What Happens When Contracts Rocket Past List Prices
by Mike Armentrout
In light of the historic low inventory levels, the existing demand appears to be exploding. This does not mean that the current demand is unprecedented in terms of volume. We simply have some markets with a very low supply of available listings and a disproportionate number of buyers.
This is not only resulting in multiple offer scenarios but is also ramping up the offering prices as buyers are leveraging whatever they can to beat out the competition. In fact, it has become a wild West environment as agents are attempting new strategies to win the bidding wars.
So with all this frenzy, one might ask when will it change? The simple answer is, when supply comes more into balance with demand. Until then however, appraisers are going to have to work through some minefields. With agents desperately seeking new listings, they are feeling the heat to close as many buyers as possible. The last thing they want to deal with is appraisals coming back less than the contract price they worked so hard to negotiate.
So what things should we appraisers be doing in such situations? Well, nothing too much different than we do for every other assignment. Here are some key points to keep everything in perspective.
Select the Best Comps Available
Our task as appraisers does not change because a contract is higher than a list price nor does it mean that the list price equals value. We must still analyze the market and select comparables that best represent the subject. This also means not selecting a sale merely to support a contract price. To illustrate; if an agent uses specific sales to price a new listing and then provides a new set of sales to support a higher contract, one would be justified to question the validity of the second set of sales. The subject property was not altered to warrant the use of different sales. This is poor methodology not to mention a violation of Uniform Standards of Professional Appraisal Practice (USPAP).
Know the Market Trends
One place to begin is to know what's happening with list price to sale price ratios. Look for the highs and lows as well as the statistical mode. If data indicates a mode of 102% and a high of 105%, then a sale that results in a LP/SP ratio of 110% may be an outlier. Obviously, appraisers cannot apply this as an adjustment to the sales grid like we often do for listings but it can be a valuable metric to comment on. Some might argue that the initial list price may have been low but even low list prices do not typically get bid up when supply and demand are in balance.
Properly Consider Amenities and Condition Ratings
Let's be honest, the most intense bidding will be most common with the nicest properties. Buyers will fight harder for that gem that has been recently remodeled or the home that backs to the wooded reserve. Remember that home owners and sellers are constantly improving their properties to compete with the highest price tier of their market. Super adequacy (over improvement) can be a valid issue in some cases but is not the norm. Being the nicest home in the neighborhood may bring a higher price but it will be difficult to move into an unprecedented price range without a trend of similar competing sales. This makes deriving appropriate adjustments imperative for any features that may be driving the offers into uncharted waters.
Are Time Adjustments Warranted
We have all selected a group of sales we deem comparable only to have some that are older than six months. While we know that more recent sales reflect current trends better, there are simply times that the older sales are more comparable and superior representations of the subject. In such cases, we should carefully determine if any kind of time adjustments are appropriate. Many lenders may scrutinize time adjustments more than routine adjustments but they may be justified none the less. If prices are moving upward quickly, this may be the best way to indicate price trends when dated sales are cited.
Analyze That Contract
Reviewing the terms and conditions of a purchase contract is vital. That's why it is required by USPAP Standards Rule 1-5 as well as the secondary market. It is the appraiser's responsibility to determine if items such as escalation clauses and concessions are reasonable or constitute an atypical incentive. In an out-of-balance market, buyers are not just negotiating with sellers. They are also often competing with other buyers which may result in creative terms that entice sellers to accept their offer over another. This may or may not warrant the use of concession adjustments.
There's an old adage that says "a property is worth what someone is willing to pay". This would carry weight if the market was comprised of predominantly cash buyers. Since we know however that most markets are actually driven by financing, then those markets will naturally become subject to the risk tolerances of the lenders. If a bank or investor has specific guidelines and limitations for lending decisions, this will impact the market.
In the lender's quest to mitigate risk, they order appraisals to ascertain what a typical buyer would pay for the particular property being used as collateral. Defining a typical buyer can be murky, but a basic premise is that they do not want to pay more than necessary. That is not to say that emotion can't be a factor. It's also true that a monthly payment over a 15 or 30 year term may not be as real as a cash withdrawal which may impact what a buyer will offer.
When an appraisal is completed and the reconciled value conclusion is less than a contract price, it may be a source of frustration for the parties involved. That is why it's important to understand that the difference between an appraisal's estimate of value and a contract price might simply be a premium that buyers are paying to obtain a home with such low supply. Bringing cash to a closing or renegotiation of contracts are sometimes necessary in healthy vibrant markets because it produces more knowledgeable buyers and sellers.
Appraisers do not have a goal to "kill" deals, particularly when it usually means headaches and additional work, but they also do not exist to make deals work. Our purpose remains to provide unbiased data and conclusions for our users.