The appraisal is a critical component in the overall sale of a home, and many people
overlook just how significant this piece of the puzzle really is.
An appraisal is an informed opinion of a home’s value. This opinion, albeit an
expert’s perspective, is subjective, but it is treated as the accurate and credible value
of a property. In other words, when an appraiser puts a value on a home, it sticks,
and is generally accepted as the actual value of a home.
It is important to recognize that while buyers may be willing to pay one price for a
home, if the buyers are getting a loan on the home and it doesn’t appraise, then the
buyers may or may not be obligated to pay that initial agreed-upon amount. The
appraisal contingency is an important layer of protection in the residential purchase
contract. Not only does it protect buyers from overpaying for a property, it prevents
lenders from betting on a property that may or may not be worth the contract price.
It also protects housing markets from huge inflationary jumps.
Appraisers, who are licensed and governed, must adhere to a strict set of guidelines
when valuing a property. In general, they must choose comparable properties that
are most “like” the property they are valuing, the goal being to make the fewest
price adjustments possible, leaving less room for subjectivity. An example would be
comparing a two-story to a two-story home, an exact floor plan match, or exact
interior size. Appraisers also look for homes in the area with similar updates or
upgrades, similar community features, and homes with similar living space or
number of rooms.
The types of similar homes appraisers can use to value a property are highly
regulated with guidelines on items such as how far away the comparable can be to
the subject property, how much larger the comparable can be, how many floors the
comparable can be, and so on. Appraisers can often make a case for stepping
outside these guidelines if there is a lack of recent sales (recent usually means 6
months, but appraisers can go back 1 year if necessary).
Many homeowners often wonder how their “upgrades” will affect the value of their
home. It’s important to recognize that appraisers don’t typically place a value on
each individual upgrade. If they must make a price adjustment for upgrades, they
will usually make an adjustment for the overall condition of the comparable
property to the subject property with one all-encompassing number, such as
$15,000, which may include flooring, kitchen, and bath upgrades, or whatever
general features the appraiser is trying to take into account as a whole. The $750
light fixture in your dining room won’t show up as a $750 price adjustment in an
appraisal. It may add value to the overall condition in a price adjustment—if there
is one.
Appraised value and perceived value are often two different things in a housing
market, particularly in fast-climbing markets. While appraisers can definitely make
adjustments to market timing and overall market increases since past sales, it’s a
smart move to analyze past sales when considering a home’s real value. An astute
Realtor with a feel for the market, the area, and comparable properties can help you
make a realistic, estimated valuation of a property.
To ad context to my explanation, let’s look at Mr. and Mrs. Hypothetical, Mary and
Joe, who list their home for $350,000. Similar make and model homes with similar
features, upgrades, lot size and location have recently sold in the ballpark of
$300,000. Within the first week of listing their home, Mary and Joe can’t believe
how many people show interest in it. They have multiple showings and multiple
offers. Along come Sue and Bob who just love Mary and Joe’s home. The kitchen
remodel is exactly what they’ve been looking for and the fountain in the backyard is
a perfect tropical environment for their koi fish. They make an offer to purchase
Mary and Joe’s home for $355,000. Mary and Joe accept, and now they are in
escrow.
Sue and Bob are getting a loan on the home, and the loan requires an appraisal. The
appraiser visits the property and reviews many other similar and recent home sales,
or what we call comparables or “comps” in industry vernacular. The appraiser
notes the kitchen remodel, but also sees that many other homes have similar kitchen
remodels with comparable features. She is able to make a slight price adjustment
for the fountain in the backyard, but since many of the home’s features are similar to
those of nearby homes and are well-suited for the “typical buyer” in that market, she
can’t make any significant price adjustments to the home’s value. In the end, the
appraiser puts a value of $307,000 to Mary and Joe’s home. Now what?
Since there is an appraisal contingency in the residential purchase contract, which
Sue and Bob kept in their contract, Sue and Bob are not obligated to pay more than
$307,000 for the home. However, that doesn’t mean that they automatically get the
home for $307,000. Since they originally agreed to purchase the home for $355,000,
if they are not willing to pay $355,000, then Mary and Joe can cancel the contract
and sell to someone else.
Sue and Bob do, however, have the option to pay $355,000 for the home, but the
lender can only base their loan amount off of a value of $307,000. That means that if
Sue and Bob planned to put 20% down on their home, then they would put 20%
down on $307,000 ($61,400), and then they would borrow the remainder from the
mortgager ($245,600). If they choose to go forward with the purchase, then they
would also have to pay the difference between the purchase price of $355,000 and
$307,000 in cash ($48,000), making their total cash outlay, before closing costs,
$109,400. If Sue and Bob don’t have the additional $48,000, or if they don’t want to
pay $355,000 after learning of the potential value, then they can either renegotiate
the purchase price with Mary and Joe, or cancel the purchase all together.
My personal approach to any contract of sale in real estate is to blend reality with
the market. In the case of Mary and Joe, their home had no chance of appraising at
$355,000 unless there was an overall market jump of around 18% since previous
similar sales. Since that is unlikely, their contract was flawed from the start. It’s
best to enter into a real estate contract that makes sense to all parties involved from
the get-go, making sure that the sale price is in line with what’s realistic in the
market.
With the right guidance, you can limit and mitigate appraisal snafus for a smooth
transaction.
P.S. Appraisers are human. That said, they make mistakes, and their opinions can be
questioned. I have challenged appraisals before. It’s not an easy task as nobody
likes to go on the defensive. Often, appraisers are able to justify their work to the
lender, and the lender accepts their defense, and thereby treats the appraisal as
gospel. I have had success in challenging an appraisal. The appraiser realized he
could have chosen more appropriate “comps,” and ultimately amended his
appraisal. This, however, is rare and shouldn’t be counted on as the norm. A good
equation is to deal smart with value from the beginning.
The types of similar homes appraisers can use to value a property are highly
regulated with guidelines on items such as how far away the comparable can be to
the subject property, how much larger the comparable can be, how many floors the
comparable can be, and so on. Appraisers can often make a case for stepping
outside these guidelines if there is a lack of recent sales (recent usually means 6
months, but appraisers can go back 1 year if necessary).
Many homeowners often wonder how their “upgrades” will affect the value of their
home. It’s important to recognize that appraisers don’t typically place a value on
each individual upgrade. If they must make a price adjustment for upgrades, they
will usually make an adjustment for the overall condition of the comparable
property to the subject property with one all-encompassing number, such as
$15,000, which may include flooring, kitchen, and bath upgrades, or whatever
general features the appraiser is trying to take into account as a whole. The $750
light fixture in your dining room won’t show up as a $750 price adjustment in an
appraisal. It may add value to the overall condition in a price adjustment—if there
is one.
Appraised value and perceived value are often two different things in a housing
market, particularly in fast-climbing markets. While appraisers can definitely make
adjustments to market timing and overall market increases since past sales, it’s a
smart move to analyze past sales when considering a home’s real value. An astute
Realtor with a feel for the market, the area, and comparable properties can help you
make a realistic, estimated valuation of a property.
To ad context to my explanation, let’s look at Mr. and Mrs. Hypothetical, Mary and
Joe, who list their home for $350,000. Similar make and model homes with similar
features, upgrades, lot size and location have recently sold in the ballpark of
$300,000. Within the first week of listing their home, Mary and Joe can’t believe
how many people show interest in it. They have multiple showings and multiple
offers. Along come Sue and Bob who just love Mary and Joe’s home. The kitchen
remodel is exactly what they’ve been looking for and the fountain in the backyard is
a perfect tropical environment for their koi fish. They make an offer to purchase
Mary and Joe’s home for $355,000. Mary and Joe accept, and now they are in
escrow.
Sue and Bob are getting a loan on the home, and the loan requires an appraisal. The
appraiser visits the property and reviews many other similar and recent home sales,
or what we call comparables or “comps” in industry vernacular. The appraiser
notes the kitchen remodel, but also sees that many other homes have similar kitchen
remodels with comparable features. She is able to make a slight price adjustment
for the fountain in the backyard, but since many of the home’s features are similar to
those of nearby homes and are well-suited for the “typical buyer” in that market, she
can’t make any significant price adjustments to the home’s value. In the end, the
appraiser puts a value of $307,000 to Mary and Joe’s home. Now what?
Since there is an appraisal contingency in the residential purchase contract, which
Sue and Bob kept in their contract, Sue and Bob are not obligated to pay more than
$307,000 for the home. However, that doesn’t mean that they automatically get the
home for $307,000. Since they originally agreed to purchase the home for $355,000,
if they are not willing to pay $355,000, then Mary and Joe can cancel the contract
and sell to someone else.
Sue and Bob do, however, have the option to pay $355,000 for the home, but the
lender can only base their loan amount off of a value of $307,000. That means that if
Sue and Bob planned to put 20% down on their home, then they would put 20%
down on $307,000 ($61,400), and then they would borrow the remainder from the
mortgager ($245,600). If they choose to go forward with the purchase, then they
would also have to pay the difference between the purchase price of $355,000 and
$307,000 in cash ($48,000), making their total cash outlay, before closing costs,
$109,400. If Sue and Bob don’t have the additional $48,000, or if they don’t want to
pay $355,000 after learning of the potential value, then they can either renegotiate
the purchase price with Mary and Joe, or cancel the purchase all together.
My personal approach to any contract of sale in real estate is to blend reality with
the market. In the case of Mary and Joe, their home had no chance of appraising at
$355,000 unless there was an overall market jump of around 18% since previous
similar sales. Since that is unlikely, their contract was flawed from the start. It’s
best to enter into a real estate contract that makes sense to all parties involved from
the get-go, making sure that the sale price is in line with what’s realistic in the
market.
With the right guidance, you can limit and mitigate appraisal snafus for a smooth
transaction.
P.S. Appraisers are human. That said, they make mistakes, and their opinions can be
questioned. I have challenged appraisals before. It’s not an easy task as nobody
likes to go on the defensive. Often, appraisers are able to justify their work to the
lender, and the lender accepts their defense, and thereby treats the appraisal as
gospel. I have had success in challenging an appraisal. The appraiser realized he
could have chosen more appropriate “comps,” and ultimately amended his
appraisal. This, however, is rare and shouldn’t be counted on as the norm. A good
equation is to deal smart with value from the beginning.
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