What Your REALTOR® Wants You To Know About Appraisals
What Are Appraisals?
Appraisals are an opinion of value conducted by an individual specially licensed as an appraiser. In theory, an appraisal is an unbiased, certified, third party assessment of a property’s market value, relative to similar properties in the area.
What Are Appraisals Used For?
Appraisals are most commonly performed on behalf of a lender so they can assess the risk associated with issuing a mortgage, refinancing a loan, issuing a home line of credit etc. The financial institution wants to ensure that a property's value is sufficient to justify the financed sum. For example, if you stop paying your mortgage, and the bank repossessed the house, can they sell it for as much as, or more than, the value of the loan?
An individual might also leverage an appraisal to get another opinion about the value of their property for purposes of sale, purchase, or to prove to their financial institution that the value of their property has surpassed the level required to remove the Private Mortgage Insurance (PMI) requirement from their mortgage.
How Is An Appraisal Different From A CMA?
First, “What is a CMA?” Like an appraisal, a Comparative Market Analysis (CMA) is an assessment of a property’s market value, based on comparable properties (comps) in the area. Many real estate agents will offer to do a CMA on your property for free. So what’s different?
Perhaps the most important distinction between the two is one of legal weight–or certification. While an appraisal is a certified document used by financing institutions to make contract (legal) decisions, a CMA is not certified and does not hold any sort of legal value.
Through licensing, and more formalized rules about procedure and process, appraisals attempt to deliver a more consistent product that can be “certified” in some way. There are no industry rules or standards strictly governing the process of creating a Comparative Market Analysis.
Which Is Better? Appraisal or CMA?
The reality is that both appraisals and CMAs have strengths and weaknesses.
Because of their rigid guidelines, appraisals are limited to reviewing past sales and do not take into consideration current conditions. Often, this causes appraisals to react rather slowly to market changes. That is why in the early 2020 housing madness, we saw lots of homes going under contract at crazy high prices, but appraising way below those sale prices. The appraisers were running off of older data. It took a while for them to catch up with the market reality. (I.e. what a willing buyer was willing to pay a willing seller).
The reverse has also been witnessed. Sometimes, as a market drops, appraisals regularly run “high” for a little while even though the reality on the ground has shifted. Additionally, it’s not unusual for an appraiser to pull comps from a wider area, and ignorant of local market quirks (e.g. the value of one neighborhood or county over another), end up with a number that doesn’t quite fit a property. By comparison, experienced agents with deep and current knowledge of market conditions, can generally deliver a CMA that is more reflective of the ever changing realities in your area– and take local quirks into account. But then again, you might get an inexperienced agent who’s only on their third deal and doesn’t know what they’re talking about (and lacks much if any oversight to help them with a CMA).
Any economist will tell you that determining “value” is a tricky business. Historically (and we’ve witnessed this ourselves), both appraisers and real estate agents can be way over, way under, or spot on.
Eeny Meenie Miney Mo…
One big difference we haven’t mentioned yet. You often can’t choose your appraiser. In the case of a regular transaction, the appraiser is assigned randomly by an appraisal management company to make things fair. And despite all the systems, structure, and procedural guidelines that exist for appraisers–there is still a rather large element of subjectivity. So unless you’re hiring an appraiser directly yourself (for example, because you just want to know what it would appraise for before listing), you’re pretty much at the mercy of whichever appraiser accepts the appraisal job posting.
On the other hand, you do have free choice when it comes to choosing your real estate agent. When doing so, it’s important to ask questions about their experience, knowledge of your market, and how often they close deals at, or close to, their original list price.
What Is An “Appraisal Shortfall” Or “Appraisal Gap?”
The difference between the appraised value, and the contracted sales price is called an "appraisal gap.” For example, you’re under contract to sell your home for $550k, but it only appraises for $500k. There is a $50k appraisal shortfall, or gap. Whether you consider that “good” or “bad” depends a lot on your situation. For most sellers, this is “bad” because you can absolutely expect the buyers to come back and ask you to lower the price. For a buyer, it can be “good” because you can use it to negotiate the final sales price down. But it can also be “bad” because you might have to cough up the extra dough to cover the difference, which takes more money out of your pocket.
The opposite situation, when an appraisal comes in above the contracted sales price, isn’t really “bad” for anyone. It’s great for the buyer because they have instant equity. It might leave a seller feeling like they could have tried for a higher sales price–which may or may not be true. (Side note: since the appraisal is the intellectual property of the buyer, the seller will not know what their home appraised for unless you tell them).
So when it comes to appraisal gaps, as a buyer, be aware that it could happen, and have a plan in place for how you’re going to deal with it (secondary financing, personal loan from family, walk away from the property, etc.). As a seller, be aware that no price is “final” until closing day. If an appraisal comes in low, you might need to renegotiate or be prepared to go back on the market.
For both buyers and sellers, having an experienced agent giving you advice based on their experience and local market knowledge can make all the difference in the world.
Are Appraisals “Final?”
Yes, but sort of no. At a certain point the appraisal is submitted to underwriting and there’s nothing that can be done. However, and we have both done and witnessed this, skilled agents can often “assist” the process by providing the appraiser with data and reasoning regarding what they feel are the most appropriate comps. Ultimately the appraiser makes their own decisions, but like a lawyer in court, a good agent can often make a compelling argument resulting in an outcome that is more beneficial to their client. If there is a factual error in the appraisal, the agent can point that out and get it corrected.
Do I Have To Have An Appraisal, Or Accept An Offer With An Appraisal Contingency?
Unless the offer is cash, yes, you will most likely have to deal with an appraisal. As a buyer, you could try to make your offer more attractive by NOT having an appraisal contingency. An appraisal contingency basically says, “I’ll buy this house as long as it appraises for the offered purchase price (or higher).” By leaving that out, you’re signaling that even if the appraised value comes up short, you’re prepared to cover that gap and close the deal at the offered purchase price.
Whether a seller chooses to accept offers that DO have appraisal contingencies depends a lot on the current market, and their personal situation. Need to sell fast? You probably can’t be too picky. Currently in a strong sellers market? You might be able to move offers with appraisal contingencies to the bottom of your stack.
Pro Tip: As a buyer, if you have a large down payment the lender may issue an appraisal waiver, which means they do not need to do an appraisal after all!
Conclusion
With the notable exception of all-cash transactions, if you’re buying or selling a home, chances are high that an appraisal is going to be part of the process at some point. Whether that’s “good” or “bad” depends a lot on your situation, the particulars of any given deal, and the market conditions at that time.
Typically you don’t have much control over if an appraisal is called for or not, who the appraiser is, or what their findings are. But you do have control over who you hire to represent you, to give you advice, and to fight for you throughout the buying or selling process. So before you hit the market, do yourself a favor and assess a couple of agents in your area of interest. The right agent is worth every penny…and will usually save you a dime or two along the way.
Want to learn more about how appraisals might affect you as a seller, or you as a buyer? Curious what our Comparative Market Analysis process is like and what your property might be worth? Contact us today. Your local experts are standing by.
