If you know anyone who has bought or sold property in Portland within the last year, you have likely heard stories about needing to “waive the appraisal” to be the winning bid on a home. While this strategy has been in play for a number of years, it now seems to have become a staple of nearly every winning offer in competitive multiple-offer-situations. But, what exactly does it mean to waive the appraisal?
To understand this concept better, let’s start by looking at the normal process for an appraisal during a real estate transaction.
When a Buyer finances the purchase of a home, the Lender requires a third-party Appraiser to inspect the property, and provide an opinion of value for the home. In order for the home to qualify for financing, the appraisal has to come in at or above the agreed upon purchase price, and also be free of any conditions or required repairs (more on that later). If the appraisal comes in below the agreed upon purchase price, then the home does not qualify for financing at that price, and the Lender will only provide financing that is based on the appraised value.
For example, if you are under contract to purchase a property for $600,000 with 10% down, your Loan-to-Value ratio would be 90%, meaning the Lender is financing 90% of the purchase, or in this example, $540,000. If the appraisal came back with an opinion of value of $575,000 for the home, the Lender would then only agree to provide financing for 90% of that amount. In this case, $517,500.
In this event, neither party (Buyer or Seller) is obligated to move forward with the transaction. However, if both parties would like the transaction to move forward, the appraisal shortfall is then typically negotiated between both Buyer and Seller. Either the Seller lowers the price to the appraised value, the Buyer brings more cash to the table to cover the difference, or they split the difference in some agreed-upon fashion.
In today’s market, however, many Buyers are pre-negotiating a potential appraisal shortfall, and either guaranteeing to make up the entire difference in cash, or, offering to bring a predetermined amount of additional cash to closing — on top of whatever the appraised value is. While this is certainly an aggressive strategy (requiring additional cash reserves on hand), it is also effective, as it makes the offer far more attractive to a Seller, who now has more of an upfront guarantee on what their final selling price will be.
One of the obvious concerns with this strategy as a Buyer, is that you will overpay for a home, and give up some of the immediate equity that you might expect to have in the property upon purchasing it. While this is certainly a valid concern, in the Portland Market it has become a question, in many cases, of whether you would rather leverage some of your immediate equity, or perhaps not get into a new home at all. As a prospective Buyer, it’s important to make your offer as attractive as possible, when the Seller is selecting from a pool of 10-15 offers, so in most cases at least one of those offers will include this type of term. If you are not willing or able to, I totally get it. But, it may make for an uphill battle in terms of purchasing a home in the current market.
It’s also important to understand that with prices trending upwards as quickly as they are, the data available for appraisers to use in their valuations is not necessarily completely up-to-date. With the typical escrow period being around 30-days, the most recent data for sold homes that appraisers are able to use, is typically already close to a month old by the time your transaction closes. So, there is some lag time between the value that can be statistically supported by an appraisal, in comparison to what the market will actually bear. As prices continue to rise in Portland, the most relevant data is what is happening in real time, rather than what happened 3-6 months ago, or even last month. So appraisals aren’t always able to keep up with the market.
Enter: Appraisal gap coverage with cash.
As a potential Buyer in this market, I feel it is important to understand this concept upfront, because it changes the amount of cash that may be needed to successfully purchase a property. While the vast majority of transactions I have closed with appraisal gap guarantees ended up actually appraising at the agreed-upon purchase price (meaning no additional cash was required from the Buyer), it is important for Buyers to understand that the risk is always there. So, they should feel comfortable with bringing the additional cash to closing, in the event the appraisal does come in low.
So, how do you know how much cash over the appraisal to offer, or whether it makes sense to include this in an offer at all? Well, I can’t give away all the secrets, but whenever my clients are planning to submit an offer, the first thing I do is research the recently closed comparable homes in the neighborhood to get a sense for the value I feel an appraisal would come in at. From there, we strategize on the offer amount, appraisal gap coverage amount to offer and overall terms. This is also where we ensure that the verbiage used to address how an appraisal shortfall will be handled is specific, and doesn’t leave the Buyer on the hook for any of those potential conditions or repairs that may be required by the Appraiser.
If you’re thinking of buying a home, or have questions about covering a shortfall on an appraisal, please feel free to call or email me anytime! I love discussing Real Estate, and look forward to catching up with you all soon.
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