The use of Automated Valuation Models (AVMs) to calculate property damage in hurricane and flood ravaged New Orleans was recently discontinued, with government officials conceding the AVM values were often drastically off the mark. In most cases pre-storm appraisals will be used instead, a "shift [in] emphasis from computer-generated assessments to traditional appraisals by people," reported the New Orleans Times-Picayune.

A private company administering the Road Home program, a $7.5 billion aid program for owners of flooded homes, relied on AVM calculations of pre-storm value. It switched course last month amidst pressure from state and local officials. The use of AVMs was "not correct for a city with neighborhoods as diverse as the greater New Orleans area," State Representative Tim Burns said.

Values will now come from recent appraisals, a federal financing database or appraiser archives, reported New Orleans City Business.

At a pre-Christmas meeting with ICF Consulting, the company coordinating the Road Home program, "legislators were incensed at letters to their constituents offering minimal compensation, which ICF representatives now acknowledge may have been incorrect," Burns said. "ICF had based the awards on the use of an automated valuation method to calculate pre-storm fair market value using a set formula that is applied to a dwelling based upon its square footage."

The program is also reducing reliance on Broker Price Opinions (BPOs).

According to ICF's SEC form 8-K, filed in October, it had planned to use a $12 AVM or $85 BPO by default, and a URAR only "if neither the AVM nor the BPO [was] successfully completed." The Times-Picayune editorialized:

[AVMs and BPOs] are high-volume, low-cost methods, and they may have helped speed up the grant process. But if the results are wrong, that's not an advantage, and it's a shame that no one realized their limitations ahead of time. An unfairly low offer could be the final straw for a family trying to decide whether to stay and rebuild or leave.

Challenges like these may yet bring to light the limitations of AVMs -- and the superiority or professional appraisals -- to the wider public.

2007 real estate outlook: Some are bearish, but many optimistic
for recovery

On the bearish side, Moody's Economy.com, which produces private economic research, estimates that the median sales price for an existing home will decline 3.6 percent nationally in 2007. If true, that would be the first decline in the median sales price since the Great Depression. The company estimates that nearly 100 metro areas will experience a "measurable" decline in housing prices.

Fitch Ratings' lead homebuilding analyst Robert Curran said that the absence of investors in the pool of home buyers in 2006 caused an oversupply problem. While that should correct itself comparatively quickly, he suggested, "negative buyer psychology seems to have become pervasive, with the expectation or fear that home prices have peaked and buying now would be a mistake."

The National Association of Realtors (NAR) forecast at its annual conference in November that while existing home and new home sales would both fall in 2007 from 2006 levels, the rate of deceleration in both cases would ease. New home sales fell by 17 percent from 2005, the group estimated, and would sink 8.7 percent in 2007. Resales were down 8.6 percent in 2006 and should decline only 0.8 percent this year.

NAR's California counterpart, the California Association of Realtors, in October forecast a modest decline in home price appreciation and a decreasing sales pace in the Golden State. The group said the Central Valley, San Diego and Riverside/San Bernardino regions of the state would experience a sharper downturn than the rest.

The Mortgage Bankers Association (MBA) foresees housing oversupply tamping down construction, sales and prices until midyear. Home loan production, which the group said would fall 19 percent in 2006, is supposed to be off another 14 percent in 2007. California's mortgage brokers say the first half of 2007 will be an ideal time to buy a home: "During that period, there will be fewer buyers, more housing inventory, low interest rates, and more motivated sellers," Jack Williams, president of the California Association of Mortgage Brokers, said. The group said fixed rate loans will make a comeback in their state as homeowners refinance.

The National Association of Home Builders (NAHB) is eyeing an 11.7 percent drop in housing starts in 2007, after an 11.5 percent fall in 2006. But David Seiders, NAHB Chief Economist, said he expects that starts would "bottom out" in the first half of the year, and that builders are picking up on a "change in market momentum."

Value-skewing potential of buyer incentives increasing

In a 2007 housing market forecast (available in PDF form by clicking here), Wachovia Securities Senior Economist Mark Vitner worked out that every year, owing to population growth, obsolescence, and demand for second homes, an average of 1.75 million new homes need to be made available in the United States. During the past four years, though, about 750,000 more units have been built than that growth factor can accommodate. (Page 10 of the PDF.) This new construction will need to be "reduced substantially" over the coming years.

It is unlikely that builders will slash asking prices, Vitner opines, because that would negatively impact previous buyers in developments where the vacancies exist. Instead, they are likely to ramp up incentives. As you're well aware, incentives, particularly the most attractive ones to buyers, arguably mask the true arm's length market value of a house.

During even a robust sales cycle incentives might include landscaping, furnishings, alarm systems or other amenities. What's going on in many parts of the country now is incentives run amok.

Builders are routinely awarding cash to apply to closing costs and even buying down mortgage rates. The Modesto Bee reported in November that "most [local] builders have held their base asking price steady this year," but are doing it by "offering assorted specials such as free upgrades, lower mortgage rates or limited-time discounts on finished homes. Some of those incentives can be worth more than $100,000."

Investors Business Daily last month reported that Pulte Homes was offering San Francisco-area buyers $99,000 toward a down payment or financing, plus a week's vacation for two or a pool. Anecdotes like that illustrate square with the plainer language of accounting and investing. Home builder Lennar saw its costs related to incentives jump to 10.1 percent in the third quarter of 2006, up from 2.5 percent in the same quarter of 2005. Los Angeles based builder KB Home announced last month it would take a charge of between $235 and $285 million in the fourth quarter, owing in part to increased incentives needed to generate new orders.

A November survey of National Association of Home Builders (NAHB) members found that 59 percent of builders were offering incentives in order to maintain sales.

A Sarasota, Fla. area developer told the Sarasota Herald Tribune last week that luring buyers with promises of 100 percent financing is still working because "appraisals are coming in higher than transaction prices."