Series: How do I read an appraisal? Part 2

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USPAP (the standards that govern the appraisal profession states the following:

Standards Rule 1-5
When the value opinion to be developed is market value, an appraiser must, if such information is available to the appraiser in the normal course of business:

(a) analyze all agreements of sale. options, and listings of the subject property current as of the effective date of the appraisal; and

(b) analyze all sales of the subject property that occurred within the three (3) years prior to the effective date of the appraisal.

The appraiser MUST analyze the contract, and listing history of the subject property IF available. Analysis of these factors include:

  1. What the agreed upon purchase price is

  2. Monetary/Personal property concessions

  3. Contingencies

  4. Listing history of the property

  5. The above factors, and their affect on market value, if any.

There is a common question, “How can the appraiser’s opinion of value be impartial if they know the contract price?” The data shows that this question could be valid.

While most valuations fall into a bell curve around market value (which would be expected if purchase prices are to be trusted at all, the drop at just below contract prices and spike at/slightly above contract price would indicate that this does possibly skew opinions.

While most valuations fall into a bell curve around market value (which would be expected if purchase prices are to be trusted at all, the drop at just below contract prices and spike at/slightly above contract price would indicate that this does possibly skew opinions.

The Bad: Appraisers can get sucked into “hitting the number.” The bell curve in the above graph actually peaks approximately 3% lower than contract (a very interesting percentage given typical concessions) if the spike at contract price is ignored. Inside of a real estate transaction, there is only one party that is not financially compensated based on a closed sale/higher price and that is the appraiser. If this data is skewing opinions upward, then there is a possible long term problem. Agents seek higher commissions, banks want higher payments and the market begins to spiral upwards away from fair market value… and as we learned in 2008, prices can violently correct.

The Good: Good appraisers know their job and this risk. A good appraiser only addresses the contract price at the end of their analysis, not the beginning. Also, the meeting of the minds between the buyer/seller is a data point, one of many, but a data point that deserves to be analyzed and reconciled with the rest of the market. In an ideal world, a knowledgeable/informed seller prices their home reasonably, and a knowledgeable buyer makes a reasonable offer. Real Estate Agents have a huge responsibility in this - to set aside their own personal gains and inform their buyers/sellers (for more on this topic, watch economist Steven Levit’s warning: https://www.youtube.com/watch?v=pbFkw_roJqI).

Another question often asked is, “Isn’t market value just what someone is willing to pay?” After the long process of coming to an agreed upon purchase price, having an appraiser come in with a different market value opinion can be frustrating. Why would the two be different? A simple story may help us tease the two apart:

Imagine a small village within a large desert, with a faithful well at the center. Everyday the well produces enough water for the town's people, without fail. Each day a young man pulls up gallons of water and sells the gallons for $1 each. Each person in town has enough for the day, the man is compensated for his efforts and everyone is satisfied.

Now, on a certain day, a man struggles across the desert after a long journey, nearly dying. He is an adventurer, who has just found the greatest treasure known. He knows that when he gets back to civilization he will be rich beyond words. A young boy wanders out of town and finds the man. The man offers 1 million dollars for the water sack that the boy carries, and the boy gladly complies.

A couple of questions at this point:

1) What is the water worth to the boy?
2) What is the water worth to the man?
3) What would happen if the boy began demanding 1 million dollars per gallon in town?

Its a simple and almost silly story, but it gives us a simple example. To the boy, the water is still only worth $1. To the rich man who doesn't know the value of the water, its worth his very life. To the town, once the man has drank his fill, its still worth $1.

The price in one moment doesn't change the value. An uninformed buyer doesn't set the market. Just because a house is listed for 1 billion dollars doesn't mean that its worth it. Markets are made over hundreds of transactions, between informed buyers and sellers over the course of time.

The selling season sees more listings and sometimes pricing becomes more aggressive than the market can bear. Be sure to have an accurate home valuation before listing, as it can often save you time, frustration and disappointment.

Appraisals remain the most unbiased and reliable method of valuation, but the process and standards can always be improved upon. Algorithms are being tested, but are still decades away from reliability in anywhere other than homogeneous suburban areas. Town and Country takes our job seriously to “promote and maintain a high level of public trust in appraisal practice” (Preamble to USPAP) not merely “make the deal work.”

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