Digital home valuations have hit an inflection point. What's next?

Use of digital valuations soared to new heights during the pandemic, but the drivers of appraisal technology are different now.

The average share of loans Fannie Mae and Freddie Mac allowed waivers for jumped dramatically to 50% at one point, from a pre-pandemic level of close to 30%, according to the American Enterprise Institute Housing Center. However, that number has retreated to closer to 40% since appraisal flexibilities around examining interiors in automated ways were rolled back, but it’s still significantly higher than it was prior to the pandemic.

Three things could shape how the use of automated appraisals evolves: what happens in the overheating purchase market, whether the appraiser shortage the pandemic intensified improves, and how or whether government-sponsored enterprise policy discussions affect model development and use more broadly.

Current motivations and new baselines for growth
To understand why average use for standalone digital valuations is changing beyond what the rollback of contingencies might drive, it helps to understand how waiver shares differ by loan product type.

Prior to the pandemic in February 2020, 44% of no cash-out refinances had appraisal waivers, as did 10% of cash-outs and just 6% of purchases. By June 2021, the waivers were applied to nearly 70% of no cash-outs, 34% of cash-outs, and 10% of purchases.

These numbers represent some notable increases for refis, but with purchases on the rise, use of waivers has stopped increasing. Some researchers think another big catalyst for technological development would have to emerge before they’d go much further.

“So we now know, based on the current level of technology and data, what the maximum is,” said Ed Pinto, a senior fellow and director of the AEI Housing Center, in an interview. “Those numbers could go higher, but in general, to do so, you would need more and better data.” (Fannie and Freddie only allow waivers if their appraisal data and models are deemed sufficient to support a value without appraiser intervention.)

While some motivations and market conditions driving digital validation use have changed since the pandemic subsided, other factors could encourage continued growth in their use.

Appraiser shortages that intensified during the pandemic, for example, are likely to continue in the short term given the rising number of purchase loans that have low levels of GSE waiver usage.

“The number of appraiser licenses has not really increased, and yet the volume has substantially gone up,” said Kenon Chen, executive vice president at Clear Capital.

The aging appraisal industry is working on opening up its highly regulated requirements to more people, but it requires changes to policy that may take time, said Daniel Fries, an appraisal firm owner in Georgia.

“They’re looking at coming out with more testing and reducing the [amount of mentorship time required], but that’s in flux right now,” he said.

Even in situations where appraisers are involved, as they likely will be so long as purchases are on the rise, digital valuations and other related technology can be compelling when it comes to quality control.

For example, if the score is high enough, Cornerstone First Mortgage might use an automated valuation model on it in the submission summary report for loans uploaded to the GSEs’ Uniform Collateral Data Portal. Higher scores indicate a possible need for review.

“We use the AVM as a support tool for the appraisal when the SSR rating is higher,” President Sean Cahan said. A score of five is Cornerstone’s threshold for additional review, he said.

Getting an appraisal right is particularly important in the current market, in which buyers have been consistently overbidding, and are sometimes willing to pay cash above what a home is valued at, which has a compounding effect on home prices.

For instance, if a series of home sales in a neighborhood raise prices 3% each time, a home value that starts at $300,000 after two sales per month in a hot housing market can rise to a price of $590,000 within just one year. Appraisers can limit the speed at which a bubble like that can form due to the closed sale data used to provide a valuation, said Bill Reese, a senior vice president at Evolve Mortgage Services.

“Projecting to the point when the bubble bursts and home prices fall to levels of affordability, many mortgages will again exceed the market value of the homes securing them, which could lead to another default crisis,” he said. “Appraisers play an active role in mitigating the severity of those market realignments by flattening the appreciation curve.”

Challenges
Meanwhile, sales in a potentially overheating market have been happening quickly and increasingly through channels that aren’t immediately trackable through traditional data sources like multiple listing services, said Fries. That lack of uniform data could impact the accuracy of decisions made in automated appraisals.

“When you’re dealing with off-market sales, you kind of have to put things in low gear,” he said. “You’re probably talking about 15% of sales that are not represented in the MLS.”

Online data sources have improved a lot over time but they are by no means complete, and sometimes the information they provide isn’t entirely accurate, Fries said, noting that this is one of the reasons appraisers are still largely involved in purchase market valuations.

Another challenge in obtaining an appraisal/property inspection waiver is the lack of loan officer and processor familiarity with some of the nuances involved.

For example, where investment properties are concerned, using rent to offset the cost of the mortgage for qualifying will prevent a PIW from being used, because it makes it necessary for an appraiser to conduct a market rent analysis. If a consumer doesn’t need the rent to qualify and the mortgage’s loan-to-value ratio is 75% or below, they’re more likely to be able to use a waiver.

“Half the reason why PIWs do not make up a larger percentage [of GSE loans] is simply not enough education,” Cahan said.

Also, policymakers have recently begun discussions on whether steps need to be taken to address appraisal bias in automated valuation models.

An analysis of a historical sample of automated valuation models found they can contribute to disproportionate error rate for majority Black neighborhoods in part because they haven’t incorporated distinctions like whether or not a property is distressed, the Urban Institute found.

“Most of the algorithms [used in AVMs] don’t take into account the property conditions,” said Linna Zhu, a research associate at the institute. The study notes that AVMs “hold great promise” for reducing appraisal costs but if they produce disparate error rates, they may need tweaking.

What could change near term
While digital valuations may need to be retooled with more information and analyzed in new ways before they can be used more broadly to evaluate purchase mortgages, a handful of other shorter-term innovations are in the works.

While the private market does sometimes simply follow the GSEs’ lead, certain appraisal flexibilities allowed during the pandemic could be used to introduce more efficiency into the process, said Jillian White, head of collateral at Better.com. These could include technologies that allow appraisers to remotely measure homes’ interiors and prove location using geocoding and other parties.

“When we had the COVID flexibilities, the average amount of time taken to complete an appraisal shrunk a bit, because your appraiser didn't have to physically go to the property,” said White. “It was somewhat like a relief valve for an industry that is spread pretty thin currently.”

While accuracy is the top priority in appraisal technology today, users like White hope for increased efficiencies in the near future. Usage of technologies that deliver payments to appraisers more efficiently have been on the rise. In addition, platforms that manage the quality control process between lenders and appraisers are particularly popular right now, White, Reese and Fries also separately noted.

“The old way, I submitted it to the lender and a day or two later I got a call back if there was something that needed to be addressed,” Fries said. “Having that instant review can save time.”

While not commonplace yet, Fries estimates such platforms probably have roughly a 30% usage rate. Between that and other more broadly used technologies available that automate the property data collection process, he estimates lenders and appraisers can shave almost a week off their turn times.

However, Pinto, who has been working with appraisal technology and digital valuations since the 1990s, urges caution around expectations for either to shrink overall loan closing times. While they certainly may be effective in limiting the degree to which closing times lengthen, they can only go so far toward reducing the steps lenders in a highly regulated industry must take.

“The bottom line is it takes basically just as long to close a loan today as it did 10 years ago,” he said. “That’s not to say that if you hadn’t made progress, it wouldn’t take longer.”