How Do Appraisal Contingencies Impact Contract Acceptances?

In all the moving parts and people involved in a real estate transaction, there are 2 figures that are viewed as having a God-like control over the deal coming to fruition: the underwriter and the appraiser. Today we will delve into how a new tactic that was once virtually unheard of, is now a commonplace strategy for winning the offer. But first, let’s talk about what an appraisal is and why it is such a crucial element in the real estate transaction.

WHAT IS AN APPRAISAL?

An appraisal is an opinion of value and there are many ways to arrive at that figure. For purposes of a residential transaction, the “sales comparison approach” is generally used. This method looks at recent sales in the area that are similar in size and structure to the subject property.  Let’s say the subject property is a 3-bedroom, 2 full bath, two-story home that is 2k square feet. It has an attached garage with a finished basement. The appraiser will then look at the most recent sales in the area that have these components. 

But what if comparable house A doesn’t have an attached garage like the subject? Or comparable house B is only 1800 square feet? And comparable house C only has one full bath and one-half bath? In these cases, the appraiser will make adjustments of value as necessary to arrive at the valuation of the subject property. 

Once this valuation is made, it is essentially set in stone once the appraiser marks it “as is” on the appraisal. This report is then sent to the lending institution. The buyer’s loan is at the mercy of this appraisal, as the bank will not say those 3 magic words, “clear to close,” if the contract price does not match the appraised value. 

WHAT IS AN APPRAISAL GAP?

Let’s say the buyer is under contract to purchase the home for $200k. However, the appraisal comes back with a value of $195k. Considering the climate of today’s real estate market, today’s buyers are now often willing to “bridge the gap,” per se and pay the difference out of pocket. 

The appraisal contingency is an integral part of the real estate purchase contract that could even become a bargaining chip in negotiations. Much like the inspection contingency, the finance contingency is predicated upon the appraisal contingency. Just as if something surfaced during the inspections that the buyer disliked, the buyer was protected and had the ability to walk away from the deal or ask the seller to make repairs. Similarly, if the appraisal did not come in at the agreed-upon sale price, the buyer and seller could renegotiate the sales price to meet the lender’s requirements. After all, the bank is not going to give the buyer $200k if the appraiser said the house is only worth $195k, right? This is precisely where an appraisal gap contingency written in the purchase offer can help win the deal.

It's common to see multiple offers in today’s real estate market. Escalation clauses are frequently used in order to convey the buyer’s willingness to go up in price, without committing to that price in the initial purchase offer. With the scarce market inventory, today we not only see escalation clauses being utilized but also the appraisal gap clause. 

TO EACH THEIR OWN…

If an appraisal gap clause is written in the initial purchase contract offer, this gives the seller peace of mind. They know that regardless of what the appraised value ends up being, the buyer is willing to pay cash out of pocket to override the discrepancy and give them the money they want for the house. While many buyers find it unheard of to ever pay over the asking price, much less over the appraised value, in the current market, buyers are willing now more than ever to do both to win the bidding war and take part in the American dream of homeownership.