Question

Chapter 16: Case Study #1

Hotel worker Danny Ruiz was living with his wife and four children in a cramped New York apartment when he saw a television ad promising the family a way out. “Why rent when you can own your own home?” Penn- sylvania builder Gene Percudani asked. The company even offered to pay his rent for a year, while he saved for a down payment. So the Ruiz family fled the city for the Pocono Mountains, where they bought a three- bedroom Cape Cod home for $171,000. However, when they tried to refinance less than two years later, the home was valued at just $125,000. “I just about flipped,” said Mr. Ruiz. Later Mrs. Ruiz remarked about her husband, “He went nuts.” Percudani, a 51-year-old native of Queens, New York, built a thriving homebuilding business in this market, running folksy television ads offering New Yorkers new homes in Pennsylvania. If they joined Percudani’s program, called “Why Rent,” homeowners would find financing through another of his companies, Chapel Creek Mort- gage, which brokered loans from J. P. Morgan Chase and the company’s Chase Manhattan Mortgage unit. For years, the “Why Rent” program appealed to workers with modest salaries, such as Eberht Rios, a truck driver for UPS. Rios bought a home in the Poco- nos for $140,000. This year, when he tried to refinance, he was told the home was valued at only $100,000. One local appraiser, Dominick Stranieri, signed off on most of the “Why Rent” deals that state officials now say were overpriced, including the Rios and Ruiz homes. Percudani’s firm picked Stranieri as his appraiser because of his quick work and low fee of $250, instead of the typical $300 to $400. In exchange for a steady stream of work, Mr. Stranieri accepted without ques- tion valuations from Percudani’s company. Other common methods of creating revenues include investors and others buying distressed proper- ties and then, using inflated appraisals, selling them for a big profit. In order to secure the efforts of a “dirty appraiser,” those involved with the fraud would pay up to $1,500 under the table on top of the appraiser’s stan- dard fee of $400. Another unique twist to the plot is that few of the people involved in making mortgage loans have a long- term interest in them. Traditionally, bankers made loans directly and held them, giving the lenders a strong incentive to find fair appraisals to protect their interest. Today, however, many appraisers are picked by independent mortgage brokers, who are paid per transaction and have little stake in the long-term health of the loans. Many lenders have also lost a long-term interest in their loans, because they sell them off to investors. Appraisers increasingly fear that if they don’t go along with higher valuations sought by bro- kers, their business will dry up. Do you think a county appraiser would do a lot bet- ter than a private practitioner? Joel Marcus, a New York–based attorney recently had his property valued at $2.2 million by a county appraiser, up from $2 million the previous year, which means a $7,200 jump in his property tax bill. Based on recent home sales in his neighborhood, Marcus believes his property is valued at between $1.7 and $1.8 million. Based on this information, Marcus has appealed his appraisal. Although a good appraisal requires doing hours of legwork, visiting a property to check its condition, and coming up with at least three comparable sales, Percudani says he isn’t surprised that later appraisals, or even different appraisals made at the same time, could result in different values. “Appraisals are opinions,” he says. “Value, like beauty, is in the eye of the beholder.” Stranieri and Percudani deny any wrongdoing and say they operated independently and that any home that declined in value did so because of a weak economy. “It’s like buying a stock,” Percudani says in an inter- view. “The value goes up. The value goes down.”

Questions

1. How is an opportunity created to commit appraisal fraud? Does the appraiser act alone, or is collusion routinely involved?

2. How is appraisal fraud detected? Is intent to deceive easy to prove in appraisal fraud?

3. What pressures or perceived pressures can motivate appraisers to make faulty valuations?

4. How do appraisers rationalize their fraudulent behavior?

5. Why would a county perceive pressure to fraudulently inflate property values?

6. What controls would help to prevent appraisal fraud?

7. What natural controls exist to prevent homeowners from the desire to “massage the value” of their homes? (Hint: Think about a homeowner’s motivation.)

Answer 1

1. How is an opportunity created to commit appraisal fraud? Does the appraiser act alone, or is collusion routinely involved?

2. How is appraisal fraud detected? Is intent to deceive easy to prove in appraisal fraud?

3. What pressures or perceived pressures can motivate appraisers to make faulty valuations?

4. How do appraisers rationalize their fraudulent behavior?

5. Why would a county perceive pressure to fraudulently inflate property values?

6. What controls would help to prevent appraisal fraud?

7. What natural controls exist to prevent homeowners from the desire to “massage the value” of their homes?

Refer the below images for more detailed explanation.

& How troud ? Youtrely is an opportunity Does the appraiser involved 2 exeated act alone, to commit appraisal cor) is collusion Restoisen Answer. The opportunities to commit fraud include difficulty of detection, lack of controls and segregation of parties. Almost all appraisal frauds involve cottusion between some type of broker loro investor and an appraiser - The appraiser is promised future subs con given some type at above the Standard fee to inflate the value of a home artificially. The lack of regulation between brokers is appraisers i cauring a fraud -friendly environment- ent@: How is appraisal Rearing deceive case to prove fraud detected ? as intent to in appraisal troud ? Answer In both instances, appraisal froud was not suspected until the victims tried to refinance their homes, sequiring a second appraisal. A second appraisal would also be necessary it a home owner decades to sell. The problem is that refinancing and selling of homes usually does not allor until well after the original faulty ppraisal a possible appraisal traud is not detected until well after the crime and often many economic factors have changed Since the original appraisal that more proving the intent " to commit fraud extremely difficult valuing properties involves judgement, and different people some times value things differently. As we sow in the case, "Appraisals are opinions value line beauty, is in the eye of the beholder".

x : what appraisers pressures to make (or) fauty perceived pressores valuations ? con motivate Reajuirement : Answer Because appraisers are proked independently and are paid per transaction they fear that if they do not go along with the higher valuations sought by brokers, they will lose business. The perceived pressure is that it an appraiserdisagrees that a property is worth to support a loan, a broker will never call back with ess. They also feel that if they say no to the deal, the broker will just find some less honest appraiser with whom to worke. a : & How do behavior a appraisers rationalize their fraudulent Reafoitergent Appraisers rationalize that everyone else in the business is doing the same thing. It they do not go along with a broller valuation, the broker will just find another appraiser sides appraising properties require so much Judgement that it will be virtually impossible to prove that someone did it incorrectly u property values a like Stocks they go up - they go down". ent : why would a county perceive pressure to fraudulently inflate property values ? The sluggish economy around this time period (september al Stock market decline, corporate fraud and failures) caused Sales tax revenues and State income tax revenues to slide, meaning local governments needed to count on Property taxes all the more without the revenue generated from increasing property taxes, country government Programs fait and bodgets von large deficits. Answer

o. What : controls would help to prevent appraisal fraud ? Reasoitement Answer) Because appraisal trood is osually detected when a Second appraisal is done years later, a good control would recorre two appraisers from independent entities to value the same property is compare results. If the values difter significantly further investigation may be rear The negative is that doing two appraisals for each property is time consuming and costly - Virtually doubling the price. required. ? may be : W o what natural controls owners from the desire to their homes & exist to massage prevent home - the valve" of Realuirement Answer Home owners naturally have counter balancing incentives that act as Controls on the one hand, a homeowner would like the appraised value of the home to be lower than at actually is to reduce the property tax burden- on the other hand, the homeowner would like the appraised value to be higher than et actually is because the home- Owner can then take out a a large large mortgage mortgage on on the home to boy other assets.