Lady biting a pencil in frustration.

Have you jumped on the refinance bandwagon? If not, you may want to consider it. As of the end of October 2020, interest rates on a 30-year refinance mortgage were averaging around 3.2%. These are the lowest rates in the last 40 years! If you decide to take advantage of these all-time low rates, your lender will most likely order an appraisal. What happens if the new appraisal is less than original one? Before you assume the appraiser made a mistake, let’s look at three reasons why a new appraisal could come in low.

The Case File

Front of a navy painted house with lights on.

Three years ago, James Brown purchased a nice three-bedroom home in a quiet town with good schools. The home had been recently renovated and was in great condition. He paid $475,000. The appraisal at that time matched the purchase price.

James wants to do a cash-out refinance and get $15,000 to pay off some other debts. To make that happen, the lender says the appraisal needs to be at least $494,000. James expects it to come in close to $505,000. When the appraisal comes back, however, it was for only $489,000.

James is devastated. The lender suggests that he takes out only $10,000 instead of the $15,000. The appraiser looks like the bad guy. But what could be the cause of the lower than anticipated value?

Reason #1: The Range of Value

The primary reason appraisals differ is because, in reality, real estate appraisals are designed to provide a range of value rather than one set price. A real estate appraisal measures the actions of typical buyers and sellers in the marketplace and rarely do two buyers offer the same exact amount.

Let’s say that Mr. Brown decides to list his home. He lists it for $530,000 and expects to get an offer at $505,000. Within one week, he receives 100 purchase offers. Of those 100 offers, we could expect that approximately 30% would be ridiculously low and 10% would be really high with a slew of ridiculous contingencies. The remaining 60% would be considered reasonable offers. There would be some low cash offers and some high offers with contingencies such as seller paid closing costs or closing delays (i.e. buyer needing to sell their house first); but generally speaking, all the offers should be within 10% of each other. All the reasonable purchase offers created a range of value.

Using our example of Mr. Brown’s house, 60% of the offers would be between $480,000 and $530,000. While every seller would love to get the highest price, nearly all of the high-priced offers will have some sort of contingency that would make the offer less appealing. It is very possible that Mr. Brown may accept an offer of say, $490,000 if the buyer is paying cash and can close within two weeks. That accepted purchase price becomes the “market value” of the property.

An appraisal measures that value range within the report. Hence, Mr. Brown’s most recent appraisal of $489,000 is within that appraisal range of $480,000 to $530,000. It is possible that the appraiser may be willing to adjust the value up to the desired $494,000, since it is also within the range.

Now, here is a word of caution: federal lending requirements and appraisal standards do not allow lenders (or property owners) to “pressure” the appraiser into “hitting” a target number. The lender hired the appraiser as an independent third-party to provide a non-bias estimate of value. The appraiser will decide if the market data can support a change of value, but they cannot be pressured to do so.

Reason #2: Lack of Market Data

Another reason for a difference in appraised value can be caused by a lack of supportable evidence. All appraisers rely heavily on recent sales of properties that are similar to the property being appraised. Most lenders will require that all of the sales used in the appraisal have to be sold within 6 months and be within a limited distance. This can severely limit the data available to the appraiser.

Let’s say that Mr. Brown decided to refinance in the spring after what was a record-breaking terrible winter. When you combined below zero temperatures, tons of snow and COVID-19 it isn’t much of a surprise that there were hardly any sales all winter. The appraiser has to use what few sales are available if he wants the bank to accept the appraisal. This lack of data can, unfortunately, slightly skew the true market value. The appraiser has to balance the requirements and stipulations set by the mortgage market with his ethical requirement to determine a fair market value for the property. In these cases, it is common for the new appraised value to differ slightly from a prior value.

Reason #3: Economic Impact

A third, and less common, reason an appraisal comes in low is due to a change in the economic climate within the market area of the subject property. We have all seen how the national economy affects property values. A change in the local economy can also raise or lower local property values.

For example, let’s say a major employer in the area of Mr. Brown’s home shut down. There was a loss of over 2,500 jobs. Because of the uncertainty of future employment, fewer people are looking to buy homes in the area. In order to encourage buyers, sellers slowly reduce the list price of their homes. This creates lower sale prices than were seen only one year ago. An appraisal must reflect this loss in value – even if it is only temporary.

A homeowner always hope that his property is appreciating in value. A lower appraised value can seem devastating, but before you freak out and assume the worst, consider the possible causes. Look at the range of value contained in the appraisal report. What was the value of the cost approach (usually establishing the high range) and what were the adjusted values of each of the comparable properties (creating the low and mid-ranges)? If your first appraisal is inside that number, then as long as the appraisal can be used by your lender for the refinance, do not fret, the value is still there.

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Uniform Residential Appraisal Report Form

Receiving a copy of a residential real estate appraisal report can be a little intimidating. It may seem like a lot of money for such a such a short report. But that is hardly the case. That appraisal report you are holding tells you so much more than a simple property value.

We’re going to examine, in detail, the standard form appraisal report that is most commonly used for residential appraisals. It is called the Uniform Residential Appraisal Report (URAR). This appraisal report can be used for a variety of real estate-related transactions such as a obtaining a mortgage, verifying a purchase price, estate planning, or settling a divorce. While there are other appraisal reporting methods, the URAR is the appraisal you will most likely receive when valuing any single-family residential property.

The Three Valuation Sections of an Appraisal Report

There are three valuation sections of an appraisal report – the cost, sales comparison and income approaches to value. These are contained within the appraisal form, but depending on the property, not every approach to value may be utilized by the appraiser. Let’s look at each of these three real estate valuation sections to see what your appraisal report is really telling you.

The Sales Comparison Approach

The sales comparison approach is designed to compare your property, the subject, with three or more similar properties that have recently sold. The grid below allows an appraiser to compare important features such as the land (called the site), the design or style of the home, the age, condition, rooms and size (called the Gross Living Area). There is also space for the basement, heating and cooling systems, garage, decks and a few lines for non-standard features.

Sales Comparison Approach table

To the right of each comparable you will find monetary adjustments that add or subtract value from the comparable’s sales price. In the above example, your home has 2,862 square feet but comparable #2 only has 2,310 square feet. The appraiser must add the value of the 552 square feet to make the comparable similar to your property. In other words, if the comparable was the same size as your property, what would the buyer have paid for it? That is the concept behind the sales comparison approach.

There is a section after the comparison grid whereby the appraiser will explain his or her reasons for making the adjustments. Then they will take the adjusted sales prices of the comparables and use it to set the value of your property. Sometimes it will be a simple rounded average and other times, one of the comparables are more similar to your property, so the appraiser may place more weight on that value.

In the example show above, it looks like comparable #3 was more similar. Notice that the “Gross Adjustments” were only 4.3% but they were 21.4% for comparable #1. So, let’s say the appraiser decides that comparable #3 is a better indicator of value and places more weight on that value, the appraiser may conclude that the market value of your property is $242,500.

The Cost Approach

The cost approach looks at what it would cost to buy an identical parcel of land and construct an identical home – just like it is right now. The principle behind this approach is that a buyer would not purchase your home if he or she could build an identical home for less.

Cost Approach to Value info

This approach works well for newly constructed homes, but does not help much if the property is old, antiquated, or suffering from extensive deferred maintenance. This approach may or may not be included in your appraisal report.

In this example, the appraiser determined that the indicated value by the cost approach was $259,050. It is common to have the cost approach be slightly higher than the sales comparison approach, that is unless your home has been built within the last 5 years.

The Income Approach

The income approach is used only if the property is being rented or would be most likely rented by a new buyer. This approach is rarely used with single-family residences. Even if your property is currently being rented, if it is surrounded by owned homes then the appraiser will most likely not consider this approach a good indicator of value. It is common that the income approach value is substantially less than what is indicated in the sales comparison approach.

Income Approach to Value Data

The Real Estate Appraisal Range of Value

Right below the sales comparison approach, you will find the reconciliation section. This is where the appraiser will determine the property’s value and explain their reasons for their conclusions.

Real Estate Appraisal Range of Value reconciliation section

It is most likely that the appraiser will decide that the sales comparison approach is the strongest indicator of the property value. In the bold section at the bottom, the market/appraised value of the property was determined to be $242,500. But, in reality, the appraiser is supplying you with a range of value.

Where is the Appraisal Range of Value?

Even though the appraisal report must conclude with one value number, it is more accurate to say that the appraisal as created a range of value. Notice what the appraisal report has revealed.

Appraisal Range of Value Report

How Can I Use the Appraisal Range of Value?

The appraisal contains at least six different values. The combination of these values creates a range of value. Knowing this range can help you to make more informed decisions. For example, if you will be selling your house, the appraisal just told you that the list price should be close to $254,500 and the lowest accepted price should be $240,300. Anywhere in between and you have received the market value for your property. If the appraisal is being used to get a mortgage, the bank is going to use the appraised value ($242,500). If that number is too low for you to finance as much as you would like, the range of value shows you the appraiser’s “wiggle-room.”

In a perfect world the appraised value should come in the middle of the range with there being no more than a 5% difference plus or minus within the range. In this example, the appraised value is less than 1 percent from the low range of value. This could indicate that the appraiser may be justified in raising the value closer to the $244,000 mark. Though remember that comparable #3 was the best indicator of your property value, so the appraiser may decide the value must remain where it is.

The next time you receive a residential real estate appraisal, look beyond the appraised value and see what the appraisal report is really telling you.

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