Today’s show is about how a bad appraisal can adversely affect your business.
Appraisers determine the value of your property in the eyes of a lender and they help the lender independently justify the loan to their loan committee and to the bank regulators. This independence prevents the kind of loan manipulation that unfortunately became far too commonplace in the 1970’s and 1980’s.
The banks have the right to choose their appraiser independently, and the borrower is not to influence the appraisal process. There is a significant incentive for the borrower to get a high number for their appraised value. The higher the number, then perhaps the more the bank may be willing to lend. If the appraised value is artificially high, then the bank ends up taking on much more risk.
Appraisers use three principal methods to value a property. These methods are:
- Replacement cost
- Multiples of net income
- Comparable sales
Generally speaking, the appraiser needs to apply their professional judgement on which of the three methods to give the greatest weight to. If the property is unique and there are no comparable sales, then they may have to rely on one of the other methods. If the property has no income yet, then the income multiples method doesn’t apply. If the property consists of vacant land, then the construction cost won’t apply.
On today’s show, we’re going to focus on what to do when the appraiser for your lender gives a value that is far from what you believe the true value of the property to be. There can be several reasons why the appraiser comes to a surprising conclusion.
In 2017, many cities started accepting carriage houses as legal accessory dwelling units. These separate buildings would be treated the same as an in-law suite located in a residential home. Here too, there were few if any examples in the market, and appraisers struggled with how to value them. They had no comps. None of the appraisers I spoke with were willing to blaze a trail and take the personal risk of setting price precedents in the market.
In another case, an appraiser valued a parcel of land as if it was agricultural land, instead of valuing it with the improvements that had been approved by city council.
It happens that sometimes you get a bad appraisal. It first happened to me back in 2012. The result was that instead of a refinance taking 3 months, it ultimately took 9 months and three separate lenders to complete the transaction. Bad appraisals were at the root of the issue in each dead-end loan application.
So what can you do to prevent a bad appraisal? As a property owner, you don’t get the opportunity to direct the appraiser. They have to do their work independently.
However, I believe it is perfectly fair to show the lender your analysis at the start of the project. To show the lender you’ve done your homework and that you have a good understanding of the market. Include all of the relevant data in your executive summary that forms part of your loan request. Not all real estate transactions are advertised on the MLS. Private sales which are transacted outside of the public eye are no less real. They too should count when considering the landscape of transactions considered in the market analysis. You can include all those off-market transactions that you might be aware of that the appraiser is unlikely to find because they’re not advertised.
The impact of a bad appraisal can be significant delays. It can put a borrower in the impossible situation of having to seek an emergency extension of a loan while they complete a refinance. Show the lender your analysis and it may increase the chances of a fair and accurate appraisal.