An empirical analysis of property appraisal and mortgage redlining

Abstract

The recent literature advances a hypothesis that addresses the possibility of mortgage redlining caused by a dynamic information externality in property appraisals and mortgage lending. In particular, Lang and Nakamura (1993) hypothesize that because property appraisals depend on past transactions, appraisals in neighborhoods where transactions were infrequent tend to be less precise. The greater uncertainty about house valuation in such neighborhoods can lead mortgage lenders to impose stringent requirements on borrowers. Lang and Nakamura's article, like most economic analysis of property appraisals, is theoretical. Using a sample of mortgages purchased by Fannie Mac, we present preliminary research results that cast doubt on appraisal behavioral rules such as weighted averages or backward-looking expectations on which Lang and Nakamura and other theoretical studies are based. Instead, our results refocus attention on the moral hazard issues of appraisal. We find that in more than 80 percent of the cases, the appraisal is between 0 and 5 percent above the transaction purchase price, in only 5 percent of the cases is the appraisal lower, and in 30 percent of the cases, the appraisal and transaction prices are identical. It would take a strong statistical model to generate such occurrences. Our resufls also indicate that appraisal outcomes are used as a risk factor with different weights for loans with different characteristics (loan-to-value ratios and house prices). The results suggest that more empirical investigation of appraisal pracrices be conducted to verify the validity of conventional wisdom embedded in theoretical studies, and we offer an econometric framework toward this end.This paper is a commentary on a model of redlining propounded by Lang and Nakamura (1993). We adopt a two-part strategy. First, we present some pre "hminary empirical evidence that appears to be at odds with the model of appraisals used by Lang and Nakamura and other theoretical studies. Second, we suggest an econometric framework for testing the statistical validity of appraisal bias revealed by our research results.We compare the appraisal price of a property, which is required for underwriting and validation of a mortgage application, with the actual transaction price. The sample consists of mortgages purchased by Farmie Mae. If an appraisal falls below an accepted purchase price, a deal may be jeopardized. In our data analysis, 80 percent of the cases were appraised at values between 0 and 5 percent above the transaction purchase price, only 5 percent of the appraisals were lower than the transaction price, and in 30 percent of the cases the appraisal and transaction prices were identical.

A Taxonomic Field Investigation in to Induced Bias in Residential Real Estate Appraisals

“…For example, using a database of 600,000 residential mortgages purchased by Fannie mae in 1993, Chinloy, Cho and megbolugbe (1997) and Cho and megbolugbe (1996) discovered that 95% of the appraised values were greater than or equal to the pending sale price. This result was perhaps less than surprising given that low appraisals result in loan rejection or renegotiation and rejected loans were not represented in this database (the truncated distribution problem).…”

Research bias in judgement bias studies – a systematic review of valuation judgement literature

“…While commercial interests are highly visible in a mortgage case scenario as both banks and real estate buyers have an interest in completing a finance transaction (Cho & Megbolugbe, 1996;Smolen & Hambleton, 1997), our review indicated mixed results on the effects of client pressure on valuation judgement upon finance transactions. Given the indispensable role of market valuation for mortgage lending activities, we consider additional research a necessity to stipulate more closely the effect of a mortgage loan scenario upon judgement bias.…”

“…The valuer understands the financial implications of withdrawn transactions to clients and at the same time seeks a long-term business relation. This potentially creates a moral hazard issue for valuers with regard to deciding on an appropriate market value estimate (Cho & Megbolugbe, 1996;Kinnard, Lenk, & Worzala, 1997). In turn, the principal's awareness of this moral hazard issue opens the door for client influence.…”

Usage of Major Heuristics in Property Investment Valuation in Nigeria

“…His finding is similar to the findings in Hong Kong (Wong, 2006). Other studies carried out to identify the existence of and nature of anchoring and adjustment in the valuation process include (Cho and Megbolugbe, 1996;Diaz, 1997;Diaz andHansz, 1997, 2001;Hamilton and Clayton, 1999;Harvard, 1999Harvard, , 2001Clayton, Geltner, and Hamilton 2001;Hansz and Diaz 2001;Gallimore and Gray 2002;Cypher and Hansz, 2003;Hansz, 2004a;2004b). These studies confirmed the existence of anchoring and adjustment heuristics except Diaz (1997).…”