Determining the Value of a Home
In real estate sales “fair market value” determines the value of a home. Fair market value is the price a willing and able buyer would offer to pay a seller for a home in its current condition. Buyers and sellers determine the market value in real estate. Factors that affect the price a seller lists their property at and the amount a buyer may offer include: the comparable sales in the neighborhood, the homes currently on the market (the competition), and the pending sales (homes under contract that have not closed yet).
Most buyers in the market require financing to purchase a home. The lender providing the financing requires an appraisal to assure them that the property is worth the amount they are lending to the borrower. The appraisal is an important contingency in the process of buying a home when the buyer is borrowing from a lender. The property must appraise for at least the contract price agreed upon by the buyer and seller. In shifting markets, like the current market, appraisals have been the reason many transactions have not successfully closed. For example, this past May, a buyer and seller agreed to a sales price of $200,000 but the buyer’s appraisal came in at $180,000. Because this transaction was a short sale, the bank on the selling side of the property had their own appraisal done in order to determine if they would approve the sale. Their appraisal came in at the contract price of $200,000. These two appraisals for the same property were done within a month of each other and the home was in the same condition for both appraisals yet they ended up being $20,000 apart. The buyer and seller felt that the home was worth $200,000 and the seller’s appraisal substantiated this value. The appraisal done by the buyer’s lender killed the deal by coming in $20,000 below the sales price. The buyer was using an FHA loan to purchase the property. When an FHA appraisal is done, it remains with the property for 90 days causing any future buyers using FHA financing to use that appraisal. In today’s market, the majority of buyers are using FHA because it offers the lowest down payment at 3.5 percent. The result of this low appraisal by the buyer’s lender caused the seller to have to drop their price $20,000 below the market value — the value that was determined by the buyer and seller. In this case, and many other cases in today’s market, the appraisal is determining the value of real estate, not the market.
When a property appraises for less than the agreed upon sales price, the buyer can cancel the contract, the buyer can come up with cash for the deficiency, the seller can drop the sales price to the appraised value or the buyer and seller can meet somewhere in the middle. In most cases when the buyer’s appraisal comes in low, the buyer does not have the extra cash to make up the difference so the seller usually drops the price from the contract price or the market value to get their home sold. This is more prevalent in today’s market of distressed properties. On bank-owned properties, the bank’s focus is on getting the inventory sold quickly and on short sales, the owners are not receiving any of the proceeds and are not motivated to hold firmly to their price.
In the current market where demand is gaining strength and supply is starting to shrink, we should see prices increasing. However, these low appraisals are keeping home values below the market value. The National Association of Realtors said that 16 percent of realtors surveyed reported at least one home sale cancellation in June of this year due to an increasingly number of low appraisals. Before the housing bubble burst a few years ago, appraisals were coming in high to compensate for the inflated prices of homes. Now appraisers are being overly cautious and the appraisals are coming in too low. Lenders are questioning appraisals during the underwriting process and asking for another opinion at the close of escrow, and sometimes overriding the appraiser. They are also using distressed properties, the ones that sold at the bottom of the market as comparables to homes that are in great condition.
New legislation meant to reform the appraisal process now forces lenders to use outsourcing to get appraisals done through a neutral third party – an appraisal management company. Since this legislation adds an additional party to the appraisal process, it also adds another cost to transaction; the fee of the appraisal management company. The appraisal management company now contacts the appraiser rather than the buyer’s lender. This process is now forcing appraisers to cut their fees to get work from the appraisal management companies which in turn means that the least expensive (and often least qualified) appraiser are getting the jobs rather than the more experienced (and often more expensive) appraisers. For the most accurate appraisal, it is important to have knowledge of the area where the home is being appraised, since values vary greatly from neighborhood to neighborhood. In the past, real estate agents and lenders relied on appraisers that were experts in their geographical area or in a specialty niche, i.e., condos, farms, luxury homes, etc. We are seeing less qualified appraisers working for less-than-experienced appraisers and using technology that does not provide them with important factors that greatly affect value.
In July, a local family sold their home in a traditional sale (it was not bank-owned or a short sale). The buyer and seller agreed to a sales price of $145,000, the house was in perfect condition with tasteful upgrades and showed pride of ownership. The buyers recognized this and felt very comfortable with the contract price. The buyers’ appraisal came in at $135,000. Since the sellers were already under contract to purchase another home, they were pressured to drop their price by $10,000 since the buyers did not have the extra cash to make up the difference. The home the sellers were buying was a new home built by a new homebuilder, the appraisal on this home came in $30,000 below the contracted price. The builder was willing to drop a fraction of the $30,000 difference. The appraiser could not find a comparable home with a guest casita and did not give any value to the square footage of the casita in the appraisal of the new home. Fortunately, the buyers had the cash to make up this difference and move forward to close, knowing the home was worth more than the appraiser’s opinion.
The market is supposed to create values in real estate. Values are being influenced in large part by appraisals today. Today’s system for appraising properties is not working; in fact it is contributing to keeping values low in a market when home prices should be increasing.
Written by Carlie Back