Why do you need a copy of the sales contract Mr. Appraiser?

appraisers read contractsHave you ever wondered why the appraiser needs a copy of the sales contract? They’re just going to use it to come in at the contract price, right (not really)? If you’ve ever asked yourself this question I hope I can help you understand why it is important that the appraiser review the sales contract when doing an appraisal on a home that is selling.

By its very nature an appraisal is performed to find out what the market value of a house or other piece of real estate is. A very important part of this involves determining what a buyer is willing to pay for the property. Part of the definition of market value states the following:

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.

In the scenario of a sales transaction the contract provides a very important hint or clue in determining the market value of the property, if it is not affected by undue stimulus. Besides the contract, the appraiser uses a minimum of 3 closed sales of similar homes to compare the subject to. Because appraising is not a science it cannot be exact, however the value estimate determined by the sales can be tested and possibly fine tuned to narrow the opinion of value down to a more precise point. If the contract price falls within the range provided by the sales, the contract provides additional support to refine the opinion of value.

So you may ask, “What does all of this have to do with the appraiser analyzing the contract”? Well I will tell you. The appraiser looks at the contract to determine various things including loan interest rate, down payment, seller contributions, and extras that might be included in the sale. If the interest rate is lower than what is typical to entice the buyer to purchase the home, this may have resulted in a higher sales price. Or, what if there was a tractor included in the sale of a farm that would be helpful in maintaining the property (true story)? The value of the tractor would have to be adjusted for in the appraisal since this is not typical, and it does not reflect cash equivalency. Sometimes sellers will help the buyer by contributing more to closing costs because the buyer does not have the funds. This has to be analyzed and adjusted for or it will give an inaccurate indication of value for the subject property.

The terms of the contract are checked against what is typical in the market, and if it varies adjustments are made. As I said, this is done so that the adjusted value of the subject property is not overstated or understated. So as you can see, it is more than just looking at the contract price. It involves taking a very close look a the terms of sale and comparing it to what is typical in the market. Do you have any other questions about sales contracts and appraisers? Leave it below and I would be glad to answer it for you.

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Comments

  1. Shouldn’t the appraiser also have a copy of the inspection and be required to take that into account?

    • Whenever a home inspection is available it should be taken into consideration. The home inspection provides a statement of the condition of the home by a professional rather than the appraiser shooting from the hip with condition assumptions. The appraiser is not a home inspector so whenever possible they should use the best information they can get, which is sometimes the home inspection report.

  2. While I agree with your initial point of view, what happens then, if a seller demands that the buyer come up higher in price, and the buyer does that, hoping it comes in less to what the buyer feels it’s truly worth, assuming that the appraiser will give an honest opinion of value? Now we have a situation where if it’s not truly worth that price, but the appraiser simply “brings it in” as I’ve seen happen frequently, which is unfortunate. I just want an unbiased opinion of value. I’ve also had 2 appraisers 50k apart from each other in value, for the same home. I think the management companies have hurt the consumer more than help them.

    • I’m not sure if fully understand the question Diana but I will give it a shot. From my experience the initial offer and counter offers commonly occur with a property because both buyer and seller are trying to get the best deal for them. If the seller counters to a higher amount than what the buyer originally offered, and the buyer agrees, then you’ve got a price that was agreed upon by both parties, which is what we consider to be an arm’s length transaction. The buyer will then look at that and see how it measures up to what other similar homes are selling for. If the contract is within the range of the other recent sales and current active listings then it provides support for the final opinion of value the appraiser comes in at. The contract is one piece if the puzzle but not the only piece. It has to be looked at in the context of all of the value indicators. Regarding your second thought about two appraisers coming in $50,000 apart is no uncommon and is typically caused by such things as experience, knowledge of area, and accuracy of data sources. If the appraisers are using similar data sources and similar comps the value should be closer, however sometimes appraisers do not do a good job of picking the right comps that reflect similar value influencing characteristics such as school systems, etc. Hope this helps answer your question.

  3. The terms of the purchase contract are unrelated to the fair market value of the property. The appraisal is being conducted by the bank to determine what the property’s value is to an open market should the bank have to foreclose on the property. Whether the buyer is buying below fair market or above fair market is not relevant to what fair market is.

    I don’t think there is a seasoned real estate professional in the business that thinks appraisals are the actual market price of the property. They are reverse engineered to see if the contract price can be supported, and if so, 90% of the time they come in exactly at the contract price. That would be statistically improbable if appraiser’s did not have access to the listing or contact price to target.

    • I agree that the contract in and of itself is not a single determinant of value but combined with recent closet sales, actives, and pendings, it can be another useful value indicator to consider. I will have to disagree with you regarding the reverse engineering as this seems to contradict your previous statement about the contract not being related to the fair market value of the property. A competent appraiser will set comparable property parameters relating to the physical characteristics of the property to determine the properties value. I think the reverse engineering you describe might occur if you search for comps based on the contract price, but that is not the correct way to do it. After developing an opinion of market value I then look at the contract and compare that to the range of value provided. If the contract is arms length and falls within this range then it is taken into consideration during the reconciliation.

  4. Is it required in some states (VA) that customers must present contracts if pending on homes when request an appraisal?

    • Yes, that is true. The appraiser must analyze any contracts or listings of the property. In a situation where a home is under contract for purchase the pending contract can be an additional indicator of value along with the sales and listings of other comparables used in the report.

  5. I agree with Christopher – seems absolutely ridiculous that the appraiser should see the contract. The whole purpose is to get a completely independent review of the value – not to partially base the value on what you are paying. Makes no sense. The only thing I could concede is that the contract may reveal some kind of major deficiency or something of value that may come with the house. But, this would seem rare.

    • Thanks for your comment Norm. I can see where you might think it would hinder the appraisal however an arms length contract is one additional piece of information that can add support for the appraisers opinion of value. You might think of it as an additional sale. If the contract price is within the range provided by the other sales then it add’s support and the contract price is validated. You are right when you say that the contract may reveal some deficiency or something of value. When the market was struggling several years ago many agents would include personal property items to sweeten the deal for buyers, and as appraisers we cannot include these items. The sellers may also pay more in closing costs to help the buyer, which typically increases the price. This has to be separated from the true sale price and accounted for in the adjustment grid.

      • I appreciate your viewpoint, and there is some truth about additional property, etc. not trying to give you a hard time. Seems to me that an appraisal with a contract implies that you are appraising the value after the sale, which is fine I guess. But, one would think the banks would want to see the value before the sale, since they should be trying to determine whether the appraisal is reasonable compared to the contract price. When you cross this information, you pollute that objectivity. but thanks for hosting this blog.

        • No problem Norm, I appreciate contrasting viewpoints. The appraisal is actually performed after the property has gone under contract so it is relevant. Just because the home is under contract for a certain amount does not mean that the home will be appraised for that amount, it could be higher if it is supported by recent market sales, or it could be lower if the contract is not supported by sales. I have unfortunately had to appraise some homes lower than the contract amount so in that case the contract did not pollute the opinion of value or else it would have came in at the contract amount. Thanks for reading and I hope you continue to contribute with comments.

  6. Christopher Schubert says:

    Two years ago to the day you wrote this. Huh.

    Couldn’t you just look at the contingencies of the sales contract and have the actual sale price redacted? Wouldn’t that produce a more independant number?

    • Great question. We are required to note the contract amount so that is one reason we have to look at it. If the contract is arms length, meaning no one is under undo pressure to buy or sell, then the contract amount is actually another reliable value indicator along with the other sales from the sales comparison approach. The comps that we use provide us with an adjusted range from which to reconcile the final opinion of value. The contract price can help support where we reconcile within that range because it was arrived at (through negotiation) through normal market forces . If the contract price is higher or lower than this range then that can also provide us with valuable information.

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