The Accuracy of Long-term Real Estate Valuations

Real estate valuations are important for financial institutions, especially banks, for at least two reasons. First, valuations are often needed during the underwriting or refinancing of mortgage loans, where valuations should provide a fair assessment of the (future) market value of the property that will serve as collateral for the loan. Second, valuations are needed if the institution or bank wants an updated assessment of collateral values for outstanding loans it holds on its balance sheet. Such reassessments might be necessary and required by Basel II if new information arrives or market sentiments change.

In this study, we complement the above results by focussing on a long-term horizon and examine the accuracy of single-family house valuations when used as forecasts of future house prices. Here, the future could refer to the date when the borrower is most likely to default. The long-term valuation would then be a forecast of collateral recovery value given default. Informal evidence indicates that the default probabilities are highest in the early years of a mortgage loan, so that a long-term horizon of up to five years seems to be a reasonable choice.