It was October and my Cameron Park sale was progressing as expected. The termite inspection revealed some dry rot issues that the sellers agreed to repair and my clients waived a few issues pointed out during the home inspection. It was all normal stuff that I had seen a hundred times before. Most property issues discovered during the inspection period can be resolved between reasonable people who are sufficiently motivated to make a deal. My clients were. It was their first home purchase and they wanted to be into their new home before Thanksgiving where they planned to have family over to celebrate.
At some time during every escrow, the odds are that something will happen that could possibly derail the sale. There are just too many uncontrollable variables that must occur within a designated time frame. Individual personalities and different priorities can complicate even minor negotiating issues. This sale got scary when the day before Halloween the buyers’ lender called to tell me the appraisal came in $10,000 less than the purchase price.
The appraisal has replaced the whole house inspection as the most frightening unknown in the purchasing process. Here’s why. Many sellers are ordering property inspections and doing repairs before putting their house on the market. This eliminates or minimizes the unexpected discovered during escrow. With REOs and short sales, property defects discovered during the home inspection are not usually negotiating items. The remaining deal spoiler is often the appraisal.
Most real estate contracts are contingent upon the appraisal meeting the agreed upon purchase price. When it doesn’t, everything stops. The buyer can simply cancel escrow and go look for another property. A few years ago this situation would never have happened. Appraisals rarely came in less than the purchase price. If they did, the agents would have an opportunity to question the appraiser and submit other comparables for further consideration. New banking regulations now prohibit agents from personally questioning an appraiser as to the accuracy of their work. Submitting a written request for reconsideration can take up to 90 days.
The expedient alternative is to negotiate the purchase price between the buyer and seller. The seller could reduce his purchase price, the buyer can pay over the agreed upon price or both split the difference. Although the buyers wanted the house and were well-qualified, they had no excess funds to pay over what the lender would agree to finance, which is based upon the appraisal. The sellers were already underwater and bringing all their cash into escrow to avoid a short sale. We were at an impasse.
Looking back, the listing price on the house may have been a little higher than the other recent sales of similar size and age but this home had advantages. The heating and air conditioning were only two years old, a new roof was installed last year and the bathrooms and kitchens were completely remolded. The appraisal showed no price adjustments for any of these features.
The other issue with the appraisal was the comparables used to determine value. Most were REOs or short sales. A few years ago an appraiser could use three comparables in their valuation process. Today lenders are requiring six to 10 comparables sales. To meet this quota appraisers are using homes that aren’t similar to the “subject” property and many are distressed short or REO sales. Using distressed property sales as comparables when considering the market value of sales between individuals is problematic. Here’s why.
When establishing the “market value” for a property in an appraisal an appraiser makes certain assumptions regarding the property being appraised and the comparable sales used in the compilation of value of the subject property. The valuation process is based upon what a knowledgeable, willing and “unpressured” buyer would probably pay to a knowledgeable, willing and “unpressured” seller. Here is the problem: Although the buyers in REO and short sales are willing and unpressured, the sellers are not.
Institutional sellers of REO properties are under extreme pressure to liquidate their inventory regardless of price. Banks incur a tremendous amount of property liability once they foreclosure on a home. Federal banking regulators closely monitor the status of the bank REOs. Federally regulated banks are penalized if they are not quickly liquidating these non-performing assets. Fannie Mae and Freddie Mac regularly give a bonus to their in-house property managers for turning REOs quickly and penalize them for having excessive inventory lingering around past 90 days.
Short sale sellers are also under pressure to sell their home or face foreclosure and eviction. What do they care what the home sells for? They are not receiving any proceeds and their credit is already or will be ruined. When their mortgage lender considers the approval of a short sale they are also under pressure to accept the buyer’s offer or face an extended and costly foreclosure action, possibly complicated by evicting the seller, potential property damage and costly repairs.
It is a mistake for an appraiser to use institutional sales as comparables when appraising individual sales without substantial price adjustments. It is a slippery slope of receding values when they do. It is not rational for an appraiser to assume that sellers of REOs and short sales are not under any pressure to sell these homes. Appraisers cannot continue to compare apples to cauliflower.