Reliable appraisals are crucial for the proper valuation of residential and commercial real estate and hence for the effective operation of the financial system. Since several stakeholders have expressed their concerns about the quality and independence of residential property appraisals, DNB decided to examine the quality of such appraisals. In around 95% of cases, the appraisal value was equal to or higher than the purchase price of the residential property. This is a clear indication of systematic overvaluation.
Systematic overvaluation of residential property
Figure 1 shows that the appraisal value exceeds the purchase price in almost 60% of cases. The average overvaluation is 5.3%, with the median 2.3%. In one third of cases the appraisal value exactly matched the purchase price to the euro. This suggests that in these cases, appraisers base the appraisal value on the purchase price. The appraisal value is below the purchase price in only 5% of cases. These figures are based on over 200,000 residential property appraisals conducted between 2012 and 2017. DNB's research shows that overvaluation is more common for first-time buyers compared to existing home-owners. No differences were found for areas with higher and lower price pressures, and the fact that most appraisals in this period were conducted while the housing market was rising cannot explain the observed overvaluation either. Since the introduction of the statutory LTV limit in 2013, appraisals that exactly match the purchase price have become more common while appraisals above the purchase price have become less common
Figure 1: Distribution of difference between appraisal value and purchase price
Percentage of transactions
Note: For negative values the bars represent a percentage from this value to the next, and for positive values a percentage up to and including this value. The "0” bar represents a difference of exactly EUR 0.
Overvaluation undermines the effectiveness of the LTV limit
There is a trend of systematic overvaluation in residential property appraisals. The value of a property appears to be based on the purchase price rather than on independent appraisal. Both these factors can be drivers of overheating in the residential property market and undermine the effectiveness of the LTV limit. While this limit was tightened to prevent excessive borrowing, households can still borrow too much due to systematic overvaluation. Financial institutions also tend to underestimate the credit risks attached to their mortgage loans as a result. The adverse incentives of the current system are a threat to independent appraisal, since all parties involved in the sale of a house – buyer, seller, real estate agent, adviser and capital provider – have an interest in completing the transaction.
Measures are needed to improve the independency of appraisals
The results of this analysis have been discussed with representatives from the sector. While opinions on the causes of overvaluation vary, the results were broadly acknowledged. The parties agree that there are flaws in the current system of residential property appraisal and that these contribute to the volatility in the housing market. However, the sector seems to lack the capability to remedy these flaws by itself. The fact that the various parties involved have different interests also plays a role.
DNB's analysis shows that it is necessary to take measures to improve the independence and hence the quality of appraisals. DNB and the Dutch Authority for the Financial Markets (AFM) previously concluded that the sector lacks self-regulation capability and therefore recommend imposing statutory standards for improvement.
