- Lane Hornung’s monthly Q&A.
- This month’s topic is appraisals.
- In heated markets, appraisals often lag appreciation.
In increasingly heated real estate markets in Colorado, California and across the country, home buyers are frequently engaging in bidding wars, driving up homes prices.
Despite having a willing buyer and a willing seller, often the moment of truth is the appraisal.
If the home doesn’t appraise at the selling price, it can mean the buyer has to pony up more money, the seller reduces the price, or it can crater the entire deal.
John: Just so everyone knows, can you give a brief explanation of why an appraisal is typically required when buying a home?
Lane: An appraisal is simply the lender wanting to be assured the value of the home is commensurate with what is being paid for the home. Often in today’s market, if the buyer is putting 20 percent down, the lender wants to be assured the loan-to-value ratio is in place, in case the lender is forced to take back the home if the borrower doesn’t make the mortgage payments.
John: Of course, many contend a root cause of the Great Recession was appraisers over-valuing homes, leading to the nationwide foreclosure crisis. What is happening today with appraisals?
Lane: There is an inherent challenge with appraisals. Appraisals are a rear-view mirror look at the market. They are looking back, typically for six months, for comparable properties.
John: And today’s markets, with a shortage of homes and growing demand, today isn’t necessarily the same as six months ago, is it?
Lane: Absolutely not. Appraisers are most challenged when the market is moving quickly, either up or down. Appraisals are historic markers, while the subject property is really a snapshot of where that home is valued by the market at this moment in time.
John: How much can an appraisal be off?
Lane: Homes can easily have risen 5 percent, 10 percent, or 15 percent or more in the past six months and that will not be reflected in historic, so-called comparable sales. I’ve personally seen appraisals, both completed by licensed appraisers mind you, differ by 50 percent. Specifically, the second appraisal was 50 percent higher than the first appraisal.
John: How can an appraisal be off by so much?
Lane: Sometimes an appraiser doesn’t understand a specific market. The appraiser might be from far outside that neighborhood and simply chooses the wrong comparables.
John: Can the real estate broker help the home seller navigate the potential land mine of an appraisal that could lead to a deal blowing up?
Lane: The key right now is to select a listing agent whose goal is not to just get the home under contract, but to get it closed. There is no point in getting it under contract immediately and have the deal collapse in three weeks because the home didn’t appraise.
John: What can a listing agent do?
Lane: A good listing agent is always thinking two or three steps ahead. The listing agent should have a number of comparables to share with an appraiser, if needed, to justify the price. Also, the listing agent might detail amenities in the house that sets it apart from some other homes in the neighborhood.
John: What else?
Lane: The listing agent could solicit multiple offers. A backup buyer might be willing to pay more. Also, a cash buyer typically doesn’t need an appraisal. The terms of the deal, such as an all-cash deal, might even trump a slightly higher price, if the home needs to be financed and it might not appraise at the selling price.
John: How about the buyer’s agent?
Lane: The agent should prepare the buyer that they might decide to bring a little more cash to the closing table, in case the appraisal comes in low. The buyer’s agent should talk to their client about this strategy early in the process so the client can make a thoughtful, considered decision. In some cases a home might not appraise because it is over-priced. Other times, it may make sense for the buyer to bring extra cash to the closing table to close the gap on an appraisal that came in low. Most appraisers mean well, but it is not a science. It’s more of an art than a science, especially in a rapidly moving market.
John: Thanks, Lane.
Have a story idea or real estate tip? Contact John Rebchook at JRCHOOK@gmail.com. InsideRealEstateNews.com is sponsored by Universal Lending, Land Title Guarantee and 8z Real Estate. To read more articles by John Rebchook, subscribe to the Colorado Real Estate Journal