The 1004MC-71 INDUSTRY UPDATE

David A. Braun, MAI, SRA (Written 2009)

Part 1; AND, THEY ARE OFF! April first has come and gone; and the mandate to use the 1004MC-71 form (MCF) is firmly in place. Much like in a horse race appraisers are accelerating out of the blockswith a few still stuck in the gate. The form appears to have been primarily designed by Fannie Mae, with some input from Freddie Mac, and the Appraisal Institute. The intent of this writing is to discuss the progress of appraisers to adapt to the form and to begin a converging of the various opinions of how the analysis should be completed. The players in this scenario are the designers of the MCF, solution providers, appraisers, and reviewers. My personal expertise is as one of the solution providers, but also as an appraiser and fee reviewer. I have 30+ years of appraisal experience, am a certified USPAP instructor, the author of APPRAISING IN THE NEW MILLENNIUM, Due Diligence & Scope of Work, designed and developed the USL Documenter II software, and the Regression Plus; for Real Estate Professionals. I did not help design the MCF, nor have I interviewed those that did. I feel the MCF is too restrictive (perhaps to keep it one page), but otherwise I believe it is a positive progression in the evolution of the appraising industry. Now that most appraisers have access to spreadsheets they can assemble and analyze hundreds of records at one time. This is a stock pile of raw resources that appraisers can no longer afford to ignore. In fact, appraisers like in every other industry in America must exploit every asset at their disposal and evolve their research and development to a higher degree of efficiency. Appraisers should begin to grasp the MCF as a tool to help them and not a hurdle to jump over. In this new millennium...appraisers must evolve from form-fillers and template masters to problem solvers. i At this time most appraisers are simply trying to fill out the form with little recognition of its potential role in the appraisal process. Over time, this will change and appraisers will recognize that when a good market condition analysis is performed, the appraisal is half way complete. In the mean time industry leaders such as instructors, writers, and reviewers should keep pounding the message that the MCF is a viable tool that can provide significant insight and lead to a credible appraisal. I have found that many appraisers are hung up on how get their MLS search results exported to a spreadsheet and if necessary converting that data to a standard spread sheet format which will allow for organization of the data and
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analysis. This is not to imply that every appraisal market will require the use of a spreadsheet. Many rural markets with few properties will simply be done by hand. Appraisers coming out of the gates are like the early stage of a race for a human sprinter; their heads are mostly down right now, but shortly their heads will look up and they will be searching for points of reference to guide them. These points of reference include books, seminars, automated tools, and the designers of the form. The successful appraiser will have to expend the energies to absorb information from all of these sources. Those that ignore this wealth of information and are content to merely fill in each blank on the form will find that the users of appraisals will intentionally and systematically begin to remove them from their approved appraisal lists. Once appraisers make the effort to learn and evolve they will need automated tools in order to meet the budget constraints that they operate under. Most of the commercial form providers have integrated the MCF into their software packages. But, they have built in little automation. I have been offering automated solutions to appraisers for almost a decade. But, as an appraiser it is difficult to appraise and develop software. I have been delighted to see appraisers besides myself offering commercial report writing software and MCF tools. Many appraisers have developed tools, but most never make it to market. These efforts represent a significant shift in how automated tools reach appraisers. It is my hope that these appraiser/developers will unite and support one another to better provide appraisers with the automated tools they need to do their job.

Part 2; FRUSTRATION TURNS TO PANIC I have been talking to a lot of appraisers who are getting a little uptight. Consider that for most residential appraisers their personal financial position has been deteriorating the past couple of years because of a decreased demand for appraisals during the height of the housing crisis. Now, throw in the new requirement to perform a market condition analysis (MCA) on the 1004mc-71 form, while the work load is finally beginning to increasing. The typical residential appraiser is in no position to turn down any work. This scenario has left a good number of appraisers in a state of frustration and panic as they attempt, but fail, to produce a credible MCA in a reasonable time period. Some have reached the point that they say the heck with a credible MCA, I would be happy if I could just get the blanks filled in on the 1004MC-71 form (MCF). What should appraisers do to get over this hump? My suggestion is to begin to think positively. Most appraisers (90% plus) can meet the challenges of performing a credible MCA on the new MCF. So, most all appraisers are stating a fact when they say, I can do it! However, there is a set of skills that has to be developed, each fitting together like the pieces of a puzzle. Lets talk about a few of these necessary skills. The first and most important skill is being able to recognize what data should be gathered in the analysis. The second is how to perform the database searches that are necessary to gather all of the meaningful information. The third step is assembling that information on a spreadsheet for analysis. The appropriate data to gather is any property that was exposed to the market (listing, pending, expired, withdrawn, sold etc.) that potential purchasers of the subject property would deem competitive to the subject property. Appraisers typically think of pertinent data (comps) in the forms of closed sales and active listings. However, would a property that is very similar to the subject that was actively listed on the market at $220,000 for over a year and was recently withdrawn by the owners be meaningful information for the appraiser? Of course it would. A MCA that is based on a lot of types of data has some real potential to aid the appraiser in the valuation process. The data-basing term for these different types of comparable properties is a Record. What search parameters should be used when gathering these comparable property records? This is best answered by considering what the appraiser is going to do with the data. The MCF is basically a trending analysis; but what are we trending? Many appraisers search for comparables by a sales or listing price range; which is an incorrect method. We are not so much interested in how many properties are offered and how long they have been on the market in a specific price range. The appraiser is not trying to trend a price, he/she is trying to trend a specific property type in a specific location by price over time.
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An example appropriate search criteria for the 1004mc-71 form might be all two story homes, 1,700-2,400 square feet above grade, with 3-4 bedrooms, 2 or more baths, 5-15 years old, in the Heritage High School district. The MCF is trying to see how the properties just described by the search criteria are doing over time. Are prices for this very specific property type stable, increasing or declining? So, the search parameters should be as narrow as possible. If there are multiple quarters where there are no records of any kind (especially sales and listings) then the search parameters should be widened.

The following illustration shows how a search and thus the MCA can be expanded. The expansion is in terms of physical property type and location. The appraiser can expand the search in terms or either or both categories.

When there is little data found in the subjects sub-market area appraisers are directed by the MCF to seek answers by working outside of the red zone above. This might be more specific as in a sale and re-sale type of analysis, or by expanding the search for properties to the right of the red zone, stopping the expansion as soon as meaningful data is gathered. Once you have found the data the next step is to get the data onto a spreadsheet for organization and analysis. A spreadsheet is a specific type of software program that is designed to store data and analyze it. Prices range from free to a few hundred dollars for this type of software. The reality is that there is an exact match between what appraisers do and what a spreadsheet is designed to do. I am going to bite my tongue and only say this; you can
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learn essentially everything you need to know about spreadsheets where the MCF is concerned in a one day seminar. You can find a seminar at your local community college or the beginner spreadsheet seminar that is being offered by the Appraisal Institute. You must become proficient in gathering the data and getting it on a spreadsheet before you move on to Part 3; What Goes Where and Why on the 1004MC-71 form.

Summary of Parts 1 & 2 Most appraisers have the ability to search for and download hundreds of property records directly to a spreadsheet. The availability of this data opens the door for the appraiser to perform a quantitative market conditions analysis. A reader of Part One let me know that he pretty well detests the MCF. I explained that my main thrust was not to support the MCF (1004MC-71), but rather to support quantitative market condition analysis in general. I have some issues with the form myself, but I do believe that there are a lot of cheap shots aimed the MCF, that are simply not valid. It is irrational for appraisers to get angry at Fannie Mae for designing a form that addresses how to perform a market condition analysis, when appraisers should have addressed the issue more specifically themselves in terms of education and training. I guess I am trying to say that the world is under no obligation to wait for us (the appraisal profession) to utilize all of the new data and technology we have available. I would say that 90% of the problems appraisers face today were caused by either our own actions or lack thereof. I do believe 10% of the time we do get dumped on. In Part 3 I will discuss an issue that falls in that category. Another reader stated she did not appreciate me using scare tactics to sell my MCA software application. I explained to her that I was not trying to sell my wares, but was guilty of trying to use scare tactics to get appraisers to embrace market condition analysis in general. I did apologize to her and I will to you for using scare tactics at all, as it does show a basic lack of respect on my part. I do have the utmost respect for appraisers in general here is what I say in my scope of work book:
AVToperatesunderthebeliefthatthereisnosubstitutefortheNeighborhoodAppraiser.Their knowledgeofthelocalmarketisuniqueandcannotbeduplicatedbyremotecomputeranalysis.These localappraisersarehardworkinganddependable.Withoutquestion,thesegrittyindividualswillcarry outtheirdutiesaslongastheyhavetheknowledge,trainingandequipmenttodoso.

Which leads to my next point, They can...they can...I know they can. I and many others are doing their best to provide you with the knowledge, training, and equipment
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to be able to do quantitative market analysis. Patrick Egger sponsored by Al a mode software company traveled around the country providing both knowledge and a spreadsheet application to help appraisers, Mark Rattermann provided educational programs on the MCF and spreadsheets for the Appraisal Institute, many others (too many to mention) have provided knowledge, training, and software applications. Often times after I write an article or someone uses my MCA application I get an Email with the simple message of thank you. Perhaps the best feeling came after an appraiser said that after performing several quantitative MCAs he found that there were a lot of sub-markets in decline that he had been deeming stable based on analysis that were more subjective in nature. My final advise; expect to be frustrated, that means you are trying to learn. Do not panic, slow down, take a deep breath and spend an average of one hour per day on outside study on market condition analysis for the next month. Learn how to perform the searches you need to get the appropriate data out of your MLS and on to a spreadsheet. Take a spreadsheet class. Consider the big picture not the blanks on the form. A professional appraiser is a problem solver, not a form filler. More about problem solving versus form filling in Part 3.

Part 3; WHAT GOES WHERE AND WHY

The 1004MC-71 form (MCF) is primarily a trending analysis. Perhaps the most important trend is property values over time. The MCF investigates this directly and indirectly. It does directly by trending prices (closed, listed, and SP/LP as a percentage) over time. It does this indirectly by trending the months of housing supply, days on market, and sales activity; and by monitoring seller concessions, and the number of sales that were foreclosed properties. This writing is too limited to address each of these issues; however, I do want to discuss a couple of issues to help appraisers avoid reaching incorrect conclusions about the market. The first, addresses the limitations of trending the sales price per property over time. In Part 2 we discussed that we are trying to trend the value of a specific property type over time. However, often the data collected will not be as tight a property fit as hoped for. In this case, the appraiser must consider that there may be factors other than market conditions (time) that are causing the trend. Trending the sales price per square foot will typically be more accurate as it considers the differences in size for the data. In very slow markets keep in mind that one or two sales that are low or high may not be fully representative of the market. So, the appraiser should consider the entire body of evidence that is available before coming to a conclusion. The second issue addresses the calculations which the months housing supply (MHS) is based on. In the brief discussion above I have tried to point out that a correct opinion on the state of the markets condition will have to be based on a body of evidence. The logic for this is based the probability that any one indicator by itself could be indicating an incorrect trend. If the analysis is to have any credibility it is especially important to address the data that is meaningful with a high degree diligence. The appraiser must be able to recognize the data that is meaningful, organize the data into information, and analyze it in such a manner that the data ends up contributing to a credible market conditions analysis. While some data like the days on market are suspect, the MHS is based on quantifiable data and is typically a good indicator of what is going on in the market. This is data that closely monitors the relationship of supply and demand over time. The first three rows of data on the MCA gathers the information necessary to calculate the months of housing supply. For example, if at a given time there are 20 listings and the market is absorbing 2 properties per month then there is a 10 month supply of housing. The fact is that even though the information (number of sales and the number of active listings) used to calculate the MHS is very quantifiable there is a great amount
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of confusion on how it should be calculated. It appears that the confusion is primarily related to the Total Number of Active Listings (TNAL) count. There appear to be two basic theories on how to count up the TNAL. These are: Some variation of Cumulative TNAL, and An Average TNAL

A cumulative TNA counts up all of the properties that were listed at any time during the time period. It counts even if it is sold, expired, or withdrawn. It is my belief, based on mathematical evidence presented later in this report, that a calculation based on the average TNAL will produce the correct MHS, while a calculation based on a cumulative TNAL will almost always produce an MHS that is over 100% to high. I have found nothing in the written information distributed by Fannie Mae that ask for a cumulative type of TNAL, in fact the word Active seems to always be paired with the word Listing in most everything that Fannie Mae has written. I am personally very confused because I have been told that my Total Solution application is the only one that is based on an average type of TNAL count. While I spent many hours working through a scope of work decision and programming the Total Solutions to produce an accurate MHS it appears that many other simply asked Fannie Mae officials how it should be done. Their answer was to use the cumulative method of TNAL. While this communication is unofficial I have seen the Emails and I believe he has made this statement to more than one person. I never dreamt of asking Fannie how they would calculate the MHS for several reasons; 1. Fannie already gave a pretty good written example of how it should be calculated. 2. Fannie clearly explained the purpose of the form and the purpose of the MHS. 3. The appraiser is responsible, not the client, for using a scope of work that will result in a credible opinion or conclusion. 4. As an appraiser I know the client cannot ask me to use a technique or formula that will compromise the opinions and conclusions of my results. 5. As an appraiser I am trained to complete analysis such as the MHS. 6. They might give me the wrong answer. Overstating the MHS by 100%+ could lead me to an unrealistically pessimistic view of the current market conditions. If this happens a lot of people could be hurt starting with the lender and moving to the borrower, real estate sales company, etc. The MHS is not something that only appraisers use. It is a common term in the real estate industry and is discussed in the April 2009 REALTOR magazine. On page 20 it states that, Although there are no steadfast rules to determine future pricing, .months supply of
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inventory (total inventory divided by the number of houses sold per month) is a great guideline. A normalized or balanced market has five to six month of inventory. Appraisers are not a liberty to recreate a new meaning for the term months of housing supply as its meaning is already in place and being used by many others in the real estate community. I have no doubt that the lender, borrower, Fannie, Freddie, FHA, and VA (did I forget anybody) really does want me to report a clear and accurate understanding of the market trends and conditions. Lets consider the appropriate way to decide how to calculate the MHS and any other part of the appraisal process; by making an informed scope of work decision. The first step in deciding a method for calculating the information on the MCF is to understand its use. The use of the TNAL is to help calculate the Monthly Supply of Housing. There are some other factors which should be considered when performing each task on the MCF. 1. 2. 3. 4. 5. The purpose of the form Guidance from Fannie & Freddie USPAP compliance Accepted Appraisal Techniques & Methodology Liability management

Official information from Fannie & Freddie can be found: On the form itself Fannie Mae Announcement 08-30 Fannie Maes Appraisal and Property Report and Forms (FAQ) Freddie Macs Bulletin dated 11-24-08

Factor One; The purpose of the form: is stated at the top as; The purpose of this addenda is to provide the lender/client with a clear and accurate understanding of the market trends and conditions prevalent in the subject neighborhood. An accurate count and trending of the MHS will both provide information on the market trends and its current market conditions. While the trend is very important to underwriters, the point in time condition is also important. In other words, if a market has positive economic trends it is still important for the underwriter of the loan to know if

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the market is in good condition or is it in a dismal state. An accurate MHS and its trend are excellent indicators of the state of the subjects sub-markets health.

Factor Two; Fannie & Freddie: Fannie provides a formula and example for finding the MHS over a 6 month period which follows: Step 1: Calculate the absorption rate. If there are 60 sales during a 6 month period (e.g., Prior 7-12 Months column), the absorption rate is 10 sales per month (60 / 6). Step 2: Calculate the months housing supply. If there are 240 active listings, there is a 24-month supply of homes on the market (240 active sales / 10 per month) ii The MCF (1004MC-71) asks for the Total # of Comparable Active Listings

Factor Three; USPAP Compliance: The Appraisal Standards Board has some specific things to say about the appraisers utilization of a pre-written form. It is the responsibility of the appraiser to properly develop an appraisal, and to properly report the assignment results. A template or form may or may not adequately report the assignment results. It may be necessary for the appraiser to supplement a form with addenda to comply with USPAP requirements. iii In reporting the results of a real property appraisal, an appraiser must communicate each analysis, opinion, and conclusion in a manner that is not misleading. iv Factor Four; Accepted Appraisal Terminology & Methodology: Supply: ...the amount of a type of real estate available for sale...in a given market at a given time. v The form asks for Total # Active Listings. All realtors, appraisers and most laymen understand what an Active Listing is. Once a property is sold, withdrawn, or expires it is by definition no longer an active listing. Factor Five, Liability Management: The designers of a form may have a specific technique that differs from accepted appraisal techniques and methodology in mind. An appraiser is put in a precarious liability predicament if his/her opinions and conclusions are affected by a technique that is specific to the clients specifications, but different than would have resulted if the calculations were performed by accepted appraisal techniques and methodologies. In such cases it is the appraisers responsibility to clearly present the definition and clearly demonstrate how there technique affects the
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outcome of the analysis. This no small matter especially when the forms that require the MCF to be a part of the analysis include specific statements that the borrower is an intended user. This means if the borrowers loan situation changes for the worse because of the appraisers market condition analysis and the borrower can show that the appraiser used a flawed method or technique to calculate the MHS or other indicators, the appraiser better have some specific reasons for calculating it incorrectly. I have not observed or been made aware of any specific formal directive by Fannie and Freddie to calculate the MHS anyway other than they have described in their example or what is accepted appraisal principles and methodology. Calculating the Monthly Housing Supply on the 1004MC-71 form As simple as the calculations for estimating the MHS appears, in practicality there are many interpretations how to calculate it. It appears that the discrepancies result from different opinions on how to calculate the Total Number of Active Listings (TNAL). The breakdown in logic results from the fact that the TNAL can only be measured at a point in time, while the form is asking for a count over a period of time. This has produced some very different counts of the TNAL by appraisers and by the vendors of automated solutions to the 1004MC-71 form. Some appraisers and vendors use a cumulative or aggregate method of counting the active listings during the period. In this method every listing coming on the MLS is counted, but none that fall off are netted out of the total. I have found no formal directive from Fannie or Freddie to calculate the TNAL in this manner in the above listed sources. To begin with lets simplify the analysis by avoiding this glitch in theory of point in time VS Period of time by calculating the MHS for a sample of data that occurred over a six month period. We will achieve this avoidance by estimating the MHS at points in time on a weekly basis. Then we will compare those results to the results of a cumulative counting method and to the results of an Average Total Listing Count.

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PRACTICLE EXAMPLE Lets say there are currently 5 active listings A new listing comes on the market each week There is a closed sale every other week A listing is either withdrawn or expires every fourth week This is 6 month (26 week) period.

RUNNING TOTAL TABLE

Begin with New Listings 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 5 active listings Active Listings Exp/WD 0 6 0 6 0 7 1 6 0 7 0 7 0 8 1 7 0 8 0 8 0 9 1 8 0 9 0 9 0 10 1 9 0 10 0 10 0 11 1 10 0 11 0 11 0 12 1 11 0 12 0 12

week 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26

Sale 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1

abspt

MHS

3.5

4.5

5.5

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Cumulative Method:

12

Months of housing supply for the 6 Mo. Period (26 / (13 / 6))

26 13 6

Cumulative listings Sales Months

Average Method:

4.15

Months of housing supply for the 6 Mo. Period

9 13 6

Average Total Listings Sales Months

(9 / (13 / 6))

Summary: The MHS for points in time on a weekly frequency ranges from 3 to 5.5, and averages 4.25. The cumulative method over the six month time period estimates a MHS of 12, almost 3 times the average above. The Average Total Listing method over the six month time period estimates a MHS of 4.15.

Conclusion: The MHS based on the Average Total Listing method meets the requirements of all of the following factors of influence. 1. The purpose of the form Clear & Accurate- It better reflects the actual MHS at any point in time. 2. Fannie & Freddie (See example Fannie presented on page 4 of this document) 3. USPAP compliance

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The MNS is properly developed and a misleading conclusion is not reported 4. Accepted Appraisal Techniques & Methodology Meets accepted techniques * methodology 5. Liability management The borrower will not be able to show that the appraiser reported an exaggerated MHS. The article in the REALTOR magazine previously mentioned states that double-digit depreciation is likely with anything over a 9-10 month housing supply. The following chart (Source: Westcourt Funds) is found on page 21 of April 2009 REALTOR magazine.

In the housing market example shown earlier the actual MHS of around four to six months is about in balance according to the chart, however, a MHS of 12 which results from the cumulative listing count indicates that the market is in or going to be in a serious decline according to the chart. These overstatements of the MHS will likely cause users of the appraisal report to inappropriately penalize the loan underwriting. It may have caused the appraiser to inappropriately make negative adjustments for market conditions in the direct sales comparison approach. The bottom line is the appraiser will have produced a misleading appraisal report.

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This indisputable logic does not mean that Fannie & Freddie will not come out with a formal directive that will require a listing count based the cumulative method in the future for calculating the Months of Housing Supply. But, I cannot change to a method that I believe typically produces errors of from100%-200% without an official mandate to do so. I have presented this writing as an explanation of why the Total Solutions application calculates the Total Months of Housing Supply based on an Average TNAL versus the Cumulative TNAL and to demonstrate that I have performed adequate due diligence in my selection of the method used. My personal take on this situation is that Fannie & Freddie have done their job; they have presented a clear purpose of the analysis and have even provided a good outline for the appraiser to follow. Now it is time for the appraisal Industry to do ours. We do not need Fannie & Freddie to fill in the form line-by-line for us as we are experts in appraisal techniques and methodology. I suppose they will have to if we do not step up and do it ourselves through a proper scope of work analysis. It may be their form, but is your analysis and your signature on that form. I know ignorance is bliss, but appraisers must know what goes where and why for every line on the MCF.

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PART 4; MAKING MC ADJUSTMENTS and DETERMINING WHEN VALUES ARE DECLINING I have been criticized for being too zealous about this new 1004MC-71 form. In actuality, I am enthusiastic about appraisers gathering large amounts of data onto a spreadsheet for analysis. The power gained from the appraiser being enlightened through this process is staggering. I am on record for supporting Fannie Mae in the over-all process, and condemning the appraisal profession for not beating Fannie to the punch. I believe strongly that the form (not the process) is far too limited. The Total Solution program that I developed is an example of adding to and expanding a standardized form. Performing a market condition analysis is a lot like sky diving in the sense that you either do it or you do not. Many critics are correct when they say, Appraisers are providing misleading market condition analysis. I agree that many appraisers are limiting their data and scope of work to such a degree that the results and conclusions are just not reliable. Appraisers are much more like the Wright Brothers at Kitty Hawk, than the modernday jet pilot- but we have to start somewhere. If you are going to leap from the airplane discard the umbrella you have been given and embrace more powerful tools. In this part of The 1004MC-71 INDUSTRY UPDATE the process of extracting the appropriate market conditions (time) adjustment for the direct comparison grid and determining the value trends direction (stable, increasing, declining) will be addressed. This method is appropriate for vacant land, apartments, and various commercial properties. Microsoft Excel is the canvas used in the following adjustment extraction process. The examples are taken from AVTs Market Conditions Adjustment Extractor. You can view it and other automated appraiser tools at http://www.scoopgear.com/automated-valuation-techn.html.

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The market conditions extraction process has the following steps: 1. Gather the appropriate sales data. a. Perform an MLS search b. Return the search query to an spreadsheet 2. Analyze the data based on some sort of value per unit. a. Unadjusted sales price per property b. Sales price per square foot c. Fully adjusted sales price d. Apartments might be per unit e. Condominiums might be per bedroom 3. Plot the date of sale and the appropriate unit of comparison as on a scatter chart. 4. Insert the appropriate trend line into the plotted points. 5. Compare the X and Y points for the effective date of the appraisal and the comparable sales date on the trend line. a. Manually with a ruler b. Mathematically by solving the equation 6. Calculate the percentage difference in the two value units (Y-axis). 7. Apply the percentage difference to the comparable sales price. 8. Adjust the sales price by the difference found in step 7 above.

Most appraisers have been exercising Steps 1 and 2; so there will be no discussion here. Some appraisers have had access to applications such as the Total Solution, S.M.A.R.T. system, and others applications that construct the scatter chart for you when performing a MCA. Those of you who do not use one of these automated systems can download an Excel workbook and instruction manual from www.alamode.com/labs that will aid you in this process. The workbook is preprogrammed to help you make a number of useful charts. There are a couple of videos as well. Therefore there is no need to cover Step 3 in this writing (and you did not think the profession was making any progress). A scatter chart follows with a linear trend line (regression line):

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The sales prices per square foot are on the Y-axis, while time is plotted on the X-axis. Each sale is plotted as a dot on the scatter chart. It is apparent where the scatter chart got its name. The trend line was placed by Excel based on regression and was fitted to have the summation of the least square of the differences in each point and the trend line. The data does not seem to fit a straight line very well as value tends to move upwards for a while and then top out around October 2008. Values appear to fall from that point on. This can be seen in the following chart. The red colored trend line appears to fit the data much better. The trend line in this chart is based on a polynomial line. Polynomial lines are appropriate when the value trend changes direction or is curved. The value trend presented in this chart is not conducive to the MC adjustment formula that appraisers traditionally use such as adjusting the sales price upward at a rate of 7% per year.

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In the chart above the effective date of the sale is 4/1/09 and the sale sold for $200,000 on 4/1/08. Exercise 1: Based on the data presented what is adjustment should be made to the sale? (A) Based on a straight line analysis, and (B) based on the polynomial curve presented. The purple dotted lines represent the various intersections. Lines 1 and 4 represent the effective date of the appraisal and the comparables sale date respectively. The straight regression line intersects Line 4 (Sale Date) at $118.02 and Line 1 (Efft Date) at $134.07. This indicates an appreciation rate of 13.6% ($134.07 - $118.02) / $118.02. The polynomial regression line intersects Line 4 (Sale Date) at $103.93 and Line 1 (Efft Date) at $105.36. This indicates an appreciation rate of 1.37% ($105.36 - $103.93) / $103.93. On a $200,000 property the difference between these two methods is $24,460 (13.6%1.37%) x $200,000. This is a significant error.

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Exercise 2: Using the same data find the appropriate market condition adjustment for a comparable sale which sold for $200,000 on 11/1/08 with an effective date of the appraisal of 4/1/09. Find the appropriate adjustment for a straight regression line and one based on the polynomial regression line. Use the ruler method and see if you agree the answers the MC Adjustment extractor calculated.

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Exercise 3: What is the current directional trend of the market?

Answer: Declining

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In this case the value trends are definitely declining. What are the factors that should be considered in forming a conclusion about the direction (stable, increasing, declining) of the value trend line? Well, I am somewhat embarrassed to say that no one really knows but we are looking for some percentage change over some period of time. There is no one accepted definition; and this task requires a definition. Any definition will have to consider a specific time period, but much like exposure time it may be different for each sub-market. This is because we want to make the determination based on the over-all long term trend, and not the normal cyclical movements around the long term trend. The short-term cyclical movement can be based on seasonal influences, but is really just a reaction to the normal changes in supply and demand that all markets experience. This means that the direction of the long-term trend can only be measured over a time period that is longer than the normal short-term cycle for each particular market. It is the inability of the market to correct itself through the principle of market equilibrium that indicates the direction of the over-all market value trend from stable to increasing or declining. Once the market is out of balance in terms of supply and demand, and it is able at achieve balance by the principle of market equilibrium then the market will have achieved a stable valuation trend. In theory, the time period would be market specific as well. It is based on the frequency of the short term cycles.

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The above chart shows a market that cycles up and down with about a 6% fluctuation in values (from high to low). This is a hypothetical situation, but probably typical for many residential markets. Many people originally thought that a change from 1% to 3% in the median prices tracked over time was significant. My studies and analysis lead me to believe that a sensitivity level of 10% to 15% is more realistic. However, a 1% to 3% change in the trend line may be legitimate. The proper sensitivity level to indicate a change in value when looking at a trend of the median sales prices over time depends on how closely these median prices fall on the trend line. The chart below represents real market data. The normal short-term cycle is illustrated by the red (solid) line. The median sales prices per period are osculating around the trend line (Blue solid line).

Most of the data points do not fall exactly on the trend line so the sensitivity levels used for the data points (median values) should be different than for the trend line. My best definition of a declining market to date follows: A declining market is indicated when the over-all trend in values based on a polynomial trend line falls by one half of the normal full cycle variance over a time period equal to the normal frequency of one cycle for the market in question.

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The above market then would indicate a decline in values when the polynomial trend line falls at least 4% over a six month period.

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Conclusion: When the data points indicate a change in direction or strong curve then a straight-line trend line analysis is inappropriate. It is very adequate for the appraiser to simply apply a straight edge ruler to a chart that has a trend line and do the calculations by hand for each sale. However, for maximum efficiency (appraisers time) and accuracy computer programs such as AVTs Market Conditions Adjustment Extractor can be used. The call made by the appraiser on the trend of values in a particular sub-market is determined by the time period considered and the sensitivity of the percent change in value that constitutes a change in the long-term value trend. This is based on the normal value cycles of a market discussed above and the accuracy of the appraisers measurements of these changes that will be covered in Part 5 of this series. While the time period is related to the normal frequency of cycles for the specific market it is difficult to determine any conclusive pattern in less than six months. There is a balance between having timely information (based on short time periods) versus having a comfortable degree of reliability.

Be on the lookout for Part 5; STATISTICALLY SIGNIFICANT AND EXPECTED VARIANCE. In Part 5 we will discuss how reliable the market condition adjustments put forth for the adjustment grid, and the indicated direction of the value trend (stable, increasing, declining) are when a trend-line analysis is used.

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PART 5; STATISTICALLY SIGNIFICANT AND EXPECTED VARIANCE The understanding of these simple terms is disguised in a cloak of fear for most appraisers. The belief is that these terms are beyond the understanding of the typical appraiser. How reliable are the market condition adjustments put forth for the adjustment grid and in determining the direction of the value trend (stable, increasing, decreasing) when a trend-line analysis is used? This depends on the following things: The quality of the sales data The quantity of the sales data The type of unit of value that is tracked over time The homogeneity of the properties used, or the amount of adjustments made for the differences in physical characteristics.

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APPRAISINGINTHENEWMILLENNIUM;DueDiligence&ScopeofWork,page5,AVTinc.,2006 Announcement0830,FannieMae iii USPAPFrequentlyAskedQuestions,AppraisalFoundation20082009,PageF91 iv USPAPFrequentlyAskedQuestions,AppraisalFoundation20082009,PageU21 v ThedictionaryofRealEstateAppraisal,4thEdition,AppraisalInstitute,Page283

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