How and Why CASH Infusion Fuels a Housing Recovery

housing recovery Removing the Must Appraise Clause.

BEFORE you as a buyer of a home agree to “remove the must appraise clause” you need to know that means more cash from you the buyer of an undetermined amount. You also need to know the Finance Contingency does not usually cover not having enough Cash to Close.

Cash bridges the gap between Appraised Value and Sold Price in a Housing Recovery. 2012 not so much. Early 2013 we are seeing “remove must appraise clause” as a condition of acceptance in multiple offers more so than last year. I did see a few last year. Mostly flip houses with a huge change in price from “bought at foreclosure” to 3 months later “sold as flipped house” at almost twice the price as the flipper just paid for it.

This year removing the “must appraise clause” in most all upwardly mobile neighborhoods has become a given.

Sellers are not necessarily choosing highest offer in multiple offers, unless that highest offer also is all cash with no must appraise clause OR the buyer is willing to fund the appreciation with cash.

Because this is so very common right now, and will continue to be so through at least this season into August, people need to know what that means.

LENDERS are not supposed to Fund a Housing Recovery.
THAT is WHY we had a Real Estate “Bubble”.

Lenders bridging the gap between Appraised Value based on “comps” and what a buyer is willing to pay for a house, is a lot of stale air…a bubble. Appreciation fueled by cash from the home buyer is a more stable and historically common form of funding home price appreciation.

Agents get mad when a house doesn’t appraise. That’s just crazy thinking. Let’s take a look at an example as to why that is. Let’s assume the homes are equal in all ways in the example below.

Asking Price – $500,000.00

Last home sold in neighborhood – $485,000
House before that sold – $470,000
House before that sold – $460,000

$500,000 Asking Price house goes into multiple offers and sells at $515,000.

Buyer is putting 20% down. 20% down of WHAT? Buyer thinks he is putting down 20% down of the Purchase Price. BUT the lender says they will fund 80% of Appraised Value or Purchase Price…whichever is LESS.

Very important to understand that your 20% down plus The Lender’s 80% does not equal 100% of the Purchase Price when the market is rising.

If the house appraises at $475,000 in the example above, and the Purchase Price is $515,000, then the lender will loan 80% of $475,000 or $380,000. The buyer’s 20% of the purchase price is $103,000.

$380,000 80% of Appraised Value + $103,000 20% of Purchase Price equals $483,000 and not $515,000. The GAP is $32,000. That means the buyer has to bring $135,000 downpayment to the table vs $103,000. He needs to bring 20% of the purchase price PLUS the difference between 80% of appraised value and his 20% of Purchase Price.

That $$$ difference between what the buyer intended to pay as “20% down of $515,000” and the 80% of Appraised Value that the Lender is willing to lend IS “The Housing Recovery”

That “Housing Recovery” needs to be fueled with an additional cash infusion by the buyer of the home, NOT additional loaned funds as part of the mortgage.

People are asking if this is another “Housing Bubble”. All Market Appreciation does not create a “bubble”. Appreciation fueled by lenders is a bubble. Appreciation fueled with hard cash dollars from the buyer is market appreciation. BOTH can be lost when the market goes down.

No one can tell you what prices will be in 5 years or 10 years or 15 years when it is time for you to move on and sell your house. The only issue is IF the market at the time you sell creates a negative result between what you paid and what you sell for, is that lost money your money or the bank’s money?

In the future, based on cash fueling the recovery vs lenders fueling the recovery, the negative result will not create short sales and foreclosures to the same degree that it did after “The Bubble Years”.

Appraisers can take the comps and deduct from the result if they want to cover the lenders better. They can STICK WITH the actual comps. They can be instructed to add x% for a rising market. In the Bubble Years they added x% for a rising market PER HOUSE vs PER YEAR! That is where they went terribly wrong. Instead of adding 5% for a year…they added 5% to every house! Consequently 6 sales in 4 months created appreciation of 6 times 5% or 30% increase in 4 months. THAT was “The Bubble”.

Yes buyers are ticked off when they have to pay more than Appraised Value with cash infusion. BUT historically that is the ONLY way for a market to appreciate…without creating a new Housing Bubble.

Lenders should not fund appreciation of the Housing Market. Lenders should not stretch to “The Sky’s the Limit” appraisals and loans. Hopefully that is a lesson learned in The Bubble Years that will not repeat itself moving forward.

BEFORE in the heat of multiple offers you say YES! to removing the must appraise clause or Bridging the GAP between 80% of Appraised Value and your 20% down, KNOW what that means. It means you need more money…or be willing to lose your Earnest Money if you don’t have enough to bridge that gap.

How much more money do you need? No one knows…until the appraisal comes in. You DON’T know that number on the day you decide to win in multiple offers, by pulling that “must appraise” clause.


41 thoughts on “How and Why CASH Infusion Fuels a Housing Recovery

  1. If the market is appreciating and you sit down and talk to an experienced appraiser, they will tell you it is appreciating and they will also tell you by how much. The appraiser’s hands are often tied, however, to reporting on past values. Yes an appraisal is to represent the value of the property right now but lenders are not allowing appraiser’s to adjust for market appreciation without comps to back it up. They want to see three highly comparable sales that have just sold at the new value level. In a typical market, which is in a rapid recovery, this just is not practical. This means that the lender wants the appraisal to represent the market value of a property based on the mean sale date of the comps rather than the currently market derived purchase price.

    • As noted in my post Simon, this IS in fact PRACTICAL.

      What appraisers were doing in 2004 through 2007 and appraising everything no matter what is what is NOT “practical”.

      Lenders CAN NOT fund a Housing Recovery…without Crisis Mode Consequence.

      That is ONE thing we should have learned from the Housing Bubble and Credit Crisis followup of bad policies in the appraisal and lending industry.

      • If a market is in a constant state of flux (either appreciating or depreciating), comparable sales that are only 3 months old can reflect values that no longer exist. To say that an appraiser will have three comparable properties that exactly reflect the value then and there (aka within 30 days) is unrealistic in most markets. You need to have large and very active neighborhoods full of very similar type properties.

        An appraiser is going to focus on finding the most similar properties and then adjusting for time. Time is the easiest adjustment to prove through like sales.

        I do agree with you that lenders should not fund a housing recovery. This is the first article that I have read that really addresses why a buyer needs to come up with the cash that bridges the difference between the appraisal value and the purchase price. I just wish appraisers were able to give lenders a range of value which would better reflect true market conditions.

        • Simon,

          I have been polling lenders to see if any appraisers are adding for current market conditions. That instruction may follow and likely should at some point. But so far no. If you or anyone else sees an appraiser adding for future appreciation, let me know.

          They did increase from subtracting for decline to not subtracting. 🙂 But that only brings them up to current comps level.

          What they have to fix before they go to adding for appreciation is too many different appraisers adding a full year of appreciation for each and every property. That is how the bubble took flight. If each appraiser allows even 3% for appreciation for every sale in the neighborhood and there are six sales in Spring Summer…6 times 3 is 18% apopreciation. Then can quickly annualize to 36% for a year. I saw that happen in 2005.

          There is not enough checks and balances from one appraiser to another and one lender to another. I don’t see anyone even proposing that change though. 🙁 So for now…sticking to the comps will add some solid ground to a market that needs some stability before it “takes off” on lender funds.

          • I guess I am confused on how a 3% annual rate of appreciation can create an 18% appreciation. I worked for many years in appraisal and it just doesn’t work that way.

            For example, if you have 3 comps that all sold last year and market research indicates that, if sold today, all of the three comps would have sold for 3% more; then the total rate of appreciation is 3%. Appraisers will adjust each comp up 3% and then take the weighted mean of all three adjusted comparables to create the market value for the appraised property. This creates a total rate of appreciation of only 3% not 9%.

            The problem I personally saw with some appraisers is that they did not understand that appreciation occurs during the high selling season. They simply made blanket adjustments, even if the sale occurred in the 4th quarter. This would overvalue the comparable.

            The only compounding appreciation I saw was when appraisers needed to use comps that were two or three years old. (In some small communities this was unavoidable.) For a 3 year old sale they would put in a flat appreciation rate of 9% rather than calculating the exact rate of appreciation for every year.

            I believe the solution lies in educational requirements rather than blanket “standards”. Each market is different. Each property is different. The appraiser must be given the freedom to honestly appraise the property using market derived rates. The emphasis should be on competency and experience. There are just too many uneducated and inexperienced appraisers out there.

  2. Cash Needed = 20% down of purchase price + (Purchase price – Appraised price)

    in above formula, 20% could be 5% or 10% or what-ever the lender agrees to approve the mortgage with.

    • True XYZ. I used 20% as that is where the PMI kicks in if the buyer agrees without cash infusion. Excellent point!

      The buyer can agree to their 20% down being less than 20% down and paying the Private Mortgage Insurance Premium on the difference.

      Not all Finance Contingencies around the Country have a “must appraise” clause, and for those people and people who remove the must appraise clause, their 20% down could simply become 18% down or less…with PMI.

  3. This is a tough one to explain, as the buyer usually puts the down payment they are willing to pay as a % vs a dollar amount. In XYZ’s excellent point an agent would put $103,000 as the down payment blank vs “20%” as the down payment in the financing contingency, with no guarantee to the buyer that $103,000 will be a no PMI – 20% down contribution.

    So in reality pulling the must appraise clause would also require the buyer to put a dollar amount vs a % in the Finance Contingency as the amount down required. In fact when I started in real estate, this is how all offers were written. The seller did not guarantee that the amount the buyer was putting down would be “20% down” in the finance contingency.

  4. Another note to the above. IF the buyer does this then the lender needs to confirm in the pre-approval letter that the buyer qualifies with PMI and less than 20% down before a seller accepts that offer. I have not had a client agree to this scenario yet, though many in the marketplace have. Will be interesting to see how they modify the contract on counter to effect this “buyer needs to agree to pay cash difference” and how that relates to the buyer’s rights under the Finance Contingency.

    Interesting times!

  5. Adding info here as people ask questions “off blog” vs in comments here.

    Yes a lender can fund the appreciation, BUT they will be insured for the difference between 80% LTV and the down payment. These are historical lending principles.

    If the lender lends 82% vs 80% the 2% is insured to the lender by a Private Mortgage Insurance Company. If the house goes to foreclosure and sells for 80% of the purchase price, the additional 2% is not “eaten” by the bank-lender as it is now after The Bubble Years. That 2% is paid by the Insurance Company and that insurance for the lender is purchased by the buyer of the home.

    During The Bubble Years it was not the huge amount of appreciation that caused the Credit Crisis that caused the market to spiral downward. It was the Bank and Lender’s decision to be self insured all the way up to 100% of the Purchase Price vs sticking to only 80% uninsured and over 80% requiring Private Mortgage Insurance.

    For a Conventional Loan this is called PMI or Private Mortgage Insurance. For an FHA loan this is called MIP or Mortgage Insurance Premium.

    FHA kicking in a New Rule that MIP continues for the life of the loan is a bit crazy. I don’t expect that to stand. Makes no sense for insurance to continue when the LTV is 30%, which is what will happen if the MIP continues for the life of the loan.

  6. Adding discussion from facebook:

    Lesley Blankenship-Williams: Interesting – is it telling that people are actually buying homes they can afford then, if they can pony up the difference in cash?
    25 minutes ago · Like

    Ardell DellaLoggia: What it is saying is that we are back to the same long term lending standards as we were prior to the crazy Bubble Years. There are new comments on the post that explain this. The buyer technically does not have to pay the difference in cash. They can get 82% from the lender vs 80% and pay Private Mortgage Insurance Premium on the 2% difference.

    Traditionally lenders only lend 80% without requiring MI. We are back to those days.

    The $103,000 in the example can stand with no additional down payment from the buyer. The seller is simply not guaranteeing, nor did they historically guarantee, that $103,000 will be 20%. That is between them and their lender and the lender’s appraisal.

    The seller should not be guaranteeing that the house will appraise to the point that the $103,000 will in fact be 20% down. The buyer would simply have to live with the net result being that $103,000 is only 18% down.

  7. Have you seen any situations where the buyers have removed appraisal contingency only to find out that house does not appraise at purchase price and the buyers try to back out using inspection contingency?

    • I have not Lesley, mostly because the early phase of appreciation is funded by full cash buyers. They don’t have an Appraisal Contingency. They can add a “must appraise” addendum the same way that you add a Home Inspection or Title Contingency, among the many addenda that can be added to an offer. But most cash buyers did not.

      That’s where the saying “Cash is King” comes from.

      But if you read everything buyers say in Redfin forums and Seattle Bubble and all consumer comment oriented sites, you see that the ground swell is buyers using financing are sick of losing out to cash buyers. This “pull the must appraise clause” puts financed buyers back in the game of potential to win in multiple offers.

      It’s fairly new in the market since early January and February on a grand scale, so new that most of these transactions are still pending.

      I expect the only ones that will fall out are the ones where they buyer agreed to the seller’s demand in order to “win” but did not fully understand the ramifications. That is why I thought this post had to be written for the benefit of both buyers and sellers. Buyers were sick of losing to cash only offers, and so were Buyer’s Agents. This is the way they have come up with to deal with the cash only offer always winning the house.

      • My parents sold their house in a very hot school district in the bay area last April. They listed it at $925,000. There were seven offers, two over $1.1 million. The top offer (which they accepted) was $1.17 million. The buyers were going to put 20% down but the house only appraised at about $1 million. Because this was a period of rapid appreciation, they delayed closing by 2 months to get the ‘right’ comparables so the house finally appraised at purchase price.

        • Notable (and in line with this post) is the two closings that were needed to get the appraisal re-evaluated were both 100% cash offers.

  8. Wow,lots of information here….I appreciate the extra info added to the conversation as most time no questions get answered re an article and that’s frustrating….I enjoy follow up and you over delivered…so thank you
    In another article today I also saw that cash buyers are way up on past 10 years overall

  9. I’m seeing this play out too, Ardell. If the buyer has the cash to make up the difference between the appraised value (and appraised values always lag behind current market because comps are based on closed transactions) and the sales price – and they really want that home – so be it.

    The lender program that fueled the bubble IMO is stated income. Had borrowers not been allowed to fib about their income, the bubble would never have blown up as big as it did.

    What’s amazing to me is that I’m seeing lenders (not mainstream) coming back with stated income loans again.

    • Excellent point, Rhonda. Stated Income loans however have their place in the mortgage marketplace. They have always been around. What created the problem during The Bubble Years is that some mortgage professionals and buyers thought that meant you could “state” something that wasn’t the case.

      Stated Income loans have historically been used for people who are over qualified buyers with complex financials. Same with Interest Only loans. They were used by wealthy people who could play high finance games on a monthly basis.

      “Stated” means state what you make…not lie about. Used often for people with cash businesses, and were not used by people to buy something they couldn’t actually afford.

      Subprime loans were always around too, but they represented a very small % of the marketplace. Are they totally gone now? We used to call it “C Paper”.

      • It’s not just ‘liar loans’ it’s every single thing that brought about the catastrophe in the first place. We don’t learn from our mistakes and the reason we don’t is that so many of the same fingers are in the same cakes. If certain people hadn’t gotten rich off of the ‘mistakes’ they wouldn’t be so eager to repeat them.

  10. Ardell you note: “You also need to know the Finance Contingency does not usually cover not having enough Cash to Close.” I’m not sure I understand, or if I do understand I don’t agree. Can you clarify?

    What do you mean the Form 22A “usually does not cover not having enough Cash to Close”? Under what circumstances would the financing contingency NOT protect the buyer (i.e. allow buyer to get a return of the earnest money) where the the buyer did not have enough funds on hand to close? And under what circumstances would the buyer get such protection?

    • That has always been true in real estate, Craig. If a buyer says they have 20% down in the Finance Contingency, and they actually have no money, what do you think happens? If they are approved for the 80% of Purchase price and don’t have the 20% down they said they had, what do you think happens if they can’t close because they don’t have the 20% down?

      Where is the buyer covered if they lie about that? “Enquiring minds want to know!” 🙂

      • Thanks Ardell, but that does nothing for me in understanding your point (you answer with a condescending and conclusory first line followed by three rhetorical questions). But that is almost certainly because I did a poor job of asking the question. I am trying to understand the correlation between the protections to the buyer afforded by the financing contingency, on the one hand, and a low appraisal on the other. Let me try from a different angle.

        What would happen to the buyer’s earnest money in this situation:
        22A shows 20% down payment, and buyer has removed the “must appraise” clause. Property appraises for $50k short of sale price. Buyer has 20% of the sale price on hand, but has only an additional $10k and thus is unable to make up the $50k difference. Deal craters.

        Who gets the earnest money?

        • Sorry to be so late in responding. Busy day.

          As to who gets the Earnest Money:

          1) While I have a lot of experience in real estate, going on 23 years, I have zero experience in people canceling a transaction on the Finance Contingency. Never had the need for that to happen.

          2) As with every legal out that is not unilateral, who gets the Earnest Money is either by agreement or mediation of a dispute. Never a clear black and white answer to that.

          As to your example, that’s not exactly how it works. The buyer agrees to pay the cash difference, not simply “remove the must appraise clause”.

          This is a relatively new event and worth a blog post to shed some light on the topic. I have not had to work an offer in this manner, but clearly the example would not be as simple as you have stated. In removing the must appraise clause, there has to be some other language, likely on a Form 34, noting the buyer’s agreement to bridge that gap noted in the post with “additional cash infusion” per the post title.

          The purpose of the post is to give people a heads up before they are faced with this situation in the heat of multiple offers. If you have some advice for those people, in line with this post, as to how they should word the change, have at it.

          Personally I think it works similar to an escalation clause cap. The buyer has to put some limit on the additional cash infusion the same way they put a limit on how high they will go beyond asking price with their offer on the 35E. Should be a relatively simple method to impose a cap on that additional cash infusion at the time the must appraise clause is removed.

          Reviewing the comps would give a fair assessment of what the appraisal is expected to come in at. The cap on gap would then be negotiated between sold price and anticipated appraised value.

          To better answer your first question, the Finance Contingency not covering insufficient monies to close is usually referring to the % down the buyer claimed to have plus the closing costs which are not stated as a dollar amount in the contract. Insufficient “cash to close” has never been covered under any finance contingency I have ever seen. So buyers would be wise to be aware of that general principle.

          If they say 20% down, they are expected to have that 20% down plus their closing costs. The “Finance Contingency” is a protection as related to the financed portion of the transaction, as the name of the form suggests. It is not a protection related to the cash portions of the transaction.

          • You’ve never had a deal crater based on a failure of the buyer’s financing? That is hard to believe… And you’re giving a detailed “heads up” on an issue you’ve never addressed previously… 😉

            As you suggest, if the buyer removed the “must appraise” clause then it is in the seller’s interest to add additional language on a Form 34. That is because, if only the “must appraise” term is removed, the buyer would probably be able to rescind if the property did not appraise (because the buyer still gets the protection of the financing contingency, and the bank can issue a denial letter because property failed to appraise). I say “probably” because you are right, the answer is not crystal clear (although I disagree that EVERY dispute does not have a clear resolution, i.e. a resolution likely to be imposed by a court, sometimes the answer is clear and the disputing party is clearly wrong).

            So the “must appraise” clause actually protects the seller. Any buyer who removes just that clause is not doing the seller any favors at all. The solution? Forego the 22A entirely for a “cash” offer. That way, the risk of a failure of financing for ANY reason, whether failure to appraise or otherwise, lies on the buyer, and the seller retains the earnest money if financing fails.

            So, my “helpful input” on your post: Don’t think that removing the “must appraise” term makes your offer any stronger. It actually weakens the offer because the seller is denied the contractual right to address and hopefully resolve the low appraisal. Instead, if you want to strengthen your offer in this fashion, eliminate the Form 22A entirely.

  11. Thanks for your input Craig. The “comment stacking” feature prohibits me from responding directly to your last comment so I am re-posting the relevant portions here.

    Craig: “You’ve never had a deal crater based on a failure of the buyer’s financing? That is hard to believe…”

    Ardell: I don’t really understand how a transaction CAN fail on the Financing Contingency, given the agent shouldn’t be writing the offer in the first place if they are not 100% sure their client can proceed to closing. My thinking on that is likely the reason I have never run into it in almost 23 years. That and the fact that I don’t fully delegate to lenders the responsibility to know they are submitting an offer than can in fact close. It’s “old school” from before we had “pre-approval letters” for the agent to submit an offer with a high degree of certainty regarding the buyer’s ability to finance their purchase.

    Craig: “And you’re giving a detailed “heads up” on an issue you’ve never addressed previously”

    Ardell: Having been that successful at heading the problem off before it is a problem at all, is likely the best credential for speaking on the topic. Someone who has repeatedly had the problem, may have more experience at resolving a big mess, but never having the mess in the first place is likely of higher value, I would think.

    Craig: I say “probably” because you are right, the answer is not crystal clear (although I disagree that EVERY dispute does not have a clear resolution, i.e. a resolution likely to be imposed by a court, sometimes the answer is clear and the disputing party is clearly wrong).

    Ardell: True…but with this issue I think it is very easy for a buyer to say they did not have a clear “meeting of the minds”, given the amount they agreed to pay was an unknown amount at the time the offer was written and accepted. I feel the same way about the “will pay assessments” feature added to Purchase and Sale agreements. I don’t think you can CLEARLY agree to an amount that was undertermined at the time of the agreement. It’s like an escalation clause with no cap…a blank check…not really an “agreement” to pay if the amount to pay is an undetermined amount. Language of “up to $20,000 additional down payment” needs to be added for there to be “an agreement” to pay “it”, IMO. There is no “it” with no defining max number to “it”.

    Craig: “So the “must appraise” clause actually protects the seller. Any buyer who removes just that clause is not doing the seller any favors at all. The solution? Forego the 22A entirely for a “cash” offer. That way, the risk of a failure of financing for ANY reason, whether failure to appraise or otherwise, lies on the buyer, and the seller retains the earnest money if financing fails. So, my “helpful input” on your post: Don’t think that removing the “must appraise” term makes your offer any stronger. It actually weakens the offer because the seller is denied the contractual right to address and hopefully resolve the low appraisal. Instead, if you want to strengthen your offer in this fashion, eliminate the Form 22A entirely.”

    Ardell: I don’t agree with any of that. Going WAY back to my early days in real estate there was a huge case on “hidden contingencies”. Your putting “cash” in quotation marks suggests that you are telling the buyer to lie and say they can pay all cash. That clearly is not correct, IMO. Yes…if they CAN pay all cash. If they have enough cash to purchase, but choose to finance simply for their own personal reasons, and WILL pay all cash if they can’t get a mortgage, then yes. But I don’t think that is what you are saying.

    Removing the Finance Contingency does not “strengthen” the offer, it simply gives the seller the right to Earnest Money if the buyer does not close. The seller has the right to know more than that. He deserves to know that the buyer can close, and on what basis. This is especially true in the event the buyer is FHA or VA and does not disclose the additional costs to seller or additional repair scrutiny that may be imposed on the seller for the sale to close. Hiding the fact that the home will be financed is clearly a “hidden contingency” similar to the case regarding the buyer who could not buy if they did not sell their current home. That was the “hidden contingency” case I remember.

    Hiding relevant information from the seller so that the seller will accept your offer? Not sure how you can possibly see that as an advantage to either party. The seller at the end of the day does not want the buyer’s Earnest Money. They want the sale to close. Hiding information regarding the terms by which it can close? Well, we’ll agree to disagree on that.

    • Slightly off topic, but something that came to mind as I was answering Craig. I DO believe that the buyer can say 20% down and get a 5% down loan, as long as the standard for canceling on the finance contingency is a mortgage with an 80% loan to value and the buyer indeed has the ability to put 20% down and is willing to do so if needed.

      This is often confused in real estate. The Finance Contingency gives the terms by which the buyer can cancel, but doesn’t prohibit the buyer from using an alternate financing method. This has always been my opinion and not one that is widely understood about Financing Contingencies.

      • I’ve been reading this with interest. We bought 2 years ago at the bottom & in what is now a newly appreciating neighborhood. Since we were hunting for so long, we’ve never stopped watching the greater Seattle and Eastside markets-its somewhere between a hobby and an obsession now. I am an analyst by trade (so neither our timing nor choice of neighborhood was a complete accident…) The contractual technicalities are important, but stepping back from that, I’d disagree that the ‘entire’ market is recovering to the point where Buyers should be advised to waive the “must appraise contingency.”

        Buyers paying cash to bridge an appraisal gap won’t fuel a long term housing recovery in what is still an ailing economy. The current upswing we are seeing is short term and at a micro level. Well priced homes in great condition (read, no extra cash needed to be move-in ready) and in the ‘right’ neighborhoods are indeed receiving multiple offers. In contrast, there are many fixers just sitting that few are willing to dump cash into. There are also nice houses in the less popular areas sitting as well.

        Currently there are buyers who saved and waited for the market to show signs of recovery & they are competing with each other. They are choosy too, you notice they aren’t spending their money on shacks or less desirable areas. If the demand was as hot as I’ve heard some agents try to say, everything would be flying off & that isn’t happening.

        Until the overall economy improves, buyers with cash for down, cash to bridge the appraisal gap, cash for rehab, etc. are a finite resource. In fact these days, they are Usually a finite resource- that’s why “Cash is King.” A true housing recovery can only happen while there is sustained demand – i.e. there are enough people who can afford rising prices over an extended period of time. With the overall US economy still in a stall, people with this amount of cash are creating small,specific Bubbles.

        The appraisal contingency allows for flexibility anyway- the buyer and seller can work out whatever they like to cover the gap; or not… The only difference I see is around refund of the earnest money and that is peanuts at the macro level. Getting the earnest money would only briefly benefit the Seller and it is a pretty weak stick to hold over the Buyer. I think I’ve read on this blog (and agree) that smart Buyers shouldn’t put up more earnest money than they can afford to lose, no matter how great the house is. If recent history has taught us anything, it is better to lose several thousand dollars than to make a half million+ mistake.

        Telling buyers remove the contingency in order to “get the house” at all costs sounds like poor (short sighted, self-serving) advice if it is coming from a buyers agent. Telling them that their cash sacrifice would fuel the housing recovery doesn’t resonate. The risk that the market can go bad quickly is why banks protect themselves via appraisals in the first place. Why should folks living on Main Street be advised to be less cautious with their own hard earned money?

        • MS. B. First and foremost, thank you for taking the time to leave a thoughtful comment.

          I don’t think any Buyer’s Agent would advise the buyer to remove the contingency out of the blue at time of offer. The way this is playing out is that if there are multiple offers, and I recently saw one with 29 offers, then the price is going to go higher than the comps. That is a given in a rising market.

          You are correct that not all houses and areas will experience this level of activity and offers, and if there are not multiple offers on a given property, then this issue would not come up at all.

          The buyer side is generally not the party that brings up the buyer’s willingness to bridge the gap on appraised value. Usually it comes up when there are at least 6 offers in hand and the buyers themselves are bidding it up higher than the comps. The seller’s asking price reflected a price that could pass appraisal. The buyers are the ones pushing the price to a place where the property couldn’t possibly appraise at that price based on the comps.

          Let’s say the comps support a price sold price of $470,000 and the buyers bid the house up to $515,000. (real example I saw last Spring-Summer in Kirkland). What good is accepting the highest offer of $515,000 if it is a given on that very day that there is no way it can appraise at that price, and the buyer includes a “must appraise” clause with the $515,000 offer. There is no need to “wait and see” because there is no way the home could possibly appraise at that price. Appraisers don’t have any secret comps that the agents were not aware of when they listed the house.

          When a seller is faced with choosing one of many offers, they want the offer that is going to stick. They don’t want to lose that one buyer closer to closing and after all the other buyers have left the room.

          Offering a price that can’t possibly appraise and leaving in the must appraise clause is like an empty promise…a “check’s in the mail”…a let’s offer a price we know won’t appraise to WIN and then pull the price back at time of appraisal after everyone goes home.

          A seller can’t regain that initial out of the gate momentum, and has to be careful which of the offers is chosen.

          Almost always the issue of removing the must appraise clause, or buyer’s willingness to put down more money to bridge the gap, is never a counter by the seller. It is a verbal and soft peddled request “suggesting” that the offeror who does this…will likely be “the winner” in multiple offers. The Agent for the Seller proposes it may be a good idea for the buyer if they want to get the house. I have never seen it come in the form of a written counter offer. Not saying that has never happened. Just saying it is usually a phone call from the agent for the seller and the issue is soft peddled and not shoved down a buyer’s throat by the seller of the home with 6 offers in hand.

          Making an offer 10% more than it can possibly appraise for is like writing a “bad check” if there is a “must appraise” clause. Knowing there is no way to back it up and close is a given, not a mystery, at time of offer.

  12. Simon asked “For example, if you have 3 comps that all sold last year”. Actually the appreciation gets bunched up into one strong selling season, as you noted. The comps are recent. In fact most of the high comps are still pending, as Lesley noted.

    Since appraisals are not public information, we can only see each house selling for more than the last one so that 6 sales at 5% more for each, whether that is in a year’s time or 60 day’s time, ends up at a cumulative appreciation rate for the six sales of 30%. Everyone lists and sells higher than the last neighbor sold. Consequently volume of sales becomes the key factor in runaway price increases, except where several buyers bit it up significantly on one individual sale and fund the appreciation with cash infusion, as noted in the post.

    If all six sales happen in 60 days and not more sales in the neighborhood or area for the rest of the year, then that 30% becomes the annual rate of appreciation.

    How the appraisers justify it on paper I can only see for the one transaction of mine in that stream of 6. But they all appraised and closed, so there must be some way to justify an extreme increases in a short period of time.

    • If the market is actively supporting such an increase in prices, then the appraiser is under obligation to follow the market. Appraisers are relying on past sales as an indicator of market activity. It is true that active listings are usually always priced higher than the last sale, but that does not mean that it will sell for that amount. The transaction needs a willing and able buyer. If buyers are willing and able to pay 30% more than the 60 day old price, then appraisers need to follow the market. Appraisers do not “create” or “make up” price appreciation. It is easily measured in the marketplace.

      The appreciation should be seen in the sale price not in line adjustments. In this way, the appraiser stands behind market data and not personal opinion or perceived inflation.

      • I’d love to see a discussion of appraisals in general. The homes I bring to market have a much higher quality of components and finishes than usual, and it’s often a struggle to get them to appraise. Appraisers seem to measure square footage, count beds and baths, find comps and call it a day. Things like real wood panel doors, real window mullions, high-end materials in kitchens and baths, solid masonry construction, slate roofs and such don’t impress them one bit. They do impress certain buyers. And I haven’t even mentioned architectural quality.

        • Mike, the old rule of thumb by appraisers is that these extra things cannot exceed 10% of the value without them. If the house appraises at $500,000 on basics alone, all of the quality finishes and extras like extra land, a tennis court, a solid gold bathtub :), etc. on a combined basis cannot exceed a total of 10% of the value without them or $50,000. On a $200,000 house the limit would be $20,000 for those exact same extras.

          There is a point where the appraiser will not appraise “over improved for the neighborhood” and that point is 10% more than a comparable property. They don’t literally add 10%. They just fudge each number by a bit until they get to the end result.

          Appraisers determine value and then use the form to back into their opinion of value. People think it is the other way around and the detail equals the price. Not so.

  13. Good explanation Ardell. As an example, I did a complete kitchen in marble and copper–no stainless, all copper (even the sinks and appliances). The appraiser said that stainless steel was the ‘upgrade standard’ and he couldn’t allow anything over that. So what you’re saying is consistent with that. And I’m wearing shorts 🙂

  14. Wow this is quite a bit more complicated than I thought. My aunt (in real estate) was explaining this idea to me and I didn’t quite get it.That ‘no appraise clause’ makes quite the difference – thanks for a more indepth explanation I could read a few times 🙂

  15. 5. Underestimating the costs of owning a home.Whether it’s a rusty pipe or a leaky roof, things go wrong and need to be fixed. Many homebuyers don’t anticipate the additional costs for repair and maintenance, or for an increase in utility costs, says Erin Baehr, a certified financial planner and president of Baehr Family Financial. Consider the age of your new home and how well it’s been treated by the previous owners in your budget. Be prepared to set aside a small percentage (1% at most) of the home’s purchase price annually for repairs and upkeep.

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