The appraisal came in too low. What do I do?

 Understanding the Real Estate Process from A – Z – A Buyer’s Guide to Real Estate – Part 12

This is the twelfth post of a series in an FAQ format that I hope will help would be buyers better understand the real estate process that they are about to go through. There is a follow-on series to the posts for real estate sellers.

FAQ  –  The appraisal came in too low. What do I do?

Once again, don’t panic. There are several reasons that the appraisal may have come back lower than

the selling price. One is obvious – the place is overpriced and the value is just not there to support the sale price.  A second is that the appraiser might not have done a good job of assessing the house’s value. He or she may not be familiar with the area and have picked the wrong “comps” to compare the house to (which happens sometimes when out of area appraisers are assigned the appraisal). In general, experienced and competent appraisers will be able to do a good job of rendering an opinion of value, even if they are a bit out of their normal territory.

So, what do you do now? Your mortgage company is not going to write a mortgage on the place if it is significantly below the value of the price that you have agreed to pay. The ball is back in your court. You can throw the ball over to the Seller by letting him know that the appraisal came in low and asking him to reduce his price to match the appraised value; or, you can decide to make up the difference yourself, if you are confident that the values are rising and will eventually reach or surpass the sale price; or, you can try to reach some compromise with the Seller. Quite often the last choice is the one that works.

If the seller refuses to budge off the price that he agreed to you really only have two choices – kick in the extra money on the deal above what the mortgage company will finance in order to reach the sale price; or, walk away from the deal. Many times Buyers are reluctant to take that final option to walk away because they have real money already sunk in the deal, as well as emotional momentum to go ahead with it. The Buyer at this point has probably spent close to (or more than) $1,000 on the home inspection and the mortgage costs (the appraisal fee and any other application fees). That is sunk money that they will not get back. If they walk away at this point they will get their Earnest Money Deposit back.

Many times the Buyers are pretty well tapped out at this point, because of the expenses that they have already incurred and the closing costs that are yet to come. That may force them to seek some additional financial help, maybe from mom and dad, or to work with their mortgage person to try a different mortgage approach – perhaps with a different mortgage product that will free up some cash to be used to pay down the appraisal difference. 

Most of the time the Sellers are willing to work with the Buyers to adjust the price. Perhaps they priced too high to test the market and realize that the appraisal price is actually a good number for their home. It may take them a little while, because they have to give up on the euphoria of having gotten such a good price for their house. They will come to realize that they appraisal price probably does represent the “market value” and that the Buyer that they have in hand is better than going back on the market to try to find someone else who might be willing and able to pay above  the market price.

The best course of action is to listen to the advice of your Realtor® and let them do their negotiating

job on your behalf. Both of the Realtors involved have probably been through this before and know how to navigate these tricky waters. Either, or both, of the Realtors may advise trying to get a second appraisal is they agree that the appraiser did a lousy job.  There will probably be some negotiation about who pays for that second appraisal and your will need the agreement of the mortgage company underwriter to accept the results.

At some point, you will reach a sale price that reflects the market value and one that the mortgage company can support. If that is still below what you and the Seller can agree upon, it is time for some soul searching. In a market like the one that we are in right now, with low inventory and high prices, it may well be that you will have to accept starting over on your search and perhaps resetting your priorities and criteria. The only alternative is to find a way to finance the added cost above the

appraisal value, if this is truly the house of your dreams.

Life is full of compromises and this is a big one. You risk being “house poor” for some time or having to kick in the money that you had held back for updates or repairs, in order to move ahead. Just be darn sure that this is a place that you will want to stay in for at least 7-10 years, because it will take you that long to recoup the extra cost in appreciation. If you are young and working in an industry in which promotions may mean moves, this is probably not a wise course for you. If you are in a stable position where advancement won’t require moving, then you will probably be OK over time. 

About BPOs, CMAs and Appraisals…

Would be home buyers may occasionally hear that the listed price was based upon a BPO. Sometimes, if the property is to be a short-sale the sellers will hear that term, too; as the bank or mortgage company tries to determine a fair market price.  Normal sellers will always hear the term

CMA or Comparative (sometimes Competitive) Market Analysis; and both buyers and sellers will certainly hear the term Appraisal before the deal is done. All of those terms refer to processes done by professionals in an attempt to determine the value of the property. They are all industry terms and all sound better that SWAG (Scientific Wild-Assed Guess), which it also what they all are.

Of the three terms the one with the most science involved is the appraisal, or at least that is what the appraisal industry works hard at portraying. Buried in the fine print of every appraisal is a little sentence or phrase that points out that the work is an opinion about the price.

Like all of these processes, the appraisal involves real data, mainly from past sales of similar homes, and lots of real work as the appraiser tries to adjust the data that he or she has to work with to level the playing field and make the comparison of the “subject property” reflect as close as possible the current value of the house being appraised. There is no intrinsic value to any house and the most honest assessment of value that I’ve ever heard is that any house is worth what someone else is willing to pay for it. Unfortunately, there is also usually a mortgage company involved and so the value becomes whatever the mortgage company says it is worth – thus the need for the appraisal.

So what do the appraisers use to determine a house’s market value? They start with the assumption that the house is worth what others have paid for exactly the same house. Their job is made immensely easier if the house is in a tract sub with lots and lots of recent sales of houses of exactly the same floorplan and amenities. That does happen, but the reality is that no two houses are ever built exactly alike, so the appraisers challenge is to make “adjustments” for the differences.  That’s still fairly easy in big developments; but, what happens when the house being appraised is custom built and off away from other similar houses. That’s where the appraiser starts applying all of his scientific and experience skills to try to create that level playing field, so the houses can be compared as a market.

Appraisers like to work with as little distance involved as possible, so most like to work with similar homes that are within a mile or two, but they will go out further is necessary.  Staying local takes a lot of the neighborhood factors out of the comparison. They also need the homes to be the same in terms of amenities – number of bedrooms (and locations in the floorplan) and baths, style (i.e. single story, multi story, split level, etc.) and age of the build, garage size, basement finish and much more. The appraisers use the term comps or comparable, because they want you to believe that they are looking at a group of houses that are the same (comparable) as the one that you are considering and that it is logical therefore that your house should sell for the same as those examples. It’s a reasonable and logical conclusion to draw.

The appraisal process does have flaws. The appraiser has seldom done more than drive by the comps, so they may not have a good feel for the materials, finishes or conditions inside. They try to make up

for that by looking at all of the MLS pictures that were on line for the comps. So they try to make adjustments for any differences that they note; adding on value or taking off value for those differences. The other flaw is that they are using data from past sales, so the market may have moved on from those sales, sometimes rather rapidly as is has over the last year or so. So they make adjustments for that, too. You start to see why there is that little statement about it being an opinion; a highly informed one of the appraiser is good and has worked hard at it; but an opinion none the less.

Now, BPOs and CMAs are similar processes but done by real estate professionals and dome without nearly as much rigor as an appraiser uses. Banks and mortgage companies hire local real estate professionals to render opinion about the current market value of properties that they are going to put on the market  as short-sales or as foreclosures. Most of the time a Realtor® hired to do a BPO will be required to at least visit the property to assess it’s condition. After that the process is much the same as with the appraisal, but without all of the adjusting efforts.  The Realtor will look for comps, usually within 3-5 miles of the subject property and using sales that are within the last six months within the market area. The agent will use comps that have the same number of bedrooms and baths and other key amenities; but they make no real effort to agonize over the details and make adjustments. They need to get it within a ballpark range for the bank. Because BPOs are ordered and paid for by the lender, they tend to be conservative on the value. They also tend to involve “distressed homes” that may have been damaged or vandalized, many times by the previous owner.

The Realtor that you call to list your house will do a Market Analysis (usually called a CMA) to try to determine what a fair market price will be for the house. He or she will likely find 3-5 similar

homes that have sold within a 3-5 mile radius of your home and 3-5 homes that are similar and are currently on the market.  Realtors tend to be optimistic about the market and forward looking, so they will almost always come up with the highest “value” for your home. They are trying to answers two questions -  what do I think I can get for this house on today’s market and what do I think it will appraise for if I get that price? As a Realtor, I never use the word comps when I present CMA’s that I have done. I’m careful to use the term “similar homes”, because I understand that I have not applied the rigor that an appraiser would to the selection of the homes, nor do I try to make all of the adjustments that an appraiser would. Certainly I take into consideration things like no garage or no basement and style of the house when looking for similar sold or active homes. If necessary I might make a gross adjustment for a major difference, like no garage when all of the similar homes have one.

The bottom line on all of these is that they are the opinion of the preparer, some done with great rigor and some not. The more “cookie-cutter” your house is that more likely they are to be fairly accurate. Things like location (different school districts, for instance, or located on water) or land content (1/2 and acre vs a place with 5-10 acres), and differences in amenities like finished or unfinished basements can make huge differences in the “values” returned by these processes. They are what we have to work with and it is up to you to question how the market value was determined. Like everything lese in life it should make sense to you and if it doesn’t get a second opinion. You’ll note that nowhere in any of these processes do factors like what you need to get or want to get for your house;  or even what your neighbor down the street got last year for his house (unless it is exactly the same as yours). The market doesn’t care what you need. What all of these processes are trying to determine is what someone might pay for it now. Hopefully you’ll be happy with what you can get. Call me or your Realtor to find out more or visit my web site www.themilfordteam.com.

Recommended Local Business - Nicholson Appraisal Services

Nicholson Appraisal Services, Inc.

As a Realtor® I work with appraisers quite a bit on home sales. These days appraisers are assigned mainly through appraisal management companies, but not always. There are many other reasons why you may need to call an appraiser, which I will discuss here. When you do, you can’t do better in this are than Nicholson Appraisal Services, Inc.

Obviously if you are buying an individual home (house or condo) or if you are buying a rental property of up to 4 units, you will need to have the property appraised. If you are refinancing those same properties or taking out a home equity line of credit, you will also need to have them appraised. Norma Nicholson, owner and principal at Nicholson Appraisal Services, Inc., has been a licensed appraiser for over 20 years. Norma covers many of the counties in Southeastern Michigan – Oakland, Livingston, Wayne, Macomb, Washtenaw and Genesee.

Appraisals are also critical when major life changes occur, such as deaths and divorces. In most divorce cases the division of the real property in the divorce settlement requires that the home either be bought out by one of the two parties or that it be sold outright and the proceeds split. That requires that the value of the home be determined and the courts often require that an appraisal be done. The same thing happens in estate settlements when the surviving owner dies. In order to settle most estates the property must be sold and the proceeds split. Again it is critical to get a good appraisal.

Do you feel you are carrying too much of the Property Tax Burden in your community? Have an appraisal report completed by a professional licensed appraiser that will provide supportable documentation of the true market value of your property within the present market, not a market value that was assigned to you years ago. You stand a much better chance of getting your tax basis lowered when you go to the appeal process prepared with a professional appraisal.

If things have gone south for you and you are considering bankruptcy you will need to have your home appraised. Why do you need an appraisal for a bankruptcy filing? Because the court will order one and/or sometimes two if the final opinion of value has a wide range. A licensed appraiser must generate the appraisal report. The courts will not accept what is termed as a CMA (Certified Market Analysis) by a licensed realtor. So get ahead of the game and get an appraisal from Nicholson Appraisal Services.

Other reasons or times to use a professional appraiser include:

• Insurance Claims for Fire, Wind and Water Damages – There needs to be a restoration value established before you should settle any claim, especially if the damage is such that replacement of the structure is required.
• For Sale by Private Owners – the most common mistake made by FSBO sellers is pricing. You need to know the value that someone is going to be able to get a mortgage for, before set a price for the property; otherwise you wasting your time and that f potential buyers.
• Pre-Marriage Estate Planning and Pre-nuptial  agreements – you don’t have to be Donald Trump in order toe have a pre-nup agreement, but you do need to know what the value of the things are that you are trying to protect in the agreement.

Nicholson Appraisal Services uses state of the art appraisal software that includes digital photography and they are are EDI compatible for timely turnaround time via email transmissions. As they state on their web site – “Our Company is small enough to hold quality as the number one priority. That also allows us to extend the lowest appraisal fees within the area on to you.” To visit the Nicholson Appraisal Services, Inc. web site click here. Nicholson Appraisal Services, Inc. is located in Milford at 786 S. Milford Rd, Milford, MI 48381

Nicholson Appraisal Services, Inc. accepts VISA, Mastercard and American Express. Call Norma Nicholson if you have any of the needs discussed above. You’ll be glad you did. Office: 248-684-7987 or Cell: 248-342-9637

Most appraisers don't care about your upgrades...

Some of you may know that I'm also fairly active a blogger on ActiveRain.com, which is a real estate oriented bloging site. An article appeared there recently that I wanted to share with you and comment upon. It had the same title as above and may be read in its entirety at at http://tiny.cc/K1BCh. The post was written by Tony Grego, a mortgage lender with the American Bank Mortgage Group in Indianapolis. Tony was trying to explain why sellers sometimes become so upset at the appraisals that they are given copies of by lenders and why appraisers may not give homes as much credit as the owners think they should for any upgrades that they might have made. It's a good read.

I hit the same thing quite often when I do Market Analyses for client and prospects. Many times the unique features or upgrades that the homeowner has made just aren't going to influence the price as much as the homeowner had hoped or felt that it would. I try to do a pluses and minuses analysis for each house that I evaluate, with pluses being things that might add value above the average and minuses being things that might detract from that value. Sometimes one big minus - perhaps being located on a busy road - will offset many pluses of smaller value - granite in the kitchen or a second floor laundry or other nice to have items. That is especially true if the "comps" that I'm using have similar plus features but not the big negative feature.

I actually avoid the use of the word comps or comparable in my Market Analyses because, for the most part, I have not been in most of those homes. I use the word similar instead and explain that from a data point of view they are of similar size, have a similar number of bedrooms and baths and have other features that are similar to the house that I'm analyzing and reporting upon. That makes more sense to me. So, go read the ActiveRain article and let me know what you think. It might help you understand why your appraisal came in lower than you had hoped.

Baking depreciation into appraisals

Wow, I missed yesterday altogether! Sorry about that. I got caught up in a tempest in a teapot discussion going on over in the National Association of Realtors Group on LinkedIn that I post to almost everyday, too. The topic seemed innocent enough - the practice, apparently just recently "discovered" by some, of appraisers baking a home's appreciation or depreciation into their appraisals.

I opined that we are were more than happy to have them bake-in 6 months of appreciation when homes were going in that direction; but, now everyone is upset when they take 3-6 months of depreciation into account when setting a value for the bank. Not fair, was the outcry. I'm not sure who thought that the appraisal process was ever "fair" or fair to whom. An appraisal is, after all, an attempt by the bank (and paid for by the bank) to assess the risk inherent in the loan. A part of the risk (and one could easily make the case that it is the biggest part right now) is how fast the price is moving with the market and in what direction. The appraisal is not done for the benefit of the buyer or the seller, but for the lender, because it is the lender who is putting the most at risk in most purchases.

So, for the last couple of years, appraisers have been under instructions from the banks on how to account for the risk fo depreciation of the assets that they are about to lend on. Initially there were instructions to take about 5% off every appraised value to account for depreciation. Now, with values dropping between 1 - 1.5% per month, many appraisers have been instructed to take 6 months worth of whatever the local depreciation factor is, as a way to factor in the risk of lost value. Even with that, many banks now find themselves upside down on loans that they made only 8-12 months ago.

So the posts fly back and forth – it’s not fair…they should do a real time appraisal…what if they miss the turn around…how can this be…oh, whoa is me, the sky is falling. I’m trying to make the point, sort of like in the movie The Godfather, that it’s not personal, it’s just business. The banks have to find a way to factor in the risks involved in real estate loans right now and asking the local appraisers to factor in 3-6 months of the current, local rate of depreciation may be the best and most fair way to do that. Those who don’t want that to happen are like the children who play hide and seek and yell out “Don’t see me”, when the child who is IT approaches. They don’t want the banks to look at what is staring them in the face. That’s what got us into this mess to begin with. But, maybe you have a different point of view on this. What do you think? Should the banks and appraisers be allowed to bake-in some amount of depreciation when valuing a home for a loan?

Appraisals adding to the problems...

One of the contributing factors to the mortgage meltdown mess that we're in right now was the complaisance of appraisers to go along with over valuing houses so that they could get big mortgages. Not all appraisers, mind you, but quite a few. Most were under tremendous pressures from lenders to come up with values that matched what the lenders wanted to lend on the property. The Feds eventually stepped in and slapped a bunch of hands and a few State Attorneys’ General made headlines as they pontificated about cleaning up the whole appraisal process.

Now we are suffering from the pendulum having swung too far the other way. Now lenders are telling appraisers to appraise conservatively. Lenders have designated our area as a “declining market” and have instructed appraisers to use the bank-own property sales in their comparables. The net result is dramatically lower appraisals for everything. Perfectly good homes in good neighborhoods are being dragged down by the one or two foreclosures that may be in the neighborhood or close-by. It’s crazy. In all likelihood, if you bought in the last 3-4 years your house would appraise right now for much less than you paid and likely for less than you owe.

What’s the solution to this mess? It appears that we just have to wait it out, if we can. The housing market needs to stabilize and stop dropping before we will see appraisals again showing rising values. Even then, most people will have lost 15-20% off the value of their homes and will have to wait out a period of another 3-5 years while appreciation slowly brings the value back up to where they were 2-3 years ago.

In the mean time I certainly hope that you do not have to re-finance your home anytime soon, since you are likely to not be happy with the appraisal. If you plan to sell your house anytime soon, it is likely worth the cost to get an appraisal done before you list; so that you have a good idea gong in what your house is worth in the credit market. Surprises like appraisals that are too low put a real damper on the euphoria of having made the sale. And certainly don't rely on the last re-finance appraisal that you had done a few years ago. Any appraisal over 3-4 months old is totally useless in this market.