REAL ESTATE
Insider the Appraisal
As discussed in Chapter 7 of our publication When to Buy and When to Sell: Combining Easy Indicators, Charts, and Financial Astrology, and several previous Real Estate blogs, the purchase of a home may be one of the biggest decisions, and investments, to make in one’s lifetime. Over the last few years, it has never been more difficult for young buyers, with rising inflation, property prices, and property taxes/insurance. Commercial real estate has seen its own crisis as well, highly affecting small businesses with office vacancy and plunging values. The situation appears to be only getting worse, with an increasing number of defaults and loans coming due.
One important part of the process in purchasing a home is the appraisal, or the determined monetary value of the desired property/asset. The appraisal, conducted by a professional, known as an appraiser, often plays a major role in the decision of the lender (bank or other financial institution) to approve the requested loan. For every loan, it is required that an appraisal be completed, to ensure the lender recognizes the value of the asset they are securing, and to justify the amount of borrowed funds they are awarding.
For every property “for sale” on the market, there is an “asking,” or “listing” price that the seller has decided on. Whether the buyer negotiates a lower price, agrees to the asking price, or bids the property higher, the appraisal is needed, unless it is “waived” by the buyer as a condition to their offer (highly inadvisable). The seller and their agent are familiar with this process, and are well aware that if the appraisal does not equal, or exceed, the “offer,” they may have to lower their expectations. They may decide to hold out for a cash buyer, or one with a contingency to make up any difference in cash, but that usually reduces the number of legitimate buyers they will encounter. A realtor/agent should discuss this possibility with any seller who is unrealistic with their desired asking price, to avoid potentially solid deals falling apart.
There are different ways to estimate the value of a property, and it is important to understand the source of any appraisal, so you know what you are paying for. It may also be a good idea to determine who appraised the property for the tax assessor’s office (which determines the property taxes), and compare the results with the lenders appraiser. Any discrepancy could be a “red flag” for the buyer.
The first way to estimate market value is what is referred to as a Comparative Market Analysis (CMA). Real Estate professionals and attorneys will use this method to approximate the value of a home, based on sales of homes with comparable features, within a close radius, within a particular time frame (usually 6 months or less). The CMA is used to price the home to determine the “listing” price, and is NOT an official appraisal, though they are often used as a starting point for an appraiser.
The second is a more conventional mathematically based approach, considering the age of the property and the systems within, the square footage, the number of bedrooms and bathrooms, the acreage, the usage, and the cost of replacement. Although the styles are different, some of the information often intersects, and the estimated value may be very close.
Also to be considered is the “intended use” of the appraisal, which can add or subtract value. “Uses” can include highest and best use, insurance purposes, and/or replacement cost of improvements, none of which are valid for establishing a “listing” price.
Some sellers may even have a pre-appraisal conducted on their property for the purpose knowing an approximate market value prior to listing their home. Again, any buyer should confirm the status of the appraiser, and the date which the appraisal was performed. Anything past 3-6 months could be outdated.
Some important issues to address include the age of all electrical, water, heating/cooling, and sewer/well systems, including their current condition. For instance, the value of two properties with the same lot size, number of beds and baths, and square footage, would be very different if one requires a new septic system or roof.
There are many “adjustments” that are made to the actual prices when comparing properties, as no two homes are exactly the same. At times there can be errors, overlooked items, and differing matters of opinion. Be careful to know the difference between gross adjustments and net adjustments, as they are two very different figures. Gross adjustments represent the total adjustments added together, whether positive or negative. Net adjustments are the difference between the two, and can result in a negative number. Combining the property inspection with these adjustments could be very beneficial.
A buyer should ALWAYS consider, as part of their contracted offer, to include the phrase/clause “contingent upon an appraisal equal or greater to the agreed upon price, performed by a licensed professional appraiser,” unless they plan to provide extra cash at the closing if the appraised value is less than the agreed upon price. For example, if the agreed upon price of a property is $300,000, and the buyer agrees to a $30,000 down payment, the amount of the loan will be $270,000. If the subsequent appraisal equals, or exceeds, $300,000, the deal is fair for the buyer. If the appraiser determines a $270,000 value, it changes the formula for the loan, and it may not be granted by the lender, and even if it is the buyer now has a negative $30,000 in equity. If the buyer decides to cancel their offer, they may be in danger of losing their security deposit, without the above stated clause/waiver. Worse, if the appraisal resulted in a $250,000 reported value, the buyer would then owe an additional $20,000 at closing, and would now have negative $50,000 in equity.
The vast majority of buyers would not desire, or be able to afford, this type of deal, so be extremely careful with the wording provided on a Purchase & Sales offer. The buyer representative agent should be well-versed in this type of language to protect their clients.
There is always more than meets the eye to purchasing a piece of real estate. Due your due diligence, and be prepared whether you use an agent or not. Once you sign of the dotted line, it is very difficult, and expensive, to reverse the sale.
Please visit the website www.augustassociatesllc.com for home values, listings, and professional assistance.
