Academic journal article Real Estate Economics

Appraisal, Agency and Atypicality: Evidence from Manufactured Homes

Academic journal article Real Estate Economics

Appraisal, Agency and Atypicality: Evidence from Manufactured Homes

Article excerpt

The appraisal of the "market value" of homes serving as the collateral for mortgages is a fundamental part of the underwriting process. If a loan should default, however, it is not the retail market value that the lender obtains, but rather the "recovery value." In this research, we show how recovery values differ from market values at origination and explore the reasons for the differences Using a large sample of chattel mortgages on manufactured homes, we explore the relationship among the selling prices, the book values, and the fitted values from simple hedonic models with spatial autocorrelation. We then address the differences between selling prices at origination and recoveries from repossessed homes. We find that the spread between them varies systematically with home characteristics and especially with "atypicality," that is, with measures of how unusual a home is. Selling prices both at origination and recovery affect borrower defaults.

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For decades, property appraisal has been a mainstay of mortgage underwriting and is an essential element of the verification process for lenders. The appraiser provides a professional estimate of the value of the property that can be used to verify that the selling price is representative of current market conditions. The lender uses the appraisal to assess whether the loan will perform, that is, repay in full, and whether the loan will be profitable for the lender. But is the simple point estimate sufficient for assessing the risks associated with the collateral? Can lenders improve loan decisions with information on the expected second moment or with estimates of the likely recovery values from a default?

In this research, we explore these issues with a large data set of chattel mortgages on manufactured homes. Manufactured homes, although little researched, are an increasingly important segment of the housing market. The Manufactured Housing Institute reports that 8% of the U.S. population lives in manufactured homes. In 2001, manufactured homes made up about 15% of residential starts. Chattel mortgages, unlike conventional single-family mortgages, are secured only by the structure or "home" and do not include a lien on the underlying land. In most cases, the borrower does not own the land. Instead, the land is either rented from a third-party owner or from the owner of a manufactured housing "park," which, like a single-family subdivision, often groups similar homes in one location. (1) In parks, the land leases are usually month-to-month.

The foreclosure or repossession process can be much quicker and simpler for manufactured homes because the collateral is mobile, albeit at a nontrivial cost. (2) At most times, dealers provide a ready market for repossessed units, although occasionally they are overstocked with inventory and unwilling to provide the usual level of liquidity to the market.

There are many reasons to question the optimality of existing appraisal procedures for residential mortgages in general and manufactured homes specifically. First, there may be agency issues in the appraisal process. Appraisers, like all parties to real estate transactions, are often subjected to pressures or incentives to shade their estimates so that the transaction will be approved. Loan volume drives the compensation of many participants in the process and inevitably colors all of the participants at least indirectly.

There has been a fair amount of recent experimental research investigating appraisers' incentives and biases. For example, it has been shown that appraisers may be influenced by valuations of others (Diaz 1997) and by their own previous appraisals (Diaz and Wolverton 1998). A number of studies find that clients may influence the valuations. (3)

Even more basic to the appraisal process is whether appraisals are unbiased estimates of market values. It is well known that appraisals lag behind market movements (Quan and Quigley 1989). …

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