The Truth About Low Appraisals

By D. Michael Burke

Every seller’s worst fear is that they’ll go through the process of negotiating a contract with a buyer, only to have the house appraise for less than the sales price. I have had a couple of homes appraise for less than the agreed-upon price, and every day I hear similar stories from other agents.

My point is, it is important to keep the appraisal in mind, whether you are setting your asking price or negotiating a sales price. In order to understand why a property appraised for a certain amount, or what your home might appraise for, it may help to know how appraisers arrive at a value for a specific property. I asked a professional appraiser and a friend of mine, Michael Novotny, for a few tips on how to explain this to my readers.

The first thing to understand is that there are three different ways to arrive at a home’s value:

1) A sales comparison, that takes into account what other houses in the neighborhood are selling for

2) A cost analysis, which calculates the value of the land plus the cost to rebuild the home

3) An income analysis, which calculates the value based on the potential income, such as from rent (not a method frequently used by appraisers)

The values arrived at via these three ways can differ substantially, depending on the market. The obvious one has to do with the first method: A high number of foreclosures in a neighborhood can have a dramatic impact on values in the neighborhood. "When foreclosures or bank owned transactions, known as REOs, are prevalent in a marketplace, they drive values down," Novotny explained. "Homeowners are forced to compete with these lower priced properties, and in some cases homeowners are forced to sell at these lower prices."

Of course, most people know this, but many sellers still have difficulty understanding how it changes the way the appraisal is done. There will always be houses that sell for dramatically more or less than the norm. In a market with few distressed sales, it is easy to explain why low sales are not included in the sales comparison for the appraisal. In a market where half or more sales are bank-owned, however, the appraiser can no longer discount distressed sales when arriving at a value for a home.

The cost approach to arriving at an appraised value is also impacted by the market. While values in the housing market have high points and low points, the cost of materials stays largely the same, as do builders’ wages. Therefore, in a changing market the cost-based appraisal of a home can differ considerably from the sales-based one. For example, when market values are rising, as they were in 2005 and 2006, it can actually be cheaper to build a home than to buy one. On the flip side, falling home prices can actually create a market where builders can’t possibly sell a home for profit – think of the 2008-09 market, when home prices were falling below the cost of building a house.

Although the cost of rebuilding a home is a viable way to arrive at an appraisal price, Novotny stresses, "Cost does not equal value in a marketplace." In other words, he says, "upgrades to a home do not always offer a dollar for dollar value correlation to an appraiser’s estimate of market value." Although sellers commonly think that if they put $30,000 into renovations on their home, they’ll be able to sell it for $30,000 more, this is rarely the case.

Between all of these factors, appraisals just aren’t always for the amount sellers expect. In addition, appraisals are now ordered through a third party, known as appraisal management companies, which limits the outside influence on an appraisal. Novotny also believes that since people realize the market is getting stronger, they are expecting prices to rise faster than they actually are. "Despite some increase in sales price, appraised values will take some time before they begin to go north," he explained. The market just has to go through a period of stability first.

The good news is, of course, that the phenomenon of lowball appraisals is most likely a temporary one. After the period of stability that Novotny spoke of, values should begin to go up. In the meantime, the moral of the story is that it never hurts to try to think like an appraiser. When setting your asking price or negotiating a sale price, think of how an appraiser will determine the value of your home, and make sure that the amount you have in mind is close to what an appraiser is likely to come up with. Thinking of it in this way will help to make selling your house hassle free!

As a real estate agent with lots of experience in Southwest Florida, my price estimations are usually right on the money, so to speak. To discuss what goes into determining an appropriate asking price, please don’t hesitate to contact me. For questions about appraisals, please feel free to contact Michael Novotny of Integrity Appraisal Services by visiting www.IntegrityAppraisalServices.net.

Contributed by D. Michael Burke, P.A. Keller Williams Elite Realty
Michael@CoconutPointRealEstate.com / www.CoconutPointRealEstate.com