Does it seem a bit suspect when the appraised value comes in at the sales price? Maybe you’ve felt that way before. Should you be concerned? Yes and no.
Yes. If the appraiser has deliberately met the sales price in an attempt to make the deal work, it is suspect and you should be concerned. If the house is really worth more or less, it’s not fair to have the appraisal hastily completed to help make a transaction move forward.
No. The sales price can be a good indication of market value. The agreement between a buyer and seller can very well reflect market value for a property and fall within the range of values in a neighborhood. If the buyer and seller (and others) offered on the property and all came in at a similar level close to the contract price, chances are that might be a pretty decent indication of how the market sees the property. For example, if the sales price was $225,000 and the range of values for competitive sales looks to be $220,000 to $230,000, and there is no good reason for the subject value to be reconciled at the higher or lower end of the range, then $225,000 could very well be a rational selection for market value. It is very reasonable for the appraiser to make such a conclusion and not suspect at all so long as there is support for that conclusion. In short, when the appraised value equals the sales price, the appraiser might just be saying, “Yep, that looks good based on all data. The buyer and seller did a good job working out a price.”
What do you think?
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I’m curious to what your thoughts on this are as well Ryan; but I will share mine.
This question has always been the most troublesome, and I will admit that not a lot of people agree with me. Ultimately, I hear more people answer with the ‘No’ answer to the question. If a buyer is willing to purchase at said price, and seller agrees to sell at that price; then obviously it’s market value…..
My counter to this argument is that value, especially now, is not based on what people are actually willing to pay for the property, but what they are able to finance based on current income levels. Obviously ‘value’ and this idea has been skewed, as one can see looking over the last decade. Many homes were sold on this very basis, and now watch as the market has crumbled…loans historically have been made on income to debt ratios of 1/3 income towards the cost of the home…I have seen this skyrocket into about 65-70% at it’s worst. This again is not value… this is just what the bank allowed to be financed.
This argument relates to Milton Friedmans book on how people spend money. (Free to Chose)
1. Spending your money on you. You economize and look for the most you can get for your money.
2. Spending your money on someone else. You economize but may sacrifice some worth because it’s going to someone else.
3. Spending someone else’s money on yourself. There is not as high the incentive to economize but you look for getting the most for that amount of money.
4. Spending someone else’s money on others. There is little incentive to economize or get your money’s worth.
I say that buying a home is mainly No.3, with a partial No.1. You are spending the banks money; while you might have a down payment, it is ultimately their money so there is less incentive to actually economize and look for a great deal with the most amount of worth to the purchaser. Instead, if the bank will loan you $250k; you work within that parameter….or say $300k+ or more…
To put this into context. If you had $300k sitting in the bank, and saw a home listed at $275k. Do you go in with a full price offer? Or do you look at maximizing your savings and attempting to gain the most amount of value out of it? I personally feel that the value of a home, is how much a buyer would be willing to pay, of his own money to have a home. It’s an argument of a financed dollar equated to cash value. In appraisal, that’s your ‘cash-equivalency’ I see all the time that people paying with cash are looking for deals; the argument that you will look until you find the right price falls right into the idea of ‘you spending your own money’ on something you want; not spending thing banks money.
Even though people pay the loans back, this is important to appraisers because each appraisal we do has a Definition of Market Value (for loans on the FNMA 1004) form and in pretty much all definitions of market value are the words:
‘payments in terms of cash, or financial arrangement comparable thereto’… well, if the price paid in cash for a home is equivalent to the price paid for a financed dollar, than the two are comparable. But I would challenge you to run a graph of sales prices, or $/SF of Cash Sales vs Financed Sales….more than 85% of my graphs ever run will indicate a 10+% difference. This would tell me that for every financed purchase; you are paying 10+% more than if you were to buy the home using cash.
Ralph, very interesting thoughts. I appreciate you taking so much time to lay this out. Cash buyers do look for deals often times and they are definitely more conscious of how they spend their money because it is truly theirs (not someone else’s). However, sometimes cash buyers overpay though too. How does that fit into your scenario? Cash buyers from the Bay Area can overpay on properties in Sacramento, for example, because they are used to high prices in the Bay Area and then spend money more readily here in Sacramento because it seems like a good deal. On top of that, sometimes sellers will accept an all cash offer in order to avoid the headache of a loan. This causes us to wonder if the price was discounted a bit too, right? Typically I do agree though that the tier in the market goes cash at the bottom, conventional above cash and then FHA or near 100% financing at the top. This DOES say something.
Loans are considered to be a normative part of the purchasing experience, but I hear your point and I think you make a good one. That actually smells like a future blog post too. I posted Fannie Mae’s definition of market value below and we must be very cautious about point # 5 because “special” (out of ordinary) financing may not represent market value and it may be much higher.
Fannie Mae Definition of Market Value: “Market value is the most probable price which a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller, each acting prudently, knowledgeably and assuming the price is not affected by undue stimulus. Implicit in this definition is the consummation of a sale as of a specified date and the passing of title from seller to buyer under conditions whereby: (1) buyer and seller are typically motivated; (2) both parties are well informed or well advised, and each acting in what he considers his own best interest; (3) a reasonable time is allowed for exposure in the open market; (4) payment is made in terms of cash in U.S. dollars or in terms of financial arrangements comparable thereto; and (5) the price represents the normal consideration for the property sold unaffected by special or creative financing or sales concessions granted by anyone associated with the sale.”
I tend to look a lot at markets in the terms of cash equivalency; that is to say what I, or any other purchaser of goods will pay in cash for a good or service. Credit has skewed the dynamics in the sense that people just pay less attention to the actual cost of an item where credit is involved. I say this since I have been in the boat of losing a home, tarnished credit, and I try to avoid credit now. I would rather have the cash upfront to purchase a good or service… but I look A LOT more now at the actual price paid; I want the most for my dollar.
In answering the first question about Bay Area buyers….
I did a lot of appraisals early on in the Natomas area; I knew this area to be a big flood plain area, sold on the promise of fixing levees to keep these areas out of the flood zone. I asked the builder when they were planning on funding this, and how they would go about doing it. I was told by one builder that the cost of the home takes into account some of the monies that the builder was going to contribute to fix these levees, once all the homes in the development were completed; and then Natomas Park was done… the very same builders ‘delayed’ this ‘funding’ when Regency Park started development… and so on… I knew no money was to ever go to these ‘fixes’; and I actually looked at buying in this area, but opted not to for fear of the higher water table and levee issue …these previously being Ag areas… What I did see was a lot of Bay area buyers, purchasing homes….. homes that they never even came to look at… they just bought them… because they were cash heavy coming from an area with high land values and extremely limited building capacity for a cheap dollar. I attribute a lot of the buying; or at least the starting of that buying to an ‘uninformed’ and not well advised buyer. How can a buyer be well advised when I saw many an agent buying these same properties they were telling ‘cash full Bay area buyers’ to buy, then turning around and selling these homes? I saw homes selling before they even hit the market… so where was the ‘reasonable’ exposure time…let alone marketing time. To further the matter, I actually did appraisals out in Vacaville/Fairfield/Dixon… for the company I was with at the time… The sacramento buying frenzy was no more than buyers looking for a ‘deal’ with cash along the I-80, all the way up to Sacramento because the Solano market was being overpriced and buyers being overtaxed… this definitely saw a turn when the city of Vallejo filed bankruptcy in 2008, I believe. So as the Bay area got too expensive, so did each city going up the Interstate. Cash buyers were looking for good deals and while in their mind, were paying substantially lower pricing, they did not know the Sacramento market, nor did they understand they were overpaying for homes.
Delving into the financing portion of your response; I agree that a level of financing is necessary, but there has been deviation for what has been the norm (i.e. creative financing, just means you have run out of people to finance and must now create a way to get them financed). The problem starts when you allow people… including myself to buy with no money down..no ‘skin in the game’… no real money to be lost in the ‘investment’ part of buying a home. While one may say it’s not an investment for future worth, it’s an investment in your family staying in one place for the next 30 years….But if you’ve put nothing towards it, then it’s that much easier to walk away.
Financing in itself, SHOULD be harder to obtain. It separates those who really WANT to buy a home from those who must do more to get there. It creates a need for a buyer to pay attention to price when the interest rates are higher. Over the last 70 years, our dollar has lost value, so it cost more money to buy the same things. What regulates this is the interest rate. When Treasury Secretary Paul Volker came in to bring more value to our currency, during the Reagan years, interest rates shot up to upwards of 15-18% and higher. This may have dissuaded some from buying a home; but on the flip side… those that did, paid a lot more attention to price. If you’re paying 15% on $100k; it’s a lot better than paying 15% on $150k home… so ‘value’ was just paid more attention to.
Very thoughtful response again, Ralph. Thank you. I remember the Bay Area investors gobbling up Elk Grove too when new construction was rampant. There was often a home owner occupancy rule in newer neighborhoods too, but they still purchased and then flipped upon resale. It’s hard to believe now, but prices shot up so quickly (nearly $10,000 per month) for new construction that it made sense for investors to buy into the neighborhood and then resale. Just don’t get stuck at the end of the peak though, huh.
I think your point is valid about paying attention to the price. Well said, Ralph.