If you’ve been lucky enough to have recently purchased a home you more than likely also had an appraisal on that home. If you were exceptionally lucky, that appraisal came in at or above the price you have offered to pay. But why do appraisals frequently come in below value? I’ll outline why appraisals frequently do not match the offers they hope to validate.
First, appraisals are lagging indicators in economic terms. Lagging indicators are quite easy to measure, i.e. using previous sales data, but very difficult to improve or influence. Lagging indicators are often used to confirm a pattern in many settings except real estate. If the prices of homes in an area are increasing 2-3% a quarter an appraiser will rarely use this data to factor in an increase over previous sales. The very basis of an appraisal is flawed since it’s using the historical data.
Second, comparable properties are difficult to find in many markets. In some areas of the country, particularly out west, houses were built in huge tracts with hundreds of homes built in the same neighborhood, at the same time and with nearly identical features. This makes finding comparable properties easy for an appraiser. However in much of the country, especially rural areas, the housing stock more resembles the proverbial snowflake where no two are the same. While appraisers have a system of making adjustments on the closest comparable properties it’s rare to have the appraiser actually set foot inside of the other homes. When properties are significantly different, this creates errors which in all fairness might benefit the buyer. Too often I see if the other way. Appraisers are also hesitant to make any changes to the reports, even if glaring errors are found.
Finally, appraisals have no indication of what a home will be worth. Think about it this way, you’re getting a loan for 30 years in many cases and the bank is determining the value using data that’s 3-6 months old. There’s nothing to correct for future value even though we have decades of good data to indicate future value. As average length of ownership creeps up to nearly 10 years, longer periods of owning smooth out volatility in the market. However lenders are making decisions based upon you going into foreclosure the day after you purchase. It’s simply an unrealistic view of home ownership.
While I think appraisals have an important role in many transactions the days of requiring them for owner occupied homes where the buyer is putting down 20% should probably end. Banks have reams of data showing these are the least risky loans they make and it merely adds to the expense for the buyer and taxes a thinning pool of appraisers. It’s high time we updated the system.