Why Houses Aren't Appraising

Over the weekend, I heard about three more deals that fell apart because the houses didn't appraise for financing at the deal price. Get more than three Realtors in a room, and I'd bet that within a few minutes the topic of the "appraisal problem" will come up. Never do I hear Realtors frame it as "the price too high problem", as in "I encouraged my seller to accept an offer that was just too high, and there wasn't a bat in hell chance the house would appraise."

Granted, there are some technical and structural issues with the current appraisal process, largely stemming from the HVCC (Home Valuation Code of Conduct), and the use of large bureaucratic appraisal management companies by the big banks. Sometimes the issue with an appraisal and underwriting shortfall can be laid squarely at the feet of that unwieldy system.

But not all the time. I would venture, in fact, that the primary reason a deal falls apart because of financing is that the accepted deal price was just too high. Sellers and their listing agents almost always seem very surprised when the house doesn't appraise, and point blame at the big bad banks and appraisers. But if the listing agents had done their homework and had a few tough love talks with the seller, in most cases there shouldn't be any surprise at all.

When I negotiate a deal for a client, I do my homework. Before the first offer crosses a fax machine, I know the likely comps for the house and a range where I expect it to appraise. I give my clients a value road map with a stop sign. And with 13 closed sales under my belt so far this year, I've never personally experienced an appraisal shortfall.

A 100% close rate from the point of contract is achievable. I've done it. But most listing agents think it's about as possible as stopping smoking, losing 50 pounds and dropping 4 dress sizes in under a month. But it absolutely can be done, if listing agents do their homework and are upfront and direct with their clients, the sellers. If you have a house listed at $399,000, and the lowest counter the seller will put on the table is $375,000, will the house likely appraise for that? If you review the comps, and the best scenario you can come up with is an appraisal in the $325,000 range, why are you letting the seller take a $375,000 offer? Because listing agents hope for one of two possible — but unlikely — outcomes. First is that some sale will come through in the 4 to 6 weeks it takes to get to the appraisal stage that will support the price. And the second is that a low appraisal will give the seller a wake up call and dose of reality; that they will see the light and lower the price.

Who pays for that expensive lesson? Certainly not the listing agent, and not the seller, either. Most of it comes out of the buyer's pocket. By the time there's an appraisal shortfall and a mortgage denial, the buyer has spent upwards of $1,500 — for attorney contract preparation, home inspection and the mortgage application and appraisal.

Appraisal shortfalls should be rare, not common, and seldom a surprise. Sure, I understand that there are some properties, because of their uniqueness or position in a market segment with very few comps, that are very difficult to value. In those cases, it may not be possible to predict an appraisal value and the only thing that can be done is for all parties to be aware that the appraisal is likely going to be a crap shoot. But that's not what I'm talking about here. The appraisal shortfalls I'm hearing about are in more bread and butter property categories, where there are comps available to reasonably predict an appraisal outcome.

Comments

[ar]

This post reminds me of a question I've been meaning to ask: How reliable are the recent sales prices reported on Zillow? As it relates to appraisals, I've noted what appear to me to be wide sales price discrepancies that seem difficult to rationalize: Many examples abound, but think of the renovated ranch on Rock Road in Hortonville that went for $118,000 versus a similar house a few blocks away, on Main St., that went for $150,000 -- according to Zillow reported prices (I assume you know both houses). Apart from my curiosity about the reliability of Zillow info, wouldn't "irrational" sale price discrepancies between similar properties undermine the rationality of the theory of "comps" as an appraisal benchmark?

[Binxy]

Everything on MLS is overpriced by 30-40%. That's my opinion.

It's ironic that banks are now the ones who must tell buyers this!

[David Knudsen]

Binxy, saying everything is overpriced is a stretch. There are well priced listings on the MLS, you just have to find them. I've made a good business all year by being pretty adept at sniffing those out for my clients.

ar, the sales prices reported in Zillow are generally accurate; they come from the public record. What often isn't accurate is the property description --- beds, baths, square footage, etc. --- because that also is taken from the public record, and those records are notoriously inaccurate. Also, sales on Zillow tend to lag because Sullivan County because of the way the county makes sales data available.

An appraisal is a blend, of anywhere from 3 to 5 comps. The appraiser will weight the most responsive comp, in terms of proximity, size, style and sale date, the most heavily. If there are two comps that are similar, but with a wide price discrepency, the appraiser will attempt to rationalize those with each other to arrive at a value, and also take into account whether one was a distress sale (i.e. foreclosure, short sale, relocation or estate). If an appraiser was doing an appraisal on a similar ranch in Hortonville, both of those houses would be used as comps. The appraiser would also look further afield - possibly to recent sales in Jeffersonville, Callicoon or Youngsville, for additional support for a valuation and whether to tilt down or up. But the appraisal would likely tilt towards the higher of the two values, because there was a demonstrated market for that type of house at $150,000.

[larry]

i thought the seller paid for contract preparation. and aren't home inspections traditionally done before contracts are signed, always a risk to buyers that they may lose the property anyway to a better offer after they pay for the inspection. i imagine a lost deal is an expensive lesson for all parties involved, since selling agents and buyer agents lose their commission and sellers lose the sale. do banks allow buyers to up their downpayment to make up for the difference between sale price and appraised value? it may take some time, but i would hope many sellers who lose the sale due to lower appraised values will face the music and accept the reality that real estate values are depreciating. it sounds as though some of the listing agents may be in denial.

[David Knudsen]

Yes, the seller does pay for his or her attorney to prepare the contract. But the buyer also encounters contract related costs, for their attorney to review and amend the contract. As to your other points, buyers can increase their down payment to cover the appraisal gap, but few are willing to do so. If the bank says a house is only with X dollars, they're loathe to pay more than that.

A home inspection can be done at whatever point the buyer and seller agree it should be done. During the sellers market, it was almost always done before contracts, because sellers didn't want to incur any expenses for contract preparation before the buyers had done their inspection and made any repair requests. Today, I'm seeing it about 50/50, with more and more buyers insisting that they be in contract before shelling out for the inspection.

[Bix]

That seems to be an odd attitude, David. Shouldn't a buyer know before he signs a contract whether the house has a major defect or not? I'd think that a buyer's market would make buyers less willing to buy without an inspection that could turn up deal-killers or price-reducers.

[David Knudsen]

Many buyers today don't want to shell out the money for an inspection until they have a binding contract. If they do an inspection prior to a contract, and the seller gets and accepts another higher offer, the buyers can get bumped from the deal if they don't want to pony up. So a lot aren't willing to take that chance.

When an inspection is done after a contract, the contract contains an inspection clause.