Appraisal uncertainty is impacting the local real estate market.
Thinking of wading into this sellers’ real estate market to score big profits? Wade carefully. It’s complicated.
We had a story on the current real estate market just a few weeks back. We’ve since checked in with local expert Kathy Martin, who explained her take on a hot button issue—appraisals. Martin should know. She’s a certified general appraiser in West Virginia and broker/owner of KLM Properties.
For sellers, getting to agreement in this sellers’ market isn’t the hard part—getting to the closing table is. Generally, a buyer and a seller agree on a price and the property goes under contract. Then, the buyers work with their lenders to finalize borrowing qualifications. A home inspection follows, and after all this work, the bank contracts for an appraisal—a document that determines the value of a property based on existing market conditions and that determines the maximum a bank will lend for its purchase.
When a property doesn’t appraise at the agreed-upon price, buyers and sellers have three choices: renegotiate, split the difference, or stand firm which means the seller will have to walk away or come up with the extra cash over the appraised price that dictates what lenders are willing to lend. So an appraisal that comes in under the agreed-upon price can derail the sale.
Derailments are happening too often right now, due in large part, Martin says, to the data appraisers are using: closed sales within the past six months.
Appraisers can use three methods to calculate the value of a property, Martin explains:
- a market approach—using “comps,” or comparable sales from the past six months, the most common, and the one that lenders like;
- a cost approach—which factors in the cost of materials needed to reproduce the home in today’s market; and
- an income approach, which isn’t as widely used.
Appraisers have a lot of latitude in which approach they use, though they tend to settle on a market approach. But using comps from the past six months during a pandemic doesn’t accurately reflect the value of real estate when demand is at an all-time high, inventory is at an all-time low, and construction materials are in short supply.
Martin would like to see appraisers adopt a cost approach, taking into account current material prices gathered from national cost services or by calling local builders. “Costs are one way that appraisers could support the prices we’re seeing right now,” Martin says. But that’s a double-edged sword, she explains, because in six months’ time, if material prices return to pre-pandemic conditions, that cost approach could look much different once again. “The pandemic has created the market that we have, and we have to appraise for what’s happening right now.”
Also contributing to the problem right now is that low interest rates are motivating current property owners to refinance—creating a backlog of appraisal requests.
This should all sort itself out by the year’s end, Martin says, when current comps are on the books for appraisers to use.