Understanding the Inherent Risk in AVMs and Appraisal Waivers
The FHFA has opened up discussion over the modernization of the appraisal process that could potentially pave the way for some much-needed guidance. The timing is perfect. Right now, the valuation industry needs to address some serious issues plaguing the process today: supply and demand imbalances, barriers to increasing capacity, and turn times.
One of the biggest concerns that most stakeholders have is over the Government Sponsored Enterprises’ (GSEs) reliance on Automated Valuation Models (AVMs) and appraisal waivers. Appraisal waivers have been around since the late 1990’s, with the waiver program expanded in 2017. The Enterprises make an appraisal waiver offer when the Enterprises determine that they have enough information on the current value of the property to “waive” the requirement for an appraisal from a licensed or certified appraiser. While Covid-19 has certainly had an impact on the expanded use of waivers, the FHFA is essentially now asking for advice on what should stay and what should go in their policies governing appraisals and valuations.
As Reggora continues to contribute to the discussion with FHFA, we believe that the reliance on AVMs should not be based on an assumption of condition for any substantive level of transactions. Yet we’ve seen their use pick up. In February 2021 the AEI Housing Center projected that waivers in January 2021 accounted for 46% of all valuations combined for Fannie Mae and Freddie Mac, many having an AVM inserted as part of that process in that decision.
Source: AEI Housing Center
It’s true that appraisal waivers and the use of AVMs have been risk-management tools utilized by the industry for years. They’ve played a valuable role when assessing low-risk loans in that they offer significant cost benefits to the consumer as well as relief in meeting demand, and they should certainly be part of the modernization process.
However, conventional risk management principles of real estate generally call for the use of AVMs when they are fit for purpose. There is an inherent risk of using AVMs because the models rely on key assumptions relative to the condition and the external influences on a property. Machines and algorithms cannot replace the boots on the ground role of appraisers when it comes to identifying collateral-specific risk.
An important question being asked is whether the reliance on appraisal waivers and AVMs are leading to higher levels of risk that may present challenges to liquidity. Real estate, after all, is a hard, tangible asset, and if we are basing lending decisions with a “hands-off approach” when assessing the physical and external factors that may impact the value of collateral pledged for loan repayment, will this come back to haunt us?
The higher frequency of appraisal waivers are reducing real-time property data validation, a key component in maintaining data integrity in the models utilized today to measure value through AVM and other predictive processes. One has to ask, is less first-generation property data collection contributing to a decline in model integrity because the same automated underwriting models making the decisions on eligibility are relying on a smaller population of collected data? As the number of waivers increases over time, the number of property data inputs feeding these actual models decreases, potentially eroding reliability of the models.
To gain a better understanding of the risks associated with AVM, one only needs to review the practice of extensive AVM use and the subsequent outcomes that home equity lenders experienced prior to and during the Great Recession in 2007-2009. Because of the recency of appraisal waivers, and a long time horizon of realizing actual losses when waivers were granted, systemic consequences of impaired underwriting model performance are unknown at this time.
We believe that the current level of waivers as noted in the RFI and through published reports is unsustainable from a data modeling standpoint. Risk positions have increased due to the expansion of the waiver program by not measuring physical and external influences that can impact the value of collateralized real estate for specific mortgage transactions.
To reduce risk while maintaining proper liquidity and costs, the market must find alternative valuation processes and products that replace some percentage of waivers. The alternative should be able to confirm the property condition and relevant changes while utilizing a more accessible workforce. The challenge is how to ensure data quality at the collection point (property viewing) while improving overall efficiency?
The good news is that because of the accessibility of smartphones, as well as recent improvements in new technologies such as computer vision, geolocation tracking, LIDAR, and much more, barriers are being removed to ensure consistent property-specific data collection. If the industry can come together to design a standard around what an inspection must entail, and the level of data quality required to ensure proper risk identification and management, then theoretically any type of workforce, which can visibly demonstrate meeting these standards, will be able to fulfill the inspection.
That being said, there exists a current system that allows for appraiser trainees under the supervision of a qualified appraiser to perform this type of data collection. Re-tooling appraisers and expanding the use of trainees, can and should be leveraged to mobilize an industry-wide effort to address demand and supply imbalances without reducing the integrity of data collection and collateral risk identification.
This can be accomplished while maintaining the public trust.
The main priority of the appraisal is to instill confidence and trust that the process yields results that are professionally developed, for the benefit of the consumer and the lender. It is undeniable that in 2021 the state of the residential appraisal industry will continue to offer challenges, presenting a supply-side issue where we do not have enough appraisers to meet the demand and service levels expected by both lenders and consumers. This shortage of supply continues a perception and occurrence of operational inefficiency and increased customer experience problems, as appraisal timing potentially delays transactions.
We have built a system that values client priority and loyalty at the expense of equitable customer service, creating pockets of underserved markets. While appraisal waivers seem to be providing some level of relief, they are a double-edged sword. They lessen the impact of supply imbalances, but also introduce new levels of risk. Retooling, rethinking, and supporting a modernized approach to the appraisal process will serve all stakeholders well, creating a more efficient marketplace, while maintaining value and trust. The Reggora platform is founded on this approach, providing innovative solutions to key stakeholders while creating operational efficiencies and reducing risk.