downs from fraudulent appraisals Congress went after the appraisal profession (the bankers, for the most part, escaped punishment owing perhaps to the fact that the American Bankers Association is more generous to Congressional campaigns than the penurious appraisal world) and we got FIRREA in 1989. FIRREA, as we all know by now, was the Feds pointing the finger at the appraisers while telling the bankers to beware whom they sign up on their appraisal “dance card”.

Fast-forwarding to the late 90’s and the post millennium a new crop of miscreants surfaced, namely the underwriters and the rating agencies. The advent of the slice and dice tranche in the RMBS and CMBS world gave rise to the subprime and its not-quite illegitimate but certainly suspect “piggyback” loan. A recent article in the Wall Street Journal noted that in 2000 Standard & Poor concluded that “piggyback” loans were no more likely to default than those of standard mortgages. A new symbiosis evolved between the lenders eager to lend, the home buyers and speculator investors eager to borrow on easy credit, the Wall Street underwriters eager to sell their bonds and collect their up-front commissions and the bond rating agencies eager to capitalize on the lucrative and expanding rating business.

As with the appraisal world you had lenders shopping around for the “right” value from cooperating so too with the bond world you had underwriters shopping around for the right credit rating from the rating agencies. Moody’s had revenue of roughly $3 billion from 2002-2006 for rating securities from a variety of debt pools including mortgages and other types of loans. Standard & Poor did not change its mind on “piggybacks” calling them more likely to default until 2006 at which time the subprime mortgage market ballooned to $1.1 trillion.

Now that the chickens are coming home to roost and the appraisal world is, for the most part, guiltless will the Feds move to reign in the underwriter/credit rating agency cabal? Is it time for FURREA-the Financial Underwriting Reform and Recovery Enforcement Act? Perhaps New York Senator Chuck Schumer, who never saw some skullduggery that did not warrant a Congressional action should be asked, “How about this one Chuck”?

Tags: Soapbox Blog, Martin Tessler, Mortgage Fraud, Fee Simplistic

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Fee Simplistic is a regular post by Martin Tessler, whom after more than 30 years of commercial fee appraiser-related experience, gets to the bottom of real issues by seeing the both the trees and the forest. He has never been accused of being a man of few words and his commentary can’t be inspired on a specific day of the week. In this post, he takes Jesse James to lunch” …Jonathan Miller

Although the Bloomberg administration outlawed the serving of trans-fats in restaurants they neglected to apply their zeal to the world of real estate lending in all its permutations whether it was on the debt or equity side or the acquisition side. The May 2nd NY Times reported on how the collapse of the subprime mortgage market has resulted in bond rating agencies now beginning to take a closer look at the commercial lending market and its underwriting practices. For those of us who have a sense of humor beyond the reading of USPAP and the Appraisal Institute’s textbook it reminds me of the old Hollywood westerns when the likes of Jesse James type train robbers would place their ears close to the rails to listen if a train was approaching. According to the article, Moody’s reported that the CMBS market accounted for just under $770 BILLION and represented 26.1% of all outstanding commercial mortgages inclusive of apartment buildings. In other words, the rating agencies were beginning to realize they had a big pot of gold to protect from those larcenous underwriters eager to give money away.

It seems that the rumblings on the rails have been triggered by some macro research data revealing a slight tick up in the average office vacancy rate among 58 metropolitan markets which was the first increase since 2004 and that the rate of rent growth was moderating. Thus, while office rents in Manhattan had rapidly escalated, some in the bond rating world were getting a bit nervous over the hasty manner in which deals were getting done. The Times article cited how Macklowe Properties took only 10 business days to complete its $7.25 billion purchase of 8 Midtown office buildings that the Blackstone Group had previously bought from Sam Zell’s Equity Office Properties. Most notably, the bond raters woke up to the fact that the average annual rent in the properties was $55-$59/sq. ft. BUT the deal was underwritten at $100+ /sq. ft.

The upshot of all this recent scrutiny by the rating agencies is that CMBS investors are demanding higher yields making the bonds costlier for the dealers and it has also forced a throttling back in some of the CMBS deals. A recent $4.2 billion GE Capital deal where investors were concerned that the lenders relied too heavily on projected rent increases forced the removal of $226.7 million in loans; the investment grade portion of the CMBS was trimmed by $50 million and the prospective proceeds from the high yield end of the bonds could be reduced by $8 million because of the higher yield discounting.

As a lowly toiler in the appraisal field all these years I cannot help but be reminded that the standard joke in my repertoire was

tell me the value you need and I’ll tell you the assumptions you need to get there.

Tags: Soapbox Blog, Martin Tessler, Fee Simplistic

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