I recently had a refinance client who got their home appraised for $1,000,000. You would think this would be good news, except that the client was expecting $1.2MM. Uh oh, I guess we didn’t get good news. However, the more important question is, did we get accurate news? In other words, was the appraisal valuation accurate and were the comparable sales used in the appraisal appropriate? This is where the debate started.
What makes for a good comparable?
What would be considered appropriate comparable sales is open to interpretation, but it really shouldn’t be. Quite simply, the best comparable sales are ones that are most similar to the subject property in size, finish level, property type, bedroom and bathroom count, lot size, etc.
Does bias ever come into play?
The debate comes when some parties who are biased try and stretch logic and compare the subject property to homes that are obviously not comparable. In this specific case the homeowner had some bias, as all of us who are homeowners do, thinking that the home was worth more than reality may dictate. A realtor friend of his who was suggesting other comparable sales to help boost the appraisal value also had some bias, because he wanted to help his former client and friend.
One story from a client
I’m going to copy some of my exchange below with the client mentioned above, after the appraisal came in, to help illustrate how people can choose poor comparable sales:
Client: “This appraisal value looks really low. I have a neighbor that is a big realtor in the area. Should I ask him for comps?”
Me: “Sure, that may help. Thanks.”
Client: “Brian, Just got off the phone with the realtor. He has some information that may be helpful. The comp that is really hurting me is comp #2. The realtor I spoke to sold that house. It was a fast sale, way under the market. The owner, an older lady, just wanted out. She had been renting it. She told him all she wanted was $1MM and a buyer immediately snatched it up for cash. He said that sale was a fluke, but of course it’s a sale.
It goes on…
He said there were two closings this week. One for $1.32MM, the other for $1.28MM. He said if we could substitute these comps I should be fine. He told me he could easily sell my house for $1.25MM because of our street and because I have a lot and a half.
The part of the street where I live is the second best street in the area because it’s a full sized street with parking on both sides. Other parts of our street are one way, which prevents people from using it as a through street. When you get to my part of the street it’s a two way street. So we have very little traffic on it. Also my street ends at the water, but there is an intersecting street just before the water, so it’s easy to get out of, unlike most of the town, which is one way, necessitating backing up.
The former Mayor and ex-CEO of the local electric utility lives on my street a few houses down.
The reason I’m telling you this is this is rationale for coming in with a higher number. This realtor I know is the number one guy selling homes in the area, he owns several properties here and lives a few doors down. He’s a good friend, and knows what he’s talking about with respect to valuing and selling the house. Anyway the realtor said he would be willing to speak with you or your appraiser and let him know why the value is too low.”
My research and the facts
At this point I stopped and did some research on the two recent sales that the realtor suggested we review to try and challenge the appraisal value. The client and realtor were providing a lot of information that did not apply, like who one’s neighbors are, if the street is one-way or not, if the realtor is a top realtor, etc. There was a lot of emotion and grasping at straws. There was also some factual data, but the question was, was it good data for the appraisal?
The subject property is a 2,000 square foot, un-renovated cottage with 3 bedrooms. The realtor’s comps were stunning, recently renovated, 2,500 and 2,900 square foot, 4 bedroom, Spanish Colonial style homes. Huh? How are those comparable? My detailed findings and my reply are below.
Me: “Thanks for sending the data that the realtor pulled up. A few important things that I have found after doing some research:
Greater care in analyzing the comparable sales should have happened. I am going to do my best to deliver you the blunt truth, in a very clear headed and detailed way, and hope it comes off as factual and not offensive. We all hold our homes in high regard, but the reality is that he has not provided accurate comps. His intentions are good, but his analysis is off.
Comp #2 is not the comp that is really hurting you. If we pulled that one comp out, we are still left with two other comps that sold for right around $1MM, and their bottom line values after adjustments are right around $1MM. So the reality is that all three comps are affecting the value, not just the #2 comp.
The new comps are not comps
The comps that he provided are much larger and nicer, and no appraiser or any underwriter would consider them to be actually comparable. They are not only larger, they are different style homes. The first one he sent has got a very high finish level and is quite a bit larger. Your home is not renovated and is about 2,000 square feet. His first suggestion for a new comp is 2,500 square feet and renovated. And it’s a large Spanish style Colonial whereas your home is more a cottage style. The other one he is talking about is a monster at 2,900 square feet, also has a very high finish level, and is also a very different style of home. These homes are both quite a bit larger, and have higher levels of finish. And they simply represent a very different, more substantial style of home.
If these new comps were used by the appraiser, after the appraiser adjusted these new comps downward for the extra square footage of the new comps, as well as the higher finish level and different style of home, you’d be right around the same value we have now. But it would take such big adjustments that no appraiser would use those comps, because the homes are simply not comparable/similar. And since there are other comps much closer in square footage and level of finish, and style of house, no appraiser would use these larger comps when more comparable data exists. As appraisers say, you can’t leapfrog pertinent data to cherry pick bigger and nicer comps, that’s not how an appraisal is supposed to work.
Pertinent data: Fannie Mae allows for the use of comparable sales from a greater distance than normal, that may not be perfectly comparable, but only in the absence of more comparable sales (as seen in paragraph 4 of this page from the Fannie Mae guide).
How do adjustments work?
A lot and a half is definitely worth something extra, and the appraiser did adjust for it. But you can’t take the assumed value of a dirt lot, and tack 50% of that figure onto your value because you have an extra half lot. The market does not value things that way, nor do appraisers. The home is supposed to hold most of the value. And if you could sell the lot and a half for a substantial price, that is because a builder would pay you that substantial price, and build a much larger, more finished, more substantial style of home, and recoup his money back for the lot premium he paid you.
But a home appraisal is focused on the home, and someone buying the house is supposed to be buying it for the house, not the lot value. That is why builders pay cash for lots, and then build McMansions to recoup their lot premium. No one would pay you the $1.25MM the realtor was suggesting if they were going to tear your house down, and rebuild the exact same house. The only way you’d get $1.25MM, possibly, is if a developer bought it, and tore it down and built a substantially larger house. In other words, a residential appraisal can’t rely heavily on lot value, it has to focus on the home.
Is it really under market?
And comp #2 being way under market is a story I have heard many times before. It may be true, but that is really hard to assess in a non-biased environment. I have heard places supposedly sell under market value due to divorce and all kinds of other stress related reasons. The reality is the style, condition and square footage of comp #2 are fairly close to your place. And the marketplace is an efficient place. If comp #2 was worth $1.1 or $1.2MM someone likely would have come along and bid it up, and quite frankly no realtor would usually let a seller list a home at 10-20% below market value.
If the realtor really thought the place was worth $1.1MM or $1.2MM, the list price would have been higher and he would have had a conversation with the seller that she was giving away a substantial amount of money, and that he would not suggest it. And if it was way below market, the market is so tight, with such limited inventory, multiple buyers would have come along immediately and recognized the value and bid up the price with multiple offers and paid more money.
A distress sale does not often happen in markets like we are in now. When the market is slow, inventory is high, and people need to undercut the market to find a buyer because they are in a hurry for whatever reason, that is when homes sell below value. The story just doesn’t make sense in today’s market with limited inventory with way more demand than supply.
The rest of the story
A realtor is supposed to bring the highest and best price for the client, at all times. A realtor should make sure it is exposed to the market for a sufficient time, price it right, and get top dollar for the client. I am sure the realtor did his job and got the best price he could. And as you say, a sale is a sale. But even pulling that sale out, the other comps suggest the appraisal is accurate, or very close. So we can discount this one comp #2, but other comparable sales still says the value is not higher than where we are now with the current appraisal.
Without other comps that are truly comparable, and similar in size, style of home, finish level, etc.; there is no way an appraisal challenge will be won with the data the realtor pointed out. I am afraid we are still where we were when we first started this appraisal discussion.”
The discussion has not ended, there is going to continue to be debate I am sure. After reading this, can you see how the comparable sales they are using are nowhere near comparable? Feel free to comment.
The number one realtor in this homeowner’s area shocked me in one sense. They suggested new comps that were 25% – 45% larger! And they were new and stunning compared to the somewhat tired subject property. How are those comparable? Bias, that is how those are comparable.