I recently gave a presentation and was asked if appraisal gap clauses impact the way appraisers are developing their opinion of value? In other words, do appraisal gap clauses cause appraisers to be more “conservative”?
An appraisal gap clause can be written into a contract. It states that the buyer will still purchase the home at the contract price, even if the appraised value is lower than the contract price by a certain amount.
Appraisal gap clauses have become relatively common in recent years due to many homes being sold at prices that market data does not support as being the market value. In this hot market, it’s not surprising that this type of clause is being written into some contracts. These will likely begin to become less common as the market cools off.
When it comes to the appraisal process, while we do take into consideration the contract price of the home being sold, that’s just one of many data points that we must take into consideration. The appraiser’s goal is not, nor has it ever been, to simply be a price validator, though many have used appraisals this way.
Appraisals are developed with the goal of reflecting what the most probable sales price of a home is. It is true that the contract price may very well reflect the market value of a property. But not always. For instance, in a bidding war, like in the movie Highlander, “there can be only one” winner.
Typically, it’s the one buyer that is willing to pay the most. What about the other bids from buyers who were willing to pay less? If they all bid on the same price, that might be a better indicator of value. But usually, it’s the one highest bid that wins. And at times, that highest bid is higher than the market value of the property.
Wouldn’t it be interesting if there were multiple bids at the same price and to win the bid the buyers had to have a good old fashion Survivor fire-making contest? Okay, maybe not. Too soon?
But since I mentioned it, if you’re tired of reading, take some time to enjoy these epic Survivor fire-making challenges.
Now, back to the subject at hand, the appraisal gap clause. Some buyers know that they are going to have to pay more than the market value to win the bid.
As an aside, more than once in recent times, buyers have contacted me about helping them to lower their property taxes. And, more than once I’ve had them tell me that they know they “overpaid” for their home but to win the bid but feel that their home is not worth what they paid for it. Unfortunately, in Cuyahoga County where I live, the county typically uses the purchase price of the home as its assessed market value for three years after the purchase of the property.
Often, buyers and other real estate professionals feel that the market value is whatever price is agreed upon by two parties, that is unless they feel that they overpaid. So, in reality, the market value of a property is not as simple as what two people agree as a contract price. That’s an overly simplistic way of thinking about market value. That’s why appraisers don’t just consider the contract of the home being appraised. We look at many other data points in the development of our opinion of value.
But the question is whether appraisal gap clauses impact the appraiser’s opinion of the market value of the home. While I can understand why someone might feel like they do, in reality, they do not, or should not. Our concern is in reflecting the market value of the property being appraised, no matter what the contract price is or how much a buyer is willing to pay for the property above and beyond its market value.
While some properties I appraised had market values that were below the contract price, I have also appraised properties where the market value was higher than the contract price. It really depends on the market and where it leads me.
How might the market value of a property be higher than the contract price? Think about this. If a home went under contract two or three months ago, and prices of competing homes are rapidly increasing, does the market value of the home under contract suddenly stop increasing? Of course not! Therefore, sometimes my opinion of market value is higher than the purchase price because the effective date of my appraisal may be a month or more after the property went under contract. If I was just a price validator, I would just come in at the purchase price whether the market supported a higher price or not.
If the market really is defined by whatever someone was willing to pay for a property, then there would be no need for an appraisal gap clause. But most people only believe that concept when it benefits their goal of selling their home. Clearly, many people have paid more for their home than they feel it’s worth in order to win the bid. Appraisal gaps are used to win the bid when there is no market support for the contract price. But it does not impact the appraiser’s development of the market value of the property.
Hopefully, this article has given you some food for thought on the subject.
There is so much inflation talk that I thought I should end this article with some deflation. Check out some of Jimmy Fallon’s guests having fun with balloon deflation.
If you’re an appraiser looking to sharpen your analytic skills, check out George Dell’s next Stats Graphs and Data Science 1 Class in August.
Have a great weekend!
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Here are some links to other articles I’ve enjoyed recently! I hope you will also…
Lawn Chair Precision Shows Us Folding Chair Sanity In A La-Z-Boy Housing World – Housing Notes by Jonathan Miller
Desktops Are Being Done WRONG! – Dave Towne on AppraisalBlogs
Fannie Mae’s New ANSI FAQ – The Appraisal Update Podcast
What You Need to Worry About Now…And What You Don’t – The Appraiser’s Advocate Podcast
Appraising Short-Term Rentals/Airbnb – APPRAISAL TODAY
The Tide is Turning – July Newsletter – DW Slater Company Blog
Part 3: Fixing an Appraiser Excess? – George Dell’s Analog Blog
6 Reasons Your Home May Not Appraise In Today’s Market? – Birmingham Appraisal Blog
Buyers take power from sellers. It’s their turn. – Sacramento Appraisal Blog
For my readers in the CLE area… here are some articles related to news in our local area. I hope you enjoy these also…
Growing season: Spice Field Kitchen uses summer plants to teach kids about local food – Karin Connelly Rice of Fresh Water Cleveland
Park in the mall: Cuyahoga Valley National Park transforms Tower City into green oasis- Karin Connelly Rice of Fresh Water Cleveland
I agree. They shouldn’t. Hopefully that’s the case. I always remember that the proof of value is found in the comps – not the contract price or terms.
Absolutley right my friend!