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Saturday, June 28, 2008

The appraisal blues...

Even though Fannie Mae and Freddie Mac have supposedly removed the "declining markets" penalty in our area for their purchase of loans, they may not have sufficiently gotten the word out to the local appraisers community. I've had three deals go south lately because of low appraisals. Admittedly pricing homes in this market is tough, but the fact that appraisers use sold homes only (pending if they can get a projected sale price) adds to the issue, since sold homes represent a historic view and do not reflect what is happening currently in the market. The appraisers will likely lag an upturn by 2-4 months, before enough new sold data works its way into the system. People who sell during that lag would face appraisals that are based upon old, bad data (bad in the sense that it won't reflect the current market).

The other issue is that the appraisers have to work from a data comparison point of view. They usually go see the subject home and they may have seen one or two of the comparable homes, but in many cases they are just using MLS data about the comparable homes to do the appraisals. They means that condition largely gets left out of the equation. That also means that foreclosed homes may work their way into the equation, because they may represent a significant portion of the "local market" that the appraiser has to use.

So, what does this do to real estate sales? Well, it sinks a lot of them. For now, the appraisers are just doing what the banks tell them to do, i.e. appraise conservatively vs. being optimistic about the future appreciation of the home. So, even if the buyers and sellers have arrived at a price that makes both sides happy; if the house appraises lower than the sale price and the deal can't get bank approval, it won't fly. Even if the appraiser asks for the help of the Realtors involved to identify local comparable sales, it may be that the house being appraised is the top dollar house in its category, so finding other examples could be impossible, even for the Realtors.

The options open to the buyers and sellers if the appraisal comes in low are few and painful for both sides. Of course, the sellers can just accept the appraisal and concede the difference to reach the appraised value. Or, the buyer could be adamant about buying the house, not matter what (I've only had that happen once) and make up the difference out of his/her pocket. Or, both sides can kick-in on the deal to make it work - the sellers can reduce the price that they will accept and the buyers can put more money into the deal to reduce the loan exposure of the bank. That's how we resolved one of the deals that I had. The other option is that everybody walks away, which unfortunately happens more often.

If the deal falls through, the seller is left in an awkward position. He/she now knows what the place appraises for, which is not likely to vary by all that much on the next appraisal (if it is fairly soon). Leaving the price up at a level significantly above the appraised value makes little sense, unless a cash buyer can be found who doesn't want an appraisal (highly unlikely). The seller may consider taking the place off the market or at least pricing it so that reasonable offers would come in at or near the appraised value. Taking the place off the market is not an option for most sellers these days. At least the seller will know how badly he/she may be under water, if that is the case for them.

For now and the foreseeable future, the appraisal is as scary a part of the sales process as the home inspection - both can turn up issues that sink the deal. That has always been the case with the inspection and just recently with appraisals. Both involve lots of unknowns that are out of the control of the parties involved in the deal. We won't get back to more "normal" times with appraisals until the market settles and starts back up in values. Then both pricing for the market and appraising should be easier and more consistent.

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