The 2021 real estate market is one for the history books! Let’s take a quick walk down memory lane (a long 6 months ago) to learn how the market in San Diego has changed.
In November 2020, I helped a client find a home in 4S Ranch. He purchased a 5 bedroom home with a casita for $1.25M; at the time, it felt like a lot of money! Fast forward to February 2021; a different client purchased a home with a very similar floor plan, including a casita, in 4S Ranch less than .5 miles away, for...wait for it... $1.43M. That home appreciated by $200K in 3 months! Now, 3 months after that, those same 5 bedroom homes are now going for $1.6M. This is a 400K increase in appreciation in 6 short months!
Guess what? This story is not unique to the 92127 zip code - it is rampant throughout San Diego County as a whole. This dramatic price increase in such a short period of time is causing unprecedented appraisal issues for today’s home buyers. An appraisal’s purpose is to mitigate the lender’s risk in lending money, and a lender will only loan up to the lesser of the contract value or appraisal value. Appraisers are trained to look back in time to support today’s prices. They ideally rely on 3 months of previous data to validate what a home’s value should be, and many don’t want to “stick their necks out” on the line to support the huge jumps in pricing we are seeing right now.
How ironic that looking backward can be so detrimental! Some appraisers are more bullish than others, and I have experienced this first hand. One of my properties got appraised 3 times within the same escrow; 1 out of the 3 appraised low, whereas the other 2 appraised at value. The bank will choose to look at the lowest appraised value, so even in that scenario, the buyers can find themselves in a pickle.
Why does this matter and how does it affect both buyers and sellers?
Sellers in this market are often only selecting offers with a waived appraisal contingency. For all those newbies out there, the appraisal contingency is one of the contingencies during escrow that protect the buyer and allow the buyer to cancel without losing their earnest money if the conditions are not met. The most well known include the inspection contingency, appraisal contingency, and loan contingency. Buyers are often being forced to waive the inspection contingency as well in order to secure a home over another buyer in today’s market; we are also seeing the loan contingency waived in select circumstances.
One reason you might have heard that “cash is king” is that a cash offer has no appraisal nor loan contingency, eliminating a lot of risk to the seller of the sale falling apart. Absent a cash transaction, sellers are not risking choosing a buyer who will not waive the appraisal contingency right now, since a low appraisal can be such a deal breaker. With an appraisal waiver, buyers agree ahead of time to bring forth any funds necessary to make up any appraisal shortfalls.
For buyers, this means that in addition to making sure they put together the most competitive offer (NOTE: significantly over asking), they also have to make sure they have enough money to overcome any appraisal deficits. What can happen if the appraisal comes in short?
Buyer can bring forth extra funds.
Seller can reduce the purchase price.
Buyer and seller can meet in the middle: this used to happen pre-covid.
Buyer can cancel.
Seller can cancel.
Buyer can change the loan structure in certain circumstances. If you put down more than 20%, the appraisal value becomes less of an issue. For example, my buyers of the $1.43M property had an $115K appraisal shortage, however, they were not impacted because they had put more than 20% down on the loan, so they didn’t have to come up with that difference. I have also seen buyers intentionally put down 5 -10% instead of 20%, anticipating an appraisal issue, which is smart if you can get the seller to accept your offer (harder to win the property if another buyer is putting 30% down for example).
In today’s market, sellers have the upper hand and are not willing to put themselves in a position that causes them to reduce the contract price or give the buyer an option to cancel with a low appraisal. Bottom line, buyers need to be financially prepared to overcome appraisal issues, as sellers are not going to help, and lenders have limited power since appraisers are independent third parties.
What if the appraisal seems so completely off? This also has happened to me during one of my escrows. The appraisal used 3 pending comps, which seems borderline illegal in my opinion, as pending comps don’t show the final price. These days, a listing at $1M could close well over $1.1M (and rising!), so the “pending price” is not accurate. For something that is so blatantly off, the buyer can request a review or depending on the lender, possibly pay for a new appraisal. This would only occur after a full review of the lender’s appraisal review team, to see if there is an argument for a new appraisal or just a review. Most times during the review process, the appraisal will come up, but if the deficit is large (if the contract is $835K and the appraisal is $770K), chances are the appraiser won’t come up that much higher, since their reputation and credibility would be on the line. You may eek out $10K to $20K higher but that’s about all.
Though seemingly unfair for buyers of today’s market, if you are aware of these potential scenarios going into the purchase contract, you can mitigate your risk by changing how you structure your financing. This market has put a lot of pressure on buyers, but realize that you are buying a home to improve and transform your life for the better. If you keep that in perspective, this just becomes another part of the escrow process!