Purchase Price Vs. Appraised Value-Why Aren’t They the Same?

This is an age old question that every appraiser, realtor and lender has come across at least once.  There are two common questions relating to this:

  1. Why does the appraised value always come in at or slightly above the contract price?
  2. Why did the appraiser lowball the value and kill the deal?

Now, most appraisers will tell you the appraised value is entirely independent of any contract price.  Technically this is true.  Market value does not always equal contract price.  There are many variables involved in the selling of real estate that may not take an accurate market value into consideration.  A few examples are atypically motivated sellers, emotionally invested buyers, misguided realtors, unreasonable homeowners…and countless others. 

An appraiser’s job is to be independent from all of that mentioned above and use their education, experience and market knowledge to determine their opinion of the market value. USPAP requires the appraiser to analyze the purchase contract (except in cases when it is unavailable), so the appraiser will be familiar with the contract price and the terms of sale, concessions, etc.  However, the appraised value will almost always be based on recently settled (not active) properties similar to the subject and in the same market area.

If this is true, why does question #1 above exist?  If the appraiser truly does not take the purchase price into consideration as an indicator of value, why does the appraised value often times come in at or slightly above the contract price?  In these instances, it is likely due to the realtors involved being knowledgeable in their market and knowing current market values.  They have listed the property at a realistic price and advised their buyers to offer a reasonable amount for the property.  The appraised value will reflect this not because it was derived from the purchase price, but rather the purchase price was derived from current market values.

On the other hand, we have question #2.  If the market value is lower than the appraised value, why is there an agreement of sale for a higher purchase price?  Well, the fact that someone is willing to pay a certain amount for a house does not mean that the house is automatically worth that price.  A buyer is a biased party who is not a licensed professional in determining property value, and likely is making their decision from an emotional standpoint and not an objective one.  While most realtors are very knowledgeable in the markets they work in and know what current values are, some aren’t and don’t have realistic ideas of what a house is worth.  If there are no recent sales to support a purchase price, an appraiser cannot support it, either.

Appraiser’s can only use the data available and if it is supporting a value different than a contract price, they must report it.  It goes both ways though; the appraised value could be significantly lower or higher than the contract price.  The latter is great for the buyers, who in that scenario are getting a great deal and will have instant equity.  The former is not good for anyone involved and should not be something anyone fights the appraiser on unless there is data to support it.  If there is data the appraiser missed, by all means, they should review and consider it.  If not, the parties involved often times will go back to the table and renegotiate the purchase price.  This could end up saving a buyer tens of thousands of dollars.  It will give their realtor a great reputation that ensures trust and protection of their client, not simply their commission.

Let’s not forget about the lender in this equation.  Without lender approval, the purchase will not commence no matter what the appraised value is.  Today’s lenders are scrutinizing every loan that comes through and determining the risk analysis.  They look closely at contract price vs. appraised value.  If they concur, the underwriter needs to see support for the final appraised value evidenced by recent similar sales.  If the two are inconsistent, they will typically want an explanation of why.

At the end of the day, an appraiser must support and explain their conclusions and opinion of value, whereas buyers, sellers and realtors do not.  There are different criteria and circumstances for agreeing on a purchase price vs. supporting an appraised value.  Sometimes the purchase price is on point and does represent market value, and other times it does not.  This is why purchase price and appraised value are not synonymous.

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