Is appraisal accuracy measured by contract price?
A new Guest Post from John Fariss, MNAA, a member of the Community of Asset Analysts.
In recent discussions surrounding the accuracy of home appraisals, a critical flaw has emerged in the prevailing narrative: the assumption that the contract price is the correct value of a property. This misconception is not only misleading but also fundamentally flawed when examined against the definition of market value as outlined by the Federal National Mortgage Association (FNMA). Again, I ask, does contract price equal market value? Further, should contract price be the metric by which appraisal values are measured?
Two recent articles highlight the ongoing debate about appraisal accuracy. The first from HousingWire, “Half of homes sold appraised for more than the sale price,” reports that the gap between home appraisals and sale prices is rising based on a study by Corporate Settlement Solutions (CSS). The implication in the article is that a property is undervalued or overvalued if not within $2500 of the contract price. The article implies that there is difficulty in “providing accurate valuations” as evidence by the gap in appraisals and actual sale prices.
The second article from AppraisersBlogs, “Accurate Appraisal Underreporting,” debunks the notion that appraisals are frequently inaccurate if they deviate from the contract price by more than $2,500, and argues that based on median house values of $420,000 in the US, this would amount to a difference of less than 0.01% which is insignificant. Such a “definition of “accuracy” is both misleading and dangerous.” The article accurately indicates that there is always a degree of subjectivity and variability involved in appraisals.
Both articles underscore a that gaps between appraised values and sale prices exist, but they fail to address the core issue: the contract price is not synonymous with market value.
And one more assumed assumption: Is market value the price to the buyer, or the price to the seller? The difference is transaction costs. Should transactions costs automatically be added to “value” each and every time a property resells?
According to FNMA, market value is defined as the most probable price a property should bring in a competitive and open market under all conditions requisite to a fair sale, with the buyer and seller each acting prudently, knowledgeably, and assuming the price is not affected by undue stimulus. This definition emphasizes that market value is determined by typical buyers and sellers who are well-informed and free from any undue influence.
The contract price, however, is often influenced by various factors that do not align with the definition of market value. Real estate agents, lenders, Government-Sponsored Enterprises (GSEs), and even politicians have vested interests in ensuring that the contract price is met. Agents earn commissions based on the sale price, lenders charge fees and interest, GSEs profit from long-term interest, and politicians gain favorable headlines. These stakeholders benefit from perpetuating the narrative that the contract price is the correct value, despite it often being influenced by market pressures, buyer competition, and other non-market factors as outlined above.
Appraisers, on the other hand, are the only unbiased and disinterested parties in the transaction. Their primary role is to protect the public interest by providing an impartial opinion of value based on rigorous analysis and market data. Unlike other parties involved, appraisers do not have a financial stake in the transaction’s outcome, making their assessments more reliable and aligned with the true market value, not based on the contract price of a particular buyer and particular seller. A number of years ago I co-appraised a custom home that was in contract for $2,200,000. After much work with my fellow appraiser and input from a 3rd appraiser, we concluded that market value was $1,900,000. The buyer and seller disagreed with that value, and the buyer came up with additional funds, closing the deal for $2.2M. One year later the new owner had to sell. Guess what that sale price was? You got it, $1.9M.
It’s important to note that real estate agents frequently adjust asking prices during the listing time of a house. This practice further underscores the point that contract price is not market value. There’s no such thing as a single point value when it comes to market value. Instead, market value is better interpreted as a range of prices. I recently appraised a house that had 6 verified offers on it ranging from $475,000 to $486, 000. Which of these contract prices is the accurate one? One is no more accurate than the other.
But for the CSS, that $9,000 range in offers is well beyond the $2,500 benchmark for accuracy. Realistically, a $2,500 benchmark is a fraction of a percent of the median house price in the U.S. Historically, if two appraisers reconciled to a value within 5% of each other, it was considered very good. The very tight range of less than 1% proposed by CSS is unrealistic and does not reflect actual market activity.
The narrative that the contract price is the correct value is not only flawed but also dangerous. It’s being pushed by market participants who want to eliminate the role of appraisers, and it’s being pushed by politicians looking to make headlines. It undermines the role of appraisers and perpetuates a misunderstanding of market value. By recognizing the vested interests of various stakeholders and reaffirming the importance of unbiased appraisals, we can better protect the integrity of the real estate market and ensure that property values reflect true market conditions.
How do we do that? By continuing to educate market participants, counsel buyers and sellers, get involved with appraisal groups, participate in speaking engagements, and produce better reports. Keep educating yourself. Learn better techniques, like Evidence Based Valuation© and make yourself indispensable in your local market.
August 21, 2024 @ 2:25 am
Appraisers are dammed if they do and dammed if they don’t do their job.
I read your article hoping you could give us appraisers a real solution to this major problem if us not being able to perform our jobs do to this obscene economic world wide upending market.
You never answered your own solution to your articles titled question. If we appraisers can not use sales prices of current sales we are in a real pickle since that is the basis of our most applied procedure, Comparative Market Analysis Approach. If you have some other magical method, what is it. EBV is not a answer to what buyers are willing to pay in this bizarre never before market of today. Why not take away a carpenters hammer tool. The answer is there is no answer. Lets be honest or at the very least practical. What we appraisers have to say no longer matters to the big players as you mentioned in this appraisal business. How do we argue with these big players when our most valuable tool is flawed by out if whack national word-wide economic factors or as you think our hammers ate flawed. We appraisers keep waiting for the market to return to normal so we can do are jobs with assured accuracy as we gave done for many years but the question is not just what is a normal market. To us a normal market made sense, today it does not. Buyers think rates are high but we ild timers know that anything rate below 10% which kept prices manageable based if buyers income is now causing these inflated values. Buyers do not act in their best interest as our definition of market value carries with it practicality of determining market values and a big part of the helping to fuel the typically unknowing buyers are being misled by politicians who are after votes promising to reduce interest rates down to the 2% range again. If you have a true answer to this debacle, then I will be willing to listen.
The truth is at this time us appraises don’t truly know where our opinion stands. Another if my big question has been, what do QC underwriters at FNMA feel or lending institutions about this?
I tried from the beginning if this inflated sales market frenzy to speak with them but they are not available to me and will not return my calls. This is where the buck should stop. But, in the end our profession will probably get the blame for these inflated values like we all did in 1990 and 2008. We are not magicians or fortune tellers. We are hard working proud honest appraisers who need answers and seems no one has an answer.
August 21, 2024 @ 4:41 am
Agreed! Market value is better represented as a range of values, rather than a single point value.
August 21, 2024 @ 9:53 am
How are non-certified manufactured home structures comps obtained to properly value a property overall?
August 22, 2024 @ 7:20 am
Excellent article by John Fariss who is a frequent contributor and fellow Community Asset member. Seriously, there is so much narrative about how appraisals vary from contract price……. Pause for a moment and think about it. Who is varied from what? While there may be some rotten examples that get all the attention, by and large, appraisers are professionals’ and it is their job to study markets and transactions in great detail. This borderline ridiculous narrative, that contract price should be some kind of baseline, is insanity at it’s best.
Sure, there are stats indicating many appraisals come in at purchase price but that is not a direct indication of target shooting. The way the lending industry, which controls a significant portion of the appraisal industry, operates is to require an an exact point value, and if its is a penny under they typically throw it back onto the appraisal that came in low. Appraisers will have a variety of responses to that many will decide the sale price is definitely in the range and agree with it so as not t upset the cart if they are marginally below. If they come in above, well there is rarely any pressure to push down to meet contract, so we will so those kinds of statistics.
That is a response the lending industry pretty much mandates by their own motivations.
All of that aside, let’s re-ask the question. We are often reminded that purchases are emotional decisions, and we are told buyers don’t measure homes, don’t develop linear regression trends to analyze prices, don’t adjust for Gross Living Area versus basements, don’t perform depreciated cost analysis, don’t gather years of data, etc… why is it then that anyone could possibly turn around and say that sale price should be the more reliable baseline and that when appraisal don’t come in at sale price, it is the appraisal that was wrong?
August 23, 2024 @ 2:44 pm
Lawrence, I appreciate your concerns about the challenges in valuing properties accurately. However, the core issue addressed in this post is the industry’s tendency to equate contract price with market value, and to measure the accuracy of appraisals by it. This “group think” undermines the role of appraisers, who are tasked with providing an impartial assessment based on market data which I think leads to many of the issues you brought up. While valuation complexities exist, it’s vital to understand that contract prices are influenced by various factors and do not always represent true market value, and it’s this point that the rest of the industry participants seem to overlook. I’ll say it again, the contract price is not synonymous with market value.
Unfortunately, there’s no magic solution, but collective advocacy, adaptation, and collaboration are essential. Let’s keep seeking answers together.
August 23, 2024 @ 2:51 pm
Manufactured homes are typically valued using comparable sales of similar properties within the same market area. Depending on what you mean by non-certified, the sources of comparable properties can vary. Appraisers may face challenges in finding adequate comps due to the type of certification, foundation, etc. Because market conditions and regulations can vary significantly by location, it’s crucial to contact a local appraiser who understands the nuances of the area and can provide the most accurate and relevant valuation for your specific property.
August 24, 2024 @ 11:13 am
Thank you for your thoughtful and well-presented article. It’s rather interesting that appraisers are “graded” by relocation companies based on the conclusion of Anticipated Sales Price versus the actual sales price. Appraisers are downgraded if there is a variance, and no relocation companies (like most of our other clients) will not entertain that there could be an indicated value “range”. Another thought – I don’t know how many clients I’ve had to cite the definition of market value to…so they would understand that the “highest price” is not necessarily the “most probable price” – It’s handy to have the definition readily available, especially during times of escalating prices.
August 25, 2024 @ 5:43 am
He did answer his own question. The powers that be do measure it this exact way and it shouldn’t be.