A History Lesson
A long time ago in a galaxy far, far away, getting an apartment or a house to appraise for the purchase price was in the realm of cosmic certainty. In most cases, the appraisal was merely a "check the box" drill on the way to loan approval and the closing table. Enter the exploding death star known as the financial collapse and the easy appraisal disappeared into the black hole of "banking reform."
Dodd Frankenstein
No one disputes that residential real estate financing was in need of significant revision and improved oversight after the "lenders-gone-wild" days. As is often the case with reactive governmental reform, there were significant unintended consequences. Specifically, the appraisal pendulum has swung so far in the other direction, that many deals hang in the balance, awaiting the results of the appraiser's unfathomable calculations. In addition to the increased financial scrutiny and the often maddening and ever-changing underwriting guidelines for a residential loan, there is also the very high hurdle of the new and improved "arms length" appraisal.
The Sausage Making
Starting in 2009, the regulation of appraisals began its metamorphosis from a controlled process (in which the mortgage broker or loan officer selected the appraiser) into a highly technical and supposedly objective endeavor that separated the salesperson from the underwriter. Through a series of complicated pieces of Federal legislation and accompanying regulations, not the least of which was Dodd Frank, banks are now required to comply with national appraisal standards, including strict regulation of how appraisers are selected by the lending institution. In most cases, the selection of the appraiser is handled through a third-party "appraisal management company," almost always owned by one of the large banks. Further complicating the process were significant guideline changes to the data collection process implemented by Fannie Mae and Freddie Mac in 2011, impacting the vast majority of home loans. All of the above has resulted in the appraisal becoming so chock full of complex data requirements, that no consumer could possibly understand how the process actually works. In truth, most professionals outside the world of appraisal data collection would be hard pressed to explain how an appraiser does his or her thing.
Long Story Short
Anyone selling a property where the buyer is seeking 80 percent financing may be in for a rude awakening. Unless the appraisal hits the purchase price, the buyer will not be able to obtain the needed loan amount and the parties will be back to renegotiating the purchase price. I have seen this scenario play out in a number of cases recently and it's not pretty. Yes, the borrower can go back to the bank and appeal the results of the appraisal, but that takes time and may or may not be successful. At the end of the day, the parties must seek a work-around to make the transaction happen and that often involves financial pain for both sides.
Crunching the Numbers
The differential between the purchase price and the appraised value of the house or apartment can vary significantly. When the property fails to meet the threshold price, the disappointment for the seller can be devastating. With many properties barely treading above water, a buyer's request to reduce the price may not be economically feasible. As I have discussed before, the value of the all cash buyer in this evolving market cannot be overestimated. In most cases, the all cash buyer will not obtain an appraisal and the deal will go forward without an objective analysis of what the house or apartment is actually worth. But sellers can't count on finding an all cash buyer.
Let's Split It
Fortunately for sellers in Manhattan, inventory is extremely tight at the moment. As a result, the choices for buyers are greatly limited, so there is incentive to make the deal work, rather than walking away and starting all over again. As usual, it all comes down to a number. Can the parties work together to find a financial compromise that both sides can live with?
Less is More
Sellers should be wary of buyers seeking 80 percent financing. As pricing over the past few years has been off by 30 percent or more, finding comparable options that work in an improving real estate market can be difficult to identify, and in some cases, not possible. From a seller's perspective, a financially fit buyer seeking financing of 75 percent or less, is a better candidate for a successful transaction than the buyer who bids up the purchase price, but requires an 80 percent loan.
Residential Reality: Things Are Better But...
As sales metrics improve month by month, economists seem to agree that residential real estate is awakening from its 36-month slumber. That being said, buyers and sellers are well advised to accept the uncertainties of the market and compromise on the price when the appraisal is short.