The Big Real Estate Smack Down

You really don't have to know anything about the real estate industry to understand a painful reality: the great American Dream of Home Ownership has turned into the Great American Nightmare.

Just about everyone I know -- from millionaires to borderline paupers -- has been beaten like a Himalayan Gong during the current real estate market Smack Down. Borderline paupers have been particularly stung by the tremendous decrease in the value of their property. That's because they believed that the equity they accumulated over the term of ownership would tide them over in retirement. So Long, Equity!

The wonks and the talking heads would have you believe there are numerous and complicated reasons why the Great American Dream has gone "pfft." But when you really get down to it, there is one -- and one only -- cause: the ages-old business relationship between the seller and the buyer has been usurped by the courts.

I "get it" about foreclosures. I understand why lenders go the the courtroom to enforce consequences against people why can't pay.

What I don't understand is this: I don't get the court-ordered appraisal process whereby a "disinterested third party" or the appraiser, establishes artificially low values on the properties undergoing foreclosure.

A little side track: appraisers employ one of three methods to establish the value of real estate. First, there is the comparable value method, in which the appraiser researches all properties sold within a certain area, and then comes up with a price tag based on the average selling price.

The second method is known as the income approach -- but this doesn't really apply to most residential properties where the owner is the occupant.

The third way to establish value is through the replacement cost method, whereby the appraiser calculates how much a home is worth if it was built on a lot from scratch. In most parts of the country, a minimum replacement cost for a typical residence would be in the $100 to $125 per square foot range.

By relying upon the comparable value method as the benchmark, courts set the equity factor built into every home in the community into a persistent, downward spiral. Consequently, the courts become overly-reliant on the worst-possible method of establishing value, the low-ball method. There are just too many foreclosure fire sales going on for the comparable value method to work.

Low-ball appraisals are not only unfair to the lender, they are lethal to folks who are not behind on their obligations. The sad fact is, low-balling is happening all over the country. People living in Nevada, Florida and California in particular are being hit by such practices.

Here's an example of how low-balling works: Appraisers inspect the properties in foreclosure and report to the courts that foreclosed "Property X" which sold for $350,000 five years ago is worth only $125,000 in today's market. This becomes the floor sale price, at auction, the bottom line number that would be acceptable to the court.

What happened to that $225,000 differential between the sales price six years ago and what the court will accept at auction?

Pfft!

But hold on there, chief. The courthouse auction price has a tremendous negative effect on the value of comparable homes not in foreclosure. People who are current with their obligations, in one word, get screwed by this process.

What the appraiser forgot to tell the courts is this: the house was gutted of duct work; appliances were removed or they do not work; plumbing and electric fixtures were ripped out; the AC unit went missing; and, the roof leaked.

For all intents and purposes, the foreclosed property sold at auction by the court is uninhabitable. It will not qualify for a certificate of occupancy unless extensive repairs are made to it. Put another way, the new owner  will have to spent a crap-load of cash in order to bring the place up to livable standards.

By the time the new owner is finished, and gets his or her CO on the property, its value will be back up to the $120 per square foot range, where it should be.

Another way to look at it, the property's value would be back up in the $300,000 range because the replacement method would trump the low ball method.

When replacement cost trumps comparable value, homeowners who are current with their mortgages will be able to maintain equity in their property.

Before the courts place any foreclosed property up for auction, judges should ask one fundamental question: does the property qualify for a certificate of occupancy? If it doesn't -- and in a vast majority of cases, it won't -- then the property can be sold at auction for its raw land value.