The Next Shoe to Fall -- Intimidated Appraisers

I have been a mortgage banker for 16 years.  In that time I have seen one appraisal on a purchase that was valued for less that the contracted purchase price.  In that situation, (about 12 years ago) a buyer made an offer on a condo in a project of 50 units.  This was an ordinary unit – not end or top floor and the offer was for $115,000.  The appraiser looked at all the sales of units in the project that were identical and conclude the top price was $112,00 and then set that as the appraised value.  

 In this past nine months, I have seen three appraisals come in for less that the contracted purchase price.  One was for $10,000 less, (on a $435,000 purchase price) one was for 25,000 less, (on $307,000) and the last was for $5,000 less (on $275,000) In all three situations, the purchase contracts fell and the properties went back on the market.

 There is obviously something going on with the Colorado appraisers that are causing them to begin restricting their valuation.  If this trend continues, it will have a devastating impact on Colorado property values. 

 Real Estate schools teach that the value of a purchased property is the price agreed upon by a buyer and seller who operate at “arms length.”  When a lender is involved, then an appraiser is called upon to confirm the value.  There is no reasonable expectation the appraiser is to revalue the transaction, rather the appraiser is to confirm the value.  If a disinterested buyer has surveyed the market by looking at available properties in a certain price range; the buyer, after negotiations with the seller, is the one who determines the value.  The seller, by agreeing to sell to the buyer at a price, also confirms the value of the property.

 This method works because properties, other than condo’s and townhouses, are unique.  Twenty potential buyers may look at a property and walk away. The twenty-first buyer can look at the property and make a full price offer.

 It must be the buyers and seller who determine the value.  There are two exceptions to this: They are 1) identical condo’s and town homes, and 2) builder sales under distressed conditions.

 There are many instances of condo in the same building that are virtually identical except for condition and location within the building.  Any purchase price that is substantially above the comp’s would be hard to justify.  But take the case of a condo building that is in the “right” part of town or one that has seen major infrastructural improvements. (like a new light rail station close-by) Those condos would certainly be appreciating and an appraiser would be guilty of negligence if he/she did not make adjustments to reflect the new situation.

 Builder sales within a subdivision can be extremely hard to appraise.  When the economy is good and the builder is backlogged, then the price of the home is inflated because of hefty builder profits.  When the economy turn down as is happening,  builders are forced to dump their inventory of completed or under construction homes. The builders reduce the price of their homes, sometimes dramatically, by reducing their profits to little or nothing.  This has devastating effect on the recently sold homes in the subdivision.  Many of these homes were sold with prices that included gigantic and sometimes obscene profit margins.  Now new builder homes with the same size and floor plans are being sold sometimes for $20,000 to $200,000 less.  The appraiser has no choice but to value the recently purchased contract property based upon current comps.  Only when the project is completed and the builder has no more inventory to dump, can the property values seek some level of market stability.

 Excluding the two aforementioned exceptions, there is a self regulating mechanism that affects market pricing.  That is, when a seller is overaggressive on the listing price, potential buyers either do not visit the property or they give negative feedback about the value of the property.  That mechanism forces the seller to continue to lower the price of a property until a buyer makes an offer.  The negotiated price then becomes the value of the property. 

 The workings of the marketplace between “disinterested” buyers and sellers establish the value of the property. 

 If appraisers become reluctant to value properties based upon arm’s length sales transactions, this will have devastating consequences on real estate values.  Appraisers cannot rely exclusively on old historical comps.  They must use the value established by the buyer/seller.  If appraisers don’t use such transactions prices, values will never be able to appreciate.  The large number of foreclosures and run down properties will pull down values creating devastation in real estate valuation call deflation.  In a deflationary cycle, as properties decline, prospective buyer decide to wait before purchasing which has the effect of slowing sales which leads to even more devaluation which cause purchasers to wait every longer, etc, etc.

 The Colorado economy as well as the U.S. economy is in a very precarious position.  Frightened or intimidated appraisers will only push us over the edge.