After offering well over list price, beating out multiple offers and passing the inspection, the mortgaged homebuyer faces one more major hurdle: the appraisal report.
Appraisers face unique challenges during markets characterized by rapidly rising prices, as is occurring in 2021. With the home sale in their hands, some appraisers may be tempted to simply aim for the price listed in the contract. However, appraisers are bound to report the home’s value as they see it, not as the buyer and seller see it.
The appraiser analyzes the property by examining its elements of value, or DUST, which stands for:
- demand, the number of buyers interested in the property;
- utility, the property’s possible uses;
- scarcity, the availability of similar properties; and
- transferability, the seller’s ability to transfer good title to a buyer clear of all encumbrances itemized in a title insurance policy.
Related article:
The appraiser’s role in the market
Other factors influencing the property’s value lie outside of the property itself, yet nonetheless exert force on the property’s value. These factors are known as PEGS, which stands for:
- physical considerations, such as its proximity to amenities, access to transportation and natural resources;
- economic considerations, including area rents, vacancies, homeownership levels and nearby employment opportunities;
- government considerations, such as property taxes, zoning, building codes and local services; and
- social considerations, including crime rates, school ratings and recreational opportunities.
While none of these factors include the price agreed to by a willing and able buyer and seller, that is exactly the definition of fair market value (FMV). So, why not simply aim for the agreed-to price?
The appraiser’s role
The low interest rates of 2020 and 2021 have caused a surge not just in home sales, but also in refinances, which also require appraisal reports. With demand for appraisals surging, appraisers may be tempted to take the easy route by simply confirming the home value “requested” by the homebuyer or homeowner.
However, the appraiser has a duty to let the homebuyer know their own careful estimate of the property’s FMV. This helps the buyer avoid the unfortunate situation of being immediately underwater on their mortgage upon completion of the home sale. Further, the mortgage lender needs to know this information to ensure the property securing the mortgage note is sufficient security.
Using the market comparison approach, the appraiser examines recent selling prices of similar, nearby properties to establish the property’s comparable value.
Still, in times of rapidly rising prices, using months’ old home sales as comparable properties can provide an undervaluation. Some appraisers remedy this by examining the property’s listing activity, as reported by HousingWire. For example, a property with multiple offers over the list price shows a strong demand and scarcity of similar properties. Appraisers may also include pending home sales in their analysis, which provide the most recent comparable properties.
Appraisers also report their own scarcity in population has led to challenges in 2021’s hot housing market. Here in California, the number of licensed appraisers is the lowest since the Bureau of Real Estate Appraisers (BREA) began tracking this population in 1993. Just 8,000 appraisers are active in California, the majority of them approaching retirement age.
Appraisers are reflectors
Remember: it’s not the appraiser’s role to keep a lid on the real estate market. Rather, they are merely reporters. Even if the appraiser sees a bubble forming, their job isn’t to report what they believe prices will be six months from now, but what they believe the value of the property in question to be today. In fact, the real estate agent is best situated to inform their clients of any market distortions that signal home prices are out of control and unsustainable.
In 2021, several warning signs are pointing to a real estate bubble, including:
- the coming expiration of the foreclosure moratorium;
- the fact that interest rates will not fall further; and
- in California, the 1.7 million jobs still missing from the employment market.
Without the support of interest rates or a return of jobs, expect to see the market shift heading into 2022, pulled down by distressed sales. Homebuyers who purchase in 2021 will experience negative equity in 2022-2023 and will need to remain in the property for several years to make their investment worthwhile.
Click here for more information on appraisals.
