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Contract Price Confirmation Bias: Evidence from Repeat Appraisals

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Abstract

Prior research has argued that upwardly biased appraised values of residential properties were a contributing factor of the 2008 financial crisis. Subsequent reforms have been enacted to reduce appraiser’s financial incentives to submit biased appraisals, but appraisers continue to receive the contract price of pending home sales. This knowledge may lead them to subconsciously interpret and select information to confirm the contract price exposing the economy to future crises. A novel data series of properties that were appraised twice within six months where one appraiser was uninformed of the contract price is used to test how appraisal practices differ when prices are known. Significant differences were found in the property descriptions and the selection, price adjustment, and weighting of comparable transactions for appraisers aware of the contract price. Appraisers aware of contract price were more than twice as likely to reach an appraised value at least equal to contract price; on average their valuations were 4.2%-to-8.3% higher than appraisers unaware of contract prices.

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Notes

  1. The U.S. Consumer Financial Protection Bureau estimates there were 24.5 million home loans originated in 2017 and the National Association of REALTORS estimates the average appraisal fee was $331.

  2. A federally-related mortgage loan includes home purchase loans, refinancing of existing mortgages, lender approved assumptions of existing mortgages, property improvement loans, equity lines of credit, and reverse mortgages defined by the Consumer Financial Protection Bureau (CFPB) under the Real Estate Settlement Procedures Act (RESPA).

  3. For example, a borrower would have to pay a much higher effective interest rate if he/she contributed less than 20% of the pledged collateral amount as a down payment due to the requirement to purchase private mortgage insurance in order for the loan to meet eligibility requirements to be sold to a GSE (i.e., Fannie Mae or Freddie Mac).

  4. For more details on the Home Valuation Code of Conduct (HVCC), see http://www.fhfa.gov/Media/PublicAffairs/Documents/HVCCFinalCODE122308_N508.pdf. For more details on the Dodd-Frank rule as it relates to appraisals, see http://www.federalreserve.gov/newsevents/press/bcreg/20101018a.htm.

  5. Eriksen et al. (2018) illustrated that appraisers working with an AMC were less likely to use differential weighting of comparable transactions to justify contract price, although the relationship and decision to use an AMC is highly endogenous making causal identification of the effect unclear. For example, AMCs still select which appraisers to hire and may themselves be less likely to hire appraisers who stop or slow closings by valuing properties below contract price.

  6. The UAD is a standard for data entry for residential appraisals, required by Fannie Mae and Freddie Mac after September 1, 2011. UAD data is collected according to the Fannie Mae 1004 form and forwarded electronically via the Uniform Collateral Data Portal (UCDP) to Fannie Mae and/or Freddie Mac.

  7. The full definitions can be found at http://www.freddiemac.com/singlefamily/sell/docs/uadreqs.pdf. The classification C1, brand new, never appears in the assembled data given they were previously owned. The classification C6, uninhabitable, is also not included in the data as those properties required repairs and were purposely excluded from the sample.

  8. The individual weights are unidentified because appraisers selected three or more comparable transactions resulting in at least two parameters to estimate with a single equation.

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Acknowledgements

The authors would like to thank Bob Barclay, Luke Wong, Jesse Staal, Ruwei Wang, and Weifeng Wu for excellent research assistance. They would also like to thank Lynn Fisher, Lan Shi, Lauren Lambie-Hanson, Doug Duncan and Pete Bakel for helpful discussions throughout the research project. Views expressed in the paper do not represent official position of Fannie Mae or any other employer. All remaining errors are our own.

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Correspondence to Michael D. Eriksen.

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Eriksen, M.D., Fout, H.B., Palim, M. et al. Contract Price Confirmation Bias: Evidence from Repeat Appraisals. J Real Estate Finan Econ 60, 77–98 (2020). https://doi.org/10.1007/s11146-019-09716-w

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