You would think that with such a steady real estate market as we have in Raleigh that appraisals would never be a problem, wouldn’t you? Well the truth is, from time to time, home buyers and sellers get a big surprise when an appraisal comes in below the contract price. Lets discuss how an appraiser goes about determining value and then spend a little time talking about what to do if you are ever in a situation where the appraisal fails to support the contract price of a home you are buying or selling.
It can be quite a shock to both the seller and the buyer in a transaction when at the 11th hour the lender lets everyone know that the appraised value is below the contract sales price. How can this happen? It’s important to understand how an appraiser determines value to fully appreciate what is going on in this process.
The first thing to remember is that the appraiser is completely independent from lenders, buyers, sellers, and real estate agents. Appraisers use guidelines that are dictated to them by the Uniform Standards of Professional Appraisal Practice (USPAP) and rules set forth by Fannie Mae.
The second thing to remember is it doesn’t matter if three buyers bid on a property and make offers above the listing price. In a situation like this you would think that the bidding activity might indicate the home is under priced. After all, that’s what a “market” does, right? Markets determine value based on supply and demand and what buyers are willing to pay. The appraiser does not take any of these indicators of value into consideration.
Basically, the USPAP and Fannie Mae guidelines help appraisers determine value based on past comparable sales in which the home is “bracketed” in size and value. A good example of bracketing is any improvement made to the property, such as a pool. A seller might put in a very nice pool and pay $40,000 to have it installed. So in this case, most reasonable people might think the value of the improvement is $40,000. What happens from time to time is that the appraisal guidelines might dictate that a pool in a certain area of the country is worth $25,000. As crazy as it might sound, regardless of how nice the actual pool is, the appraisal guidelines could in fact set a maximum value of only $25,000.
In this case there is an immediate $15,000 difference in value that sellers and buyers (even their Realtors too) will have a difficult time understanding. There are many examples of how these variances in value can occur on an appraisal.
I recently had a case where there was a 450 square foot finished space over an detached garage that one appraiser adamantly refused to value the same as the space in the main structure. There was a very expensive stone breeze way connecting the two structures and the detached space had a separate bathroom and its own HVAC system. It was done up nicely! And the buyer was very passionate about this particular property because of the detached space. He considered it at the very least the same value.
If you ever find yourself in a situation where the appraisal does not support the contract price, there are a few things that can be done. A second appraisal could be ordered. This costs extra money and the seller might have to pay this cost. If the buyer offered a higher amount, that means the home was worth that amount to him, so many times both parties want everything to work out. And the seller typically would pay for the second appraisal because he has the most to loose if a value equal to or above the contract price cannot be determined by an appraiser.
If none of this produces a satisfactory appraisal, the NC real estate contract says that the seller can either lower the price, or release the buyer from all obligation and return all earnest monies. If the deal falls apart over an appraisal, then everybody looses. The seller is back on the market with serious decisions to make regarding the listing price of the home. The buyer is starting all over again looking for a home. Keep in mind that any other expenses, such as loan application fees, the appraisal that just went south, inspection costs, surveys, and any other expenses incurred in the process cannot be recovered.
My final advice is to always work with a buyer’s agent who knows the area and can pull comparables before an offer is made. Sometimes, especially in older neighborhoods where there is a lot of variance in the size and style of homes, comparables are very hard to find. This is a service I provide for all my buyers and I tell them up front if I think there might be an appraisal problem. If I cannot find good comparables, I tell my buyers this too. I don’t like surprises and I find that most of my clients don’t either.
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