The danger of high appraisals in a spiraling housing market

In a market characterized by rapidly rising home prices, a low appraisal can be the ultimate deal breaker.

But what about in 2023, when prices are crashing?

For homebuyers reliant on mortgage financing, appraisals are required to inform the lender of the home’s fair market value (FMV)

 before the lender approves the mortgage. When the appraisal falls below the agreed-to purchase price, it can cause the deal to fail — dead on appraisal (DOA).

When home values are increasing quickly — like during 2021 — appraisals tend to fall behind, as comparable properties reflect yesterday’s home sales rather than the present market value, which is higher than it was even a few weeks earlier.

Appraisers can try to keep up by including pending sales or market conditions adjustments, but it’s easy to fall behind. Thus, under-valued appraisals tend to cause the most immediate harm to buyers in a rising market, a fact well-known by real estate agents and brokers practicing at any point in the past decade.

However, the pricing trends real estate professionals have come to expect began to reverse course in the second half of 2022, with California home prices down from their May 2022 peak by 7% in the low tier to 10% in the mid and high tiers as of October 2022.

Considered alongside slowing home sales volume and skyrocketing mortgage interest rates, the outlook for future pricing in 2023-2024 is bleak.

Now that prices have taken a dive, appraisers — who have come to accept the rising market of the past two years — need to make an immediate adjustment to price expectations.

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A high appraisal has long stakes for homebuyers

While a low appraisal has an immediate impact on the home sale, there are various remedies to make sure the home sale still goes through. For example, the homebuyer and seller can rebut a low appraisal, adjust the sales price or even agree to a larger down payment to make up the difference.

But while the impacts of an overpriced appraisal during a falling price environment won’t derail a sale, the consequences for the homebuyer are longer lasting.

The last time prices declined over a sustained period was during the post-Millennium Boom crash, concentrated during 2007-2009. Until 2009, appraisers were not yet required to be overseen by appraisal management companies (AMCs) and thus worked more closely with financially invested parties (e.g. lenders, buyers and sellers).

In 2007, Fannie Mae issued directions to appraisers on how to handle a declining market. While AMCs now handle much of the oversight addressed in the notice, the advice remains true. For example, during a declining market, Fannie Mae suggests appraisers:

• include an objective assessment of the market direction in the neighborhood within which the subject property is located, considering factors like:
  • recent price changes;
  • average days-on-market; and
  • the supply of homes; and
• adjust for recent sales which have included excessive seller concessions, which cause home prices to appear higher than their actual FMV.

Appraisers who ignore negative home price trends will end up over-valuing the property, causing the buyer to overpay and fall underwater immediately upon closing the sale. This also harms the lender, who is now on the hook for a mortgage encumbered by negative equity.

Therefore, it comes down to the appraiser to complete their appraisal report accurately and thoroughly, with today’s market direction (which is down) in mind.

Complaint process for appraisals

When an interested party believes the appraiser has not filed an objective and complete appraisal report, they may file a complaint with the Bureau of Real Estate Appraisers (BREA).

The BREA recently updated its complaint process. Users are now required to create an account before filing a complaint at the BREA’s complaint page.

Most complaints about licensed appraisers are submitted by lenders, AMCs and government agencies. On the other hand, individual appraisers file nearly all AMC complaints.

To determine whether the complaint warrants an enforcement action, the BREA’s Enforcement Unit establishes whether minimum appraisal standards were met under:

• the Uniform Standards of Professional Appraisal Practice (USPAP);
• the Real Estate Appraisers’ Licensing and Certification Law; and
• California appraiser law. [Calif. Code of Regulations Title 10 Chapter 6.5]

Real estate professionals: For the past decade, we have heard about your experience with appraisals coming in low. Have you started to see the opposite occur in your local market, with more appraisals coming in above the agreed-to price? Share your experiences in the comments below!