What if an Appraisal comes in low?

Happy May!   We hope this email finds you well.  The Orlando housing market is in its peak spring/summer season.  This year, we are seeing more incidences of home appraisals coming in below contract price. This month, we will revisit the home sale and appraisal process.

Q:  My neighbor’s house got multiple offers.   I heard that after it went under contract, the appraisal came back low.  Can you help me understand what’s going on?

A:  Certainly.  Your question contains multiple reflections on the current Orlando housing market.  To understand the whole process I’ll explain each one.

1. The first is that of the housing inventory shortage. Multiple factors contributed to the low inventory level.  I have written about the root cause of the shortage of entry-level homes (March 2017).  But we also have a shortage of mid-range homes.  Many homeowners are happy with the appreciation they see in their current home, but have difficulty finding the ideal next home both in terms of right price and good selection.  They end up staying and renovate their homes instead.  This has resulted in a boom in the home-renovation industry, and exacerbated the inventory problem (fewer sellers = fewer listings).

If a home is in the right condition and has the right listing price, there is a good chance of multiple buyers wanting it.  This results in a “multiple-offers situation” where the buyers make their highest and best offer to bid on the home.   The price is not always the only determining factor.  Other terms such as financing, inspection, contingencies, and closing date come into play too.   The listing agent helps the sellers sort through the offers to select the best one that best meets the sellers’ needs.

When a buyer is particularly motivated, he or she might be willing to pay a premium to buy a home.  This premium may mean different things.  It may be a full price offer, above-asking offer, or simply a reasonable offer based on comps, regardless of the listing price (buyers have access to valuations tools and are more educated about price than ever before).

2.  Market value of a home, to put it simply, is the price it brings in a competitive and open market under all conditions requisite to a fair sale. Today’s market is healthy, distressed properties such as bank-owned and short sales are rare.  Under most circumstances, a typical residential contract is negotiated under fair conditions.  We can argue the resulting contract prices therefore reflect market value.

3. When a buyer is purchasing the home with cash, a price is negotiated, and the transaction closes at that price. That is the end of the story.  However, most buyers purchase homes with a mortgage loan. When the bank is involved, a professional appraisal is required. This is the way the bank assesses its risk related to the property value.  Even though appraisal value is used as market value, I’ve coined the term “collateral value” to help people better understand the relationship.  When a buyer borrows money from a bank to purchase a home, the home is pledged as collateral for the debt.  An appraisal is hired by the bank to make sure the house value is adequate to cover the debt in case of foreclosure.  The appraiser has liability for his work.  When a market is heated or when a home is particularly improved and upgraded, I often see an unwillingness on the part of the appraiser to be “wowed”.  Many appraisal reports are strict and do not give value to “wow” factors.  This is the job of the appraisers.  They can provide an effective brake so prices don’t run wild like the last real estate bubble.  But this also causes much frustration to all parties involved in a transaction because the bank will not make a loan above the collateral value.

4. So, what happens when an appraisal comes back low? The agents can challenge the appraisal with additional information.  The buyer and seller can renegotiate the purchase price.  If no new agreement is reached, the contract may be cancelled, and the home goes back on the market for another try.

Throughout this whole process, an experienced agent can really make a difference.  We have many stories to share.  If you are thinking about buying or selling a home, talk to us first before you make a move.  We have seen all seasons of a real estate cycle.

I will stop here.  Until next month, take care!

Yien and The Yao Team.

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