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One of the most frustrating things for consumers, agents, and even appraisers involved in a real estate transaction is seeing disparate results in two or more appraisals of a property. Dig beneath the surface and you’ll often find good reasons for the differences. Here are factors to consider as you try to understand the two different opinions of value.
Estimated Value Isn’t Always Market Value
First, check the date of the appraisals. Appraisals typically have a short shelf life. In a volatile market, one that’s more than six months old will be hopelessly out of date. Even a more recent appraisal may become outdated because of a sudden economic shift, natural disaster or other occurrence. So, if a property owner supplies you with a pre-sale appraisal, check the date.
The date that really matters is the effective date of the appraisal, which may not be the same date the appraiser inspected the property. In the case of an estate appraisal, for example, the effective date is generally the date of the owner’s death, which could be several months, or even years, before the inspection.
Second, check the intended use, intended user and type, and definition of value. Appraisers must identify all three as part of their scope of work. If the intended use is “for insurance purposes” and the definition of value is “replacement cost of improvements,” then that appraisal is not valid for establishing an asking price to sell the property. Some of the other types of value that appraisers may be asked to estimate, to name a few, include:
- Value in use (the value of the property based on its current use)
- Retrospective value (the value of a point in the past, such as before a divorcing couple separated)
- Value of a partial interest
- Liquidation value
None of these are the same as current market value.
Third, consider the highest and best use. You are likely familiar with this concept, which requires an appraiser to determine the one use of the property that is physically possible, legally permissible, financially (economically) feasible, and maximally productive. Here’s an example: An agent lists a small mobile home park. He assumes the highest and best use would be to subdivide it into three building lots. An agent, who is also an appraiser, brings the buyer. At the closing, the listing agent says, “So, you’ll get rid of those trailers and sell the lots, right?” [A subdivision had been approved.] The buyer says, “No, my agent and I analyzed the income and the return from the mobile home lot rentals, and it’s more profitable to simply keep it the way it is.”
Reconciling Differences of Opinion
If the lender has reason to believe the appraisal work contains errors or the opinion reflects bias, the lender could request a reconsideration of value (ROV) by the appraiser. That’s a step we could see more frequently in the future as the result of a rule issued in late July by federal regulators—Comptroller of the Currency, Federal Reserve, Federal Deposit Insurance Corp., National Credit Union Administration, and Consumer Financial Protection Bureau. The new rule outlines how lenders can incorporate ROVs into their processes and offers sample policies and procedures to identify, address, and mitigate the risk of discrimination.
But there’s also a scenario in which you could encounter two current appraisals with different valuations, even though the definition of value, intended user and intended use are the same.
Say a property is under contract for $550,000, and the appraiser’s opinion of value comes in at $500,000. If the parties won’t renegotiate the price, the contract most often falls through. Subsequently, the property goes under contract with a new buyer, again for $550,000. The lender obtains a new appraisal, and the opinion of value comes in at $560,000. The first appraisal was 9% below the contract price, while the second appraisal is roughly 2% above the contract price.
Why might that occur?
A review appraiser would look at a range of factors.
First would be comparable selection. Did each of the appraisers select and use comparable sales that have, per Fannie Mae’s requirement, “similar physical and legal characteristics when compared to the subject property” ? Were any potential comparable sales overlooked? Did the appraiser comment on sales that were not used because the appraiser had information about those sales that made them less reliable than other sales? An example might be any of these: a non-arm’s-length transaction, a transaction in which a stigma affected the property’s resale value, or a transaction in which condition issues affected the value but didn’t show up in exterior images.
Second, the review appraiser would look at how the comparable sales were adjusted. Adjustments are changes made to the value of a comparable property to account for differences between it and the subject property. Are the adjustments defensible? Let’s say an appraiser adjusts a comparable property down $4,000 because it has two-and-a-half baths but the subject property has only two. The reviewer will look to ensure the adjustment was based on the market reaction—the difference a typical buyer in the that market has paid for a home with an extra half bath, all other things being equal—rather than on the cost of adding one.
Did the appraiser inadvertently “double dip,” i.e., adjust twice for the same issue? I’ve seen an example in which an appraiser adjusted in two places for a home having only two bedrooms—once when noting the bedroom count and once when spelling out “functional flaws.”
Were the adjustments consistent, and, if not, was there an explanation for why they were not? Let’s say the appraiser adjusted for additional acreage on the property and used an adjustment of $6,000 per acre on one comparable sale but only $2,000 per acre on another. To understand the inconsistency, the review appraiser will look for an explanation in the comments, e.g., “The acreage adjustment for comparable sale 2 is different from that for comparable sale 1 because the additional acreage for sale 1 is flat and useable, but the topography of sale 2 is a steep bank both in front of and behind the house, reducing the useable space.”
Finally, the review appraiser will pay attention to how the appraiser reconciled market data. For each comparable sale used in an appraisal, the appraiser notes gross adjustments and net adjustments and calculates them as a percentage of the comparable sales price. Gross adjustments are all adjustments added together, regardless of whether they are negative or positive; net adjustments factor in whether an adjustment is negative or positive. So, if an appraiser adjusts a sale –$5,000 for an out-of-date kitchen but +$2,000 for having more usable land, the gross adjustment would be $7,000 but the net adjustment would be -$3,000. If the comparable sale price was $100,000, the gross adjustment percentage would be 7% and the net adjustment percentage would be –3%. Lower gross and net adjustments could indicate that the comparable sale is more similar to the subject property; however, they could also indicate that the sale was under adjusted.
The appraiser’s reconciled value must be somewhere in the range of the adjusted comparable sales—it can’t be lower than the lowest adjusted price, or higher than the highest adjusted price . The appraiser should explain how and why they reconciled to their final value. So, the next time you’re scratching your head about how two appraisal reports on the same property can result in different estimates of value, think about the detailed nature of appraisals and do a little digging. You’re likely to find the answer in the reports themselves.