Is an Appraisal an Accurate Representation of Market Value?

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Is an Appraisal an Accurate Representation of Market Value?

No.

Well, not always at least. The question has come up from numerous buyers I know on whether they should they buy a property that appraises for less than the purchase price. I know this one is going to spark some debate, so rather than try to sway you one way or another I’m going to explain this whole appraisal thing in a bit more detail so you can better understand what is going on and you can make your own determination on how representative appraisals are of actual market value.

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What is an Appraisal?

You are likely only going to see an appraisal on a property if you are financing a purchase. The lenders are typically the ones who order appraisals since they want to know the “value” of a property before they lend money on it in case you default and they have to take possession of the property. They don’t want to end up with a property that isn’t worth that they loaned out on it. An individual can order an appraisal too if they want, you just don’t see it as much.

An appraisal is a thorough assessment of everything related to a particular property that may help determine the true value of that property. How big is the house, how old is the house, comps from other houses nearby, etc. It is a fairly thorough assessment and worth educating yourself on if you aren’t familiar with what all goes into an appraisal. I discuss the factors in detail here, but it’s worth looking up. Or look through the appraisal of a property you may have purchased and see what factors were considered. Once an appraiser factors all of these things in, he determines the “appraised value” of the property. This appraised value, in theory, represents the true value of the property.

If you are financing a property, an appraisal is critical because it will affect your loan amount. Let’s say you are buying a $100,000 property and you are required to put down 20%, so $20,000. That means you are actually getting the loan from the bank for 80% of the purchase price (the full purchase price less the 20% down payment), so the loan is actually for $80,000. In order for the bank to lend you that full $80,000, the appraised value has to come in at or above the purchase price of $100,000. As long as it comes in at $100,000 or higher, you are fine and you can still plan for the $20,000 down payment.

However, if the appraised value comes in lower than $100,000, things change. The bank is going to expect you to put down the difference between the purchase price and the appraised value, on top of your normal 20% down payment. Let’s say the appraised value comes in at $91,000. That means the appraiser who went to assess the property determined the house is only worth $91,000. You can still purchase this property and get the same loan as you had planned, except now you will have to pay an additional $9,000 out of pocket to cover the difference between the appraised value ($91,000) and the purchase price ($100,000).

This is what I mean when I talk about a “low appraisal”. If a property gets a “low appraisal”, it means it appraised for less than the purchase price. Again, this is okay and you can still finance the property, but you do have to make up the difference in cash at closing.

Related: What is a “Comp?”

The Problem with Current Market Appraisals

You’re already asking- Whoa! Why would I buy a property that is valued less than the asking price?? Don’t worry, I feel you. However, there are discrepancies with many markets’ appraisal systems today. As a result of the market crash and part of the recovery process, many markets’ appraisal systems are broken. With the appraisal systems being broken, it is causing many appraised values to be exceptionally inaccurate of the true worth of a property. I’m going to use an example of a turnkey rental property in Indianapolis to explain where and why discrepancies can happen. I use turnkeys as an example because they are fully rehabbed, in great condition, and rarely ever listed on the MLS. It will make sense in a minute.

Indianapolis, like most states, has insane amounts of bank-owned sales, foreclosures, and short sales. Welcome to our real estate crash, it’s what we’ve been left with. Due to the high number of bank-owned sales and the like, turnkey providers have set up shop. Turnkey providers go in, they buy up large numbers of these houses, they fix them up and they sell them off the market to investors and a lot to hedge funds. Great! Well, yes except it throws some things off.

Let’s say you go to a turnkey provider in Indianapolis and you pick out a property to buy. It is in an area where several other turnkey properties have sold and hedge funds have been buying like crazy. Turnkey properties inevitably sell for much higher than the bank-owned properties because they are fixed up and don’t need work and, well, the bank doesn’t own them. The hedge funds have been buying a lot of turnkey properties and even for the non-turnkeys, hedge funds still tend to pay higher prices. Now let’s say that 70 out of the last 100 houses to sell in a particular area were to cash-paying investors (turnkey investors and hedge funds), 25 of the 100 were foreclosures, and 5 houses were to primary homebuyers at normal price.

Because Indianapolis is a “non-disclosure state”, cash buys are not required to be reported. So an appraiser going out to assess the “value” of the property you want to buy isn’t going to see the cash-purchased turnkeys. He can probably see the foreclosure sales, but those are inevitably going to be really low because they are foreclosures. And then he can see the price of the houses purchased by the primary homebuyers.

What this translates to is an extremely skewed set of comparables to use in his appraisal. Why? Because all of the turnkey buyers and hedge fund buyers probably paid right around what you are planning to pay for yours, which should be considered in determining the value of your property but they aren’t because they weren’t recorded because they were purchased for cash. The foreclosures are priced really low, so that drags down the “value” of your property. And then the higher-priced properties, the ones sold to the primary homebuyer, count in the assessment but because it’s so few properties they don’t carry a lot of weight.  Make sense?

Basically, since that was about as clear as mud, the comparables used in a lot of appraisals today are unfair. One of the biggest determiners of a property’s “value” is recent sales. If all the recent sales that are similar to your property’s purchase price aren’t recorded and therefore not used in the appraisal, the appraised value is negating actual comparables that should in fact be used in the appraisal. The recent sales that are used in the appraisal are those of foreclosed homes which will be much lower prices, so that’s not fair either because there is a huge difference in the worth of a foreclosed nasty home and a recently freshly rehabbed home. They aren’t fair comparisons. But due to different state laws, there aren’t necessarily requirements to make sure they are more fair than that.

The biggest state in the last couple years to suffer from a broken appraisal system has been Georgia. The Atlanta market has been one of the biggest hotspots for investors for a while now, but all the while appraisals there have been in the toilet! Any investor planning to buy a property using financing in Atlanta has been warned (or should have been warned) that there is an extremely high likelihood that the appraisal on that property will come in low. Some have come in as much as $40,000-50,000 low!

Others not so much, I think I bought one that was only $7,000 low, but despite the low appraisals investors have still been buying properties there like crazy. Why? Because they understand that current appraisals aren’t necessarily representative of actual market values. If it is known that a particular market has a broken appraisal system, that fact should definitely be taken into consideration when you think about the worth of what you are paying for a property.

Related: Seven Tips for Dealing With the Dreaded Appraisal

To Buy or Not to Buy?

You have a property under contract, the lender orders the appraisal and the appraisal comes back only to show it is lower than the purchase price. Now what? Do you buy it or do you bail? Well, it depends.

  • Which market is it in? If you are buying in Indianapolis or Atlanta, for example, and you are expecting to buy a property that appraises high, well have fun not buying any properties. You could be searching for the next year to find one that appraises well! You might find one, don’t get me wrong, but don’t count on it. Understand the current appraisal systems in each market so you understand whether an appraised value is actually representative of true value. If a property is in a market where the appraisal system is known to be broken and it appraises low, then I’d still buy it because that is just how it’s going to be, assuming I have enough faith in the market to believe the real value is actually higher, like Atlanta.
  • What is the condition of the property? If you are buying a beat-up foreclosure, the appraised value is more likely to be representative of the actual value just because it’s unlikely the appraiser will ‘undervalue’ a beat-up property. If you are buying a fully rehabbed in excellent condition property though and all of the comparables in the appraisal were foreclosures, it is likely that the appraised value is not representative of the actual value.
  • Are there other nearby comps that support your purchase price? Ask the seller. Are there a lot of cash purchases that weren’t recorded that in fact justify the price you are being asked to pay? There may be. Find out what those sales prices were and make your own judgment.
  • Can you afford to pay the difference in cash? If you can, putting that extra cash down isn’t necessarily a bad thing. If you put that difference down in cash, it means your loan amount will be smaller. If your loan amount is smaller, your monthly payment will be smaller, meaning you will bring home more cash flow because your expenses aren’t so high. Also, that is just that much less money you will be paying interest on, which can save thousands!

There are plenty of people out there who wouldn’t dream of buying a house that appraises low. The uneducated reason being, if the appraised value is low it supposedly represents the actual value of a house and you know us investors, we don’t want to pay at value for anything.  We want to pay under value for everything! I believe that mentality as much as the next guy but you have to get educated. Another concern is, well if it appraises low now and for some reason I want to sell it in say a year for unexpected reasons, isn’t there a chance it could appraise low then as well and I won’t be able to sell for as much? Absolutely. That’s why you have to use your judgment on how secure you feel about the market. Believe me, Atlanta investors for the past two years have felt reeeeeeal good about buying there despite low appraisals.

If you aren’t comfortable buying a property with a low appraisal, that is fine. But make sure you are educated on why the appraisal may have come in low and based on that education decide if an appraised value is an accurate assessment of the actual value of a property.

One last question you may have is- well if the appraised value isn’t accurate, what is the actual market value? Well, that is the million-dollar question. I guarantee you it’s not the Zillow value! You may not know the actual value until more of these foreclosures dry up and/or the laws change requiring appraisers to be more stringent on what they use as worthy comparables. If you don’t believe me about all this, pick a property in Indy or Atlanta and order an appraisal on it. Then a week or two later, order another one. See if they are even in the same ballpark!

Happy investing.

Photo Credit: Robert Couse-Baker via Compfight cc

About Author

Ali Boone

Ali Boone(G+) left her corporate job as an Aeronautical Engineer to work full-time in Real Estate Investing. She began as an investor in 2011 and managed to buy 5 properties in her first 18 months using only creative financing methods. Her focus is on rental properties, specifically turnkey rental properties, and has also invested out of the country in Nicaragua.

26 Comments

  1. I’m running into appraisal issues in Indy right now! I’m trying to buy a triplex in Fountain Square. Even though the lender knows it has legal non-conforming zoning use (area’s zoned for singles and doubles), they’re insistent they need another triplex to compare it to. Plus, Fountain Square is so darn hard to price anyway. Houses with identical specs on paper can sell for $14k clear up to $140k depending on condition.

    It’s my first home purchase. I’m trying to get started in investing by living in one unit and renting out the other two. And I’ve been “under contract” for over two months trying to get this mess sorted out! Ugh!

  2. The biggest issue I see with appraisals is the requirement that they have to base most of their value on sold comps. If you are in an appreciating market and the appraiser is using comps a year old( which recently happened) then the value is going to be low! If you have to use past sales, but values are increasing, it is very hard to ever have increasing prices unless there are cash sales pushing ups values. But the cash sales are almost always lower because they want a lower price for paying cash, at least around here where there are not many hedge funds.

  3. I’m an appraiser, a good one. I’m amazed with Investors who jump in and buy a property without knowing anything about the market area in which they are buying. Ali recommends asking the seller about property sales. Mr./ Ms Investor: YOU are the one who should research the market in which you are buying property!

    I can’t tell you how many times I’ve met an investor at a property I’m appraising & when I discuss nearby comps that are selling for less, I get this response: “Well, this property should sell for more”. By the way, if I have to use older sales, and the property I’m appraising is in an appreciating market, I use upward time adjustments.

    I admit many of my peers are not doing their job when appraising properties, especially Single-Family Residences. This is why, unfortunately, you as investors have to have a better handle on what properties are selling for than any appraiser. You need to know that that property a block away that sold for $15,000 less than the one you are buying was in terrible condition & you need to give the appraiser this information so he/she won’t use this sale………without a large upward adjustment for condition.

    The way appraisals are ordered in the past several years stacks the deck against buyers because you never know how experienced the appraiser who wins the “ordering lottery” is. That’s why I always tell investors I encounter to come prepared with their own comps of properties that sold in an area where they are buying. Don’t try to hide “low sales” from the appraiser. You need to do the research and find out why they sold for a lower price and let the appraiser know why.

    • I was going to sell one of my rentals, but the house next door (mirror image) was in foreclosure. That’s what they base the value on, went from $150,000 to less then $80,000, still own it.

    • Thanks for chiming in, John! Always good to hear from an actual appraiser to understand reality a little better. Can you elaborate on why it is that appraisers can’t (or don’t) get the accurate comps that an investor would get themselves? How likely is it that if an investor presents things to an appraiser that the appraiser will actually take those things into account?

  4. John Carlson – Right on man! You hit the nail on the head. As investors, we need to be prepared for the appraiser when they come onsite and go through the comps and analysis of our valuations. After all, this is not 2005 anymore, you have to present why your property is worth what you have it listed for as a sales price. I help my appraisers, because who doesn’t need a bit of help these days?

    These days there are SOOOO many tools available on the web to help with value. There is no excuse as to why an investor cannot get the value they seek on a property. Great story Ali!

    Jack

    • Hey Jack. Are appraisers usually open to the info you present to them? Or do they argue any of it? It baffles me as to why they your research would be more accurate than theirs, I mean that is their whole job. But yes, all investors can get better deals on anything if they stay on people’s heels I find! I know some turnkey providers that will do that with appraisers on the buyer’s behalf. It’s great.

      • Ali, per your question, I think the appraisers might be prone to doing a poor job because:

        1) The appraisal round-robin system might send an appraiser into an area that the appraiser doesn’t know crap about. Local experience is critical to an accurate appraisal, they can’t just pull it up on a computer.

        2) The appraiser is in a big-a$$ hurry because they are making so little on the appraisal, because new guidelines require the use of these blood-sucking appraisal management companies that eat up a huge chunk of the fee.

        3) The market has massive condition-dispersion. You have crappy foreclosures, somewhat crappy short sales, decent condition but outdated and needs lots of cosmetics, good condition but pretty dated, and professional rehabs from flippers. The first two are distressed categories and can reasonably be comped only against each other, the last three are non-distressed and can be comped against each other but need appropriate condition adjustments. The appraiser often does not have enough information to correctly make these condition adjustments. Even photos don’t indicate age of mechanicals, roofs, etc.

        So Jack’s point about artfully guiding the appraiser seems right on.

      • We can discuss the merits and rational of paying above appraised price or not, but don’t think that the seller trying to help the property appraise is being done to help YOU.

        Pretty sure the SELLER has a pretty strong interest in getting the place they are selling to appraise for the agreed upon price. They are doing this because they know that a lot of their places are not appraising and want to do as much as they can to get them to since it is bad for them.

        If it doesn’t appraise then the buyer might:
        1) Lose the financing and can’t buy the place
        2) Do not think they should pay above appraised value and will ask for a price reduction or just pull out
        3) Buyer may not be able to afford to put up the extra cash even if they are willing to and they need to find a new buyer.

        If you want to buy the property and getting a higher appraisal will help secure financing you might get some benefit as well, but that is only incidental to what they are doing.

  5. I wish I had read these appraisal posts a few months ago. This is in West Lafayette, Indiana.

    While refinancing house a few months ago under a tight timeline (tail end of lowest interest rates), the appraiser gave an appraisal that dropped the home value ~4% even though we cleaned up the house and added ~4% in improvements when we purchased it in Dec. 2011. THE EXACT SAME APPRAISER appraised the house in Dec. 2011 for the full purchase price. When I questioned the appraiser about the drop, she talked about a house purchase that was 1K sq. ft. less space and didn’t have the same amenities. When I asked her to remove that sale as a comp she agreed but said it wouldn’t make a difference on her most recent appraisal. After much debate, she couldn’t explain the difference between the 2011 and 2013 appraisals.

    I should have been armed with more information. After this experience, I checked a few online valuations and they valued the house at a ~20% value increase from 2011 purchase price. Concerned that the 2013 appraisal will come back to haunt me later if I ever decide to sell this house. Thoughts?

    • I don’t think past appraisals stay ‘on record’ necessarily Cedric. Do watch out for online valuations though! The difference between the two could have been anything. I’m telling you, I’ve seen them change drastically just between weeks much less years. There is less rhyme or reason than you could imagine, that’s the frustration.

  6. Ali,

    I think that David’s post above hit the high points RE: Why appraisers can’t, or won’t find the best comps. The emphasis from Appraisal Management Companies (AMCs) today is to find the cheapest and fastest appraiser and then micro-manage the appraisal assignment. Numerous calls during an assignment asking when its going to be submitted. Then, after submitting an appraisal, an appraiser receives a 1-line print out of AVM generated “comps” from the AMC & is asked to comment why none of the “comps” in the print out were used.

    I saw the writing on the wall about 8-years ago & I changed my practice to focus on non-lender work like Expert Witness & Litigation assignments. I kept the best lenders, the ones who appreciate competent valuations and are willing to pay for it.I belong to several on-line appraiser forums, and many residential appraisers post that they are required to get the appraisals back to the lender within 24 hours of seeing the property. How can you do a proper analysis with this kind of pressure?

    This issue is nationwide and not just limited to Investors. I’m the “appraiser expert” on one of those experts panels where people can ask me questions. I would guess that 50% of the questions asked of me in the past 12 months are like this: “Mr. Carlson, I had a bad appraisal that screwed up my refi/sale……what do I do?” The basic answer is as I have posted: YOU need to be familiar with the market data and make sure the appraiser becomes familiar with the market area.

    I wish it were different.

  7. Does anyone have any experience with coming across appraisers that possibly appraise too high? I have one guy that I have used a few times because he is quick and affordable but twice his appraised value came in higher than what my realtor could agree with (about 5-9% higher than my realtors ARV opinion). Unfortunately both of these properties I ended up wholesaling and they haven’t been resold yet so I can’t see the sales prices for probably a few more months.

    On a side note, I know Zillows Zestimate is not reliable what so ever but is there anything wrong with using the comps under the “see sales similar to(subject property address)” tab. Since I do not have MLS access this is mainly where I go to find my comps when evaluating a property. Definitely not ideal but it’s what I have access to. Of course I zoom in to only a .5-1 mile radius, 10 years +/-, look at as many pictures as possible to determine condition differences and the whole 9.

    Thoughts?

    • Ali Boone

      ? Matt. I admittedly don’t know anything about wholesaling, but at least for rentals a high appraisal is no harm, only good. It tells the buyer they are getting a “great deal” on the house. What effect has high appraisals had on your wholesaling?

      Zillow can’t be too bad if you are looking at past sales. I know I’ve seen properties though that the actual sale price looks different than what it really was for one reason or another, so it still won’t be perfectly accurate. And 10 +/- years? For the property age?

      • Yes 10 years +/- was in regards to the age range when I’m looking at comps.

        The high appraisal definitely isn’t a negative if it was going to be for a rental property or a property I am selling. I should have specified that I am talking about appraisals that I get when I am on the purchasing side of a property to determine my ARV.

        For wholesaling an appraisal isn’t necessary. I have only obtained an appraisal for those wholesale deals because I intended to flip them but couldn’t get the funding lined up so I let them go via wholesale. The negative part of a high appraisal is that I want it to be accurate more than anything. Nothing worse than having an appraisal come in at 200k(in turn setting that as your list price) and not having a buyer interested in the house for a penny over 185k.

        I guess I somewhat answered my own question, if the appraiser isn’t accurate and he is valuing the house higher than what buyers are willing to pay I should probably find a new appraiser.

  8. Simply put, an appraisal is a tool used by banks and the government to make you pay more tax and interest–in most cases. If you can’t sell your home at what it “appraised” at, then it not worth that much, and they should lower your taxes AT LEAST.

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