How many times have you had this comment from someone who knows relatively little about the appraisal process, “I am not so sure about you appraisers. Seems like every time there is a purchase transaction needing an appraisal, you come in just above the purchase price. If the house is selling for $200,000, you come in at $202,000. If it is selling for $450,000, you come in at $460,000. Seems a little rigged to me.” Ever had a client get really upset when you asked to see the purchase contract before you begin working on the appraisal? “Well, I don’t want you knowing what the purchase price is. How can you be unbiased and give me an honest appraisal if you know what they are buying it for?”
To the ignorant (and I mean that in the most gentle of ways), these are legitimate questions. To a trained real estate appraiser however, looking at and even analyzing the contract in detail as part of the appraisal process is necessary in order to complete a credible report. In fact, the Uniform Standards of Professional Appraisal Practice (USPAP) REQUIRES that we do (Standards Rule 1-5a). Why? To answer that question, let’s step back from the trees for a view of the forest for just a minute. What is an appraisal? In layman’s terms, an appraisal is an opinion of value by a qualified professional supported by market data. That is all fine and dandy…if you have support in the market. Now, some appraisers work in metro areas where support for the market is easier. I (and many others like me) work in a more rural market where finding true ‘comps’ are sometimes like finding Big Foot in aisle 13 at the local grocery store. It is times like this that we appraisers have no choice but to just do the best we can with what little we have to work with.
In a refinance transaction (or a foreclosure, or a divorce settlement, or a tax appeal, etc.) you have one less luxury to work with than you do with a purchase. With a purchase, you have the best comparable available. This comp has the same location as your subject. This comp has the same year built, effective age, square footage, amenities, and condition as your subject. This comp is exactly like your subject BECAUSE IT IS YOUR SUBJECT!!! Let me put it another way. When appraising for a purchase, sometimes the best indicator of value is what a willing seller and a willing buyer have already agreed to sell/pay in an open and free market. Why shouldn’t this be considered? In fact, why shouldn’t it be relied upon QUITE heavily?
Now, don’t read what I didn’t write. I am not saying that it should be your ONLY consideration of value. If it were, why would the lender need an appraisal at all? Why shouldn’t Bob’s Bank of the Burbs say, “Hey, we got a willing buyer and a willing seller. Here is the purchase price, so that will be our loan amount.” There is a very good reason the bank (and potential buyer) pay upwards of $3-500 to an appraiser. Both the buyer and the lender want to know that the real estate being bought and mortgaged is actually worth the price that was agreed upon in the contract. That means…sometimes it isn’t.
Let me give you a recent example. In a recreational area not far from where I live, I was recently engaged to complete an appraisal for a purchase. The inspection was completed and the process of finding and adjusting comparables was commenced. Though the purchase price was $370,000, I could find support for no more than $320,000. The comps were good. The adjustments were within normal guidelines, and there was no reason to believe that my analysis was flawed. Therefore, I turned in the appraisal with a value of $320,000.
The expected call from the real estate agent came a day later. You can imagine how that played out. Nevertheless, when I asked him if he could provide me with any other comparable to support the purchase price, his answer was not surprising. “You used the only three sales available.” It was tough to not let the smirk on my face turn into an audible laugh. (Side note: When dealing with a professional with whom you may care about a future relationship, do not laugh at them. Just don’t).
Vindication came a week later. I was invited back to the same community and to the same subdivision. This time, the home was slightly larger, but otherwise identical to the first one in every way. Same condition. Same view. Virtually the same amenities. Purchase price? $335,000. My appraisal came in at $343,000. Law of Substitution come to mind anyone? Now, how would I have felt if I had done the unethical thing with the first deal and “made it work?” As it was, the amended purchase contract for the first home came over a week later for $320,000. Saving a buyer from a $50,000 mistake helped me sleep better at night. As an aside, ‘coming in low’ on a purchase appraisal does not always kill the deal. Rather, it often allows the two parties to renegotiate. That can only be a positive thing.
Again, an appraisal is not a fact. It is an OPINION of value. Of course, being a qualified professional and using accurate market data makes it more reliable than Uncle Leroy stating his opinion of what your trailer house is worth around the Thanksgiving table, but it is still not an exact science. Because it is not as easy as 2+2=4, there is room for interpretation. Have any two appraisers look at and value the same property and, though they will be analyzing the same market data, they will not typically agree on value. That is where the ‘opinion’ portion comes in.
You all remember the bell curve from high school, right? “Wasn’t that one one invented by Alexander Graham?,” you ask. Um, no. The curve is a way to show deviation in statistical sampling. Because an appraisal is derived from statistical samplings, the curve applies. Though an appraisal is typically reported as an exact number, no appraiser (who is honest) will bet their life that the property appraised will sell for that price-no more and no less. If a home appraises at $100,000, does that mean it would not sell for $95,000 or $105,000? Of course not. Does it mean it will not likely sell for $150,000? Probably. But, at what point does the likely selling price become unlikely? $110,000? $112,000? $112,300? In a bell curve, that number is the point in which the most likely price falls outside the first standard deviation-or the grey area. Now, try to keep up. The bottom line is, an appraisal is more accurately reported as a range rather than an exact number. Frankly, giving an exact number is (IMHO) misleading, though there is not a bank in the country who would accept a range for most transactions.
The exception to the grey area rule is homes that are nearly identical. Let’s take a townhouse as an example. If I were appraising a townhouse where the contract said the sales price was $110,000, but there were three sales of identical townhouses in the same complex that had all sold for $108,000 in the past 3 months, I would have a hard time supporting the value (even though it is well within a 2% spread. Unless the market was rising quickly or there were other considerations that could be analyzed, I am not going to ‘hit value’ on that appraisal. A real estate agent might cry, “It’s just $2,000! Can’t you make it work?,” but my ethics would cry louder that I cannot.
WARNING TO APPRAISERS: Doing the right thing when it comes to honestly deriving value can appear to hurt your appraisal practice in the short term. It will, in the long run however, be the only thing that will keep you viable and thriving. It is a fact of life that not all real estate agents are honest. Most are. Some however, rather than wanting what is best for their client, are only looking at whether or not THIS deal is going to close. A pesky (otherwise know as an ‘ethical’) appraiser can only be a hindrance to them. Some will even go to extreme lengths to make sure “you never do another appraisal in my town again!” About 95% of my appraisals for purchases come in at or above purchase prince (for the very reasons outlined in this article). However, the 5% that do not can be a headache. Let’s just say one or two deals that ‘do not go through’ because of that ‘low ball appraiser,’ can cause some turmoil and hurdle jumping. For some reason one deal that ‘goes bad’ for some agents somehow translates into, ‘That appraiser always comes in low.’ Weird, but true. Remember however, doing the right thing is always the right thing. In the end, I think all professionals would rather that the transaction be on the up and up all the way around.
There is need for a sidebar here: If you are a real estate agent and are reading this, you may be screaming at the article, “Okay, if you are not able to support value, why don’t you pick up the phone and call me? I can show you how to come in at value!” First of all, I used to make that call every time the value looked to be coming in lower than sales price. I can count on one hand the number of times the call was helpful and information was shared that helped me see the prospect in a different light. Secondly-and most importantly-federal laws that have been passed since the ‘housing crisis of 2008’ have significantly tied the hands of the appraiser in their abilities to pick up the phone and talk with anyone about value. It is nearly impossible anymore. We appraisers are not trying to be rude, we are just trying to retain our license.
When I first began as an appraiser, I had to decide whether or not I would appraise in an honest and ethical manner, or try to fit into the ‘Good ‘Ol Boys Network’ and play the silly little games that some play in order to stay ‘liked’ by those in power positions. I decided then that the most important Power in my life was not a banker, real estate agent, or any other professional. I have made a few people angry over the years (and even ended up on more than a few ‘black lists’) as a consequence of that decision. And yet, our firm still does more business than our peers. There is something to be said about running an honest business and the blessings that come in spite of the challenges.
One of those challenges, interestingly enough, is trying to explain to those not familiar with the appraisal process why a HUGE majority of appraisals DO come in at or just above the purchase price. In my case, that is about 95 out of 100. Nationally, the numbers are a consistent 88%-91% (“Red Herring Du Jour – Low Appraisals” By: Joan TricePosted on Appraisalbuzz.com Wednesday, August 24, 2011). That means only 1 out of every 10 purchase appraisals comes in below the agreed upon sales price. In other words, a super majority are coming it at or above the purchase price! Though it may smell a bit fishy, it actually makes complete sense…if you understand the appraisal process as explained above.
Here’s where the problems start. Most real estate appraisers are good and ethical, but there are far too many appraisers that care more about their professional relationship with the real estate agents in town or their clients to do the right thing when the right thing requires the appraisal to come in below the agreed upon contract. In other words, they may not feel like the data supports it, but they will ‘rubber stamp’ the deals so as not to make anyone upset. In my humble opinion, by doing so, they do a huge disfavor to themselves, the bank, the borrower, the market, and yes….even the real estate agents (listing and selling). Hear me out. No one wants to see an agent (who has worked very hard to put the deal together) lose their commission, but it may be the best thing that can happen for all the involved parties. As a potential buyer, wouldn’t you want to know if the purchase you are attempting is going to cause you to immediately be upside down in the market? If you are emotionally tied to the property, there are still other options to secure the purchase. Do you really want to get into a long-term loan and not be able to refinance (or resell) a year after the purchase because you are upside down (even if the market stayed steady)? From the bank’s perspective, you would certainly want to know what the true value of the collateral is. That is why you hired the professional appraiser in the first place, right? Now, as a real estate agent, you are an advocate for your client. If you are the selling agent, it would be reasonable (though you may lose this one commission), that your highest aspiration would be to protect your client from making a grave error. Even as a listing agent, your reputation is on the line. Most would rather be known as honest rather than “the agent who will do whatever it takes to close a deal.”
Remember (lean in a little as this is important), sometimes the appraiser’s job is to protect the buyer. Furthermore, appraising a property has, on many occasions, allowed the two parties to come back to the negotiating table and mutually agree to buy/sell based on a price that is more suited to the current market. In other words, because an appraiser was honest and did the right thing, the transaction was a better fit for all parties involved.
Of course, the purpose of this article is not to explain why or how appraisals come in below the agreed upon purchase price at times. As the title says, most purchase appraisals should (and do) come in just above the purchase price. The dynamics of the market ensure that this is true. To my fellow appraisers, do not be embarrassed or chagrined next time someone asks why appraisers ‘always come in just above the purchase price.’ Take the opportunity to educate them and explain why this is. Better yet, send them a copy of this article and save your breath.
Now, go create some value!