When the Appraisal is Below the Sales Price

There are some messages you just hate to get. An appraisal that comes in below the contract price certainly springs to mind. You get a sinking feeling in your gut, and your first instinct may be to jump to a response.
Don’t.

Pause to consider the full picture. You may have a realistic shot at getting the appraiser to revise the value, but you won’t accomplish anything by challenging the appraisal without doing your research and providing supporting information.

Step back to gain perspective

A so-called low appraisal isn’t an indictment of your skill as an agent. Consider the situation from the side of the listing agent. Part of a listing agent’s role is to obtain the highest possible price for your seller. It is a component of your fiduciary duty.

The appraiser on the other hand has a different responsibility. The appraiser’s target is not the highest possible price; it is the most probable price. Those two concepts are different.

Furthermore, the appraiser’s value does not take into account the circumstances, knowledge, and motivation of the specific buyer and seller in that transaction. Instead, the context is dictated by the definition of market value that extends well beyond that particular buyer and seller. The difference between highest possible and most probable means that, as a listing agent, a “low” appraisal may indicate you have done your job well! You may have achieved an above-market price for the property. It’s possible that the appraiser and the agent both did their jobs well.

Does this mean you don’t respond to the appraisal? Not necessarily. Your fiduciary duty demands that you press onward, which may mean helping to prepare a request for a reconsideration of value (ROV) from the appraiser. It could also mean other things, of course, such as further negotiations or evaluation of other offers—especially evaluation of offers from buyers willing and able to close the transaction regardless of the appraised value.

Does an appraisal below the offer amount indicate a failure of fiduciary duty by the buyer’s agent? No. The buyer’s agent should not be concerned with the typical buyer. The duty of the buyer’s agent is to a specific buyer: the client. Part of serving your buyer well is understanding that client’s specific needs, desires, motivations, and situation. That means that sometimes circumstances exist when the amount a specific buyer is willing to offer is higher than the market value, which is the value a typical buyer will pay in a given market.

Consider an example: You have a client in the market for a home, and at the top of her list of priorities is a pool. She would love to find a home with a pool but will pay to install one if she can’t find the right home that already has one. The cost to build a new pool is $75,000. What if the majority of the market doesn’t have the same preference level for pools? This makes things tough for your buyer, as there aren’t as many available properties with pools. As the buyer’s agent, you find two perfect homes. They are identical except that one has a newly installed pool and the other has no pool. The sellers of both homes are firm on their price.

	House #1	House #2
Price	$500,000	$550,000
Pool	No	Yes
Cost to build pool	$75,000	0
Total price	$575,000	$550,000

 

The house with a pool (House #2) costs $50,000 more to purchase. However, the buyer would need to spend $75,000 to build a pool for House #1, bringing the total spend to $575,000. House #2 thus saves this buyer $25,000.

Now here is where it gets interesting: What if the contributory value of the pool is only $30,000? This reflects the fact that the majority of buyers in the area have a preference level for pools that is not as high as the cost to build a new one.

After contracting to purchase House #2 at $550,000, it might only appraise for $530,000. Does that indicate a failure to meet the fiduciary duty by the buyer’s agent? No. Does it mean the appraiser inaccurately valued the property? No. The buyer’s preference exceeds the market value. Therefore, regardless of the appraised value, the buyer is still making the best possible decision given these circumstances.

Again, this doesn’t necessarily mean the buyer’s agent shouldn’t respond to the appraisal. Your fiduciary duty demands that you consider whether a reconsideration of value is beneficial to your client. You should also consider whether pressing for further price negotiations on the basis of the appraisal might be more beneficial to your client. You may also have to help your buyer understand how the true market for certain features—in this case, a pool—differs from your buyer’s preference for what those features are worth. You should be able to explain how that preference compares to what is in the appraisal.

Guess what? The appraiser may be disappointed, too

When an appraiser arrives at a value conclusion below the contract price, the appraiser may get that same sinking feeling that you do. Why? Because appraisers are people, too. Appraisers are aware of the consequences of an appraised value below the contract price. They know it can be a disappointing roadblock for everyone involved in the transaction.

It’s likely when the appraised value comes in under the contract amount that the appraiser spent a good deal of time reviewing and reconsidering all factors before signing the report. The appraiser knows the report will be scrutinized and questioned, and no appraiser relishes the idea of their credibility being called into question.

Mistakes do happen, but so do justifiable discrepancies

Just like all other humans, appraisers sometimes make mistakes. Even in the absence of actual errors, appraisals rely on interpretations of data, and interpretations differ among people. Sometimes it’s necessary—even helpful—to correct an error or offer a different perspective on the data.

So, if the circumstances point you in the direction of preparing a request for an ROV, what is the best strategy?

Read before you react

Before you request a reconsideration of value, take the time to read through the appraisal. Try to understand how the appraiser arrived at that value conclusion.

Appraisers frequently receive ROVs with “additional” sales that were included in the appraisal to begin with. That tells the appraiser you didn’t even read the appraisal or attempt to understand how the appraiser derived the value. When that happens, it becomes apparent that the ROV was not made in good faith based on a genuine disagreement with the analysis of the property and market. Even if you have valid points elsewhere in the ROV, you have damaged the credibility of the request.

Even if you provide additional or alternate sales, it is just as important that you evaluate the analysis of the existing comparables in the appraisal. Were there substantive differences between the subject and comparables that didn’t get addressed? Was the magnitude of the consideration for the differences that did get addressed sufficient to reflect the market reaction?

These questions are important because they should guide you toward the kind of additional sales data to support your assertion. For instance, if you see a locational difference that didn’t get addressed (or was addressed in a manner inconsistent with market data), you can focus on the location component when researching additional potential sales. It is important to then explain in your ROV request that the additional sales you submitted provide support for a locational consideration that wasn’t made or wasn’t sufficient to reflect the market accurately.

Focus on quality more than quantity

Merely submitting a list of sales with higher prices may be tempting, but this type of cherry-picking is rarely fruitful.

Many ROVs simply include sales in the neighborhood with the highest price per square foot without regard to significant differences in the property. It’s possible, though, that when differences are considered, those sales may even support a lower opinion of value! Appraisers can’t “aim” for a price, so search for properties which are objectively better comparables in some way. By searching for that–instead of focusing on the metric of price, or price per square foot–you also give yourself the opportunity to look objectively at the pool of data which the appraiser must consider.

In the example of the buyer contracting on House #2 with the pool, you might focus on the pool feature. If you find that the appraiser’s conclusion of the $30,000 contributory value of the pool was based on properties where the pools were all older or smaller than the pool of House #2, that could be an important detail to point out. You could then focus on finding sales with similar pools and making an argument that those sales could support a premium valued at $50,000. This shows the appraiser your thought process and perspective and allows the appraiser to consider whether the initial appraisal might indeed be worthy of reconsideration.

When you broaden your perspective, your emotions can take a step back, and your professional analysis can stand out. That analysis may demonstrate that a reconsideration of value isn’t really the best course of action after all, but if you do pursue the option of an ROV, you will know it is based on supporting data and gives you a higher chance of success.