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Buyers are paying to bridge the appraisal gap

Remember the good old days, when single-family home buyers would offer appraisal gap coverage to make sure they were making the best offer? Now, they’re including it just to get noticed, according to multiple agents from brokerages across the country.

Single-family home sellers are regularly getting multiple — and sometimes dozens — of offers in markets nationwide, and transactions are closing at record speeds. In some places, buyers are being given 15 minutes to walk through, if they get inside the home at all, and often less than 24 hours to write and submit a competitive offer. 

And “competitive” in today’s low-inventory, high-demand market has taken on a whole new meaning, with homes regularly selling for thousands over list price, and buyers who need to secure financing going up against all-cash investors. With all this money flying around, sellers are accepting sky-high offers from overeager buyers who find they’re at risk of falling into the appraisal gap.

What is the appraisal gap?

Writing coverage of the appraisal gap — the difference between the offer and the appraised amount the bank will lend on — into a sales contract isn’t a new negotiation tactic for a hot market like the one we’re in. But agents across the country report it’s become increasingly common in the last several months.

“I make sure my buyers [really understand that] it’s going to turn into a bloodbath,” said Alison Malkin, who’s head broker and owner of RE/MAX Essentia and is licensed in Connecticut, Massachusetts and Florida. “I ask them up front if they have to buy right now, because it’s going to be an arduous process. You’re going to be frustrated, and you’re going to spend 20% more than you wanted to.”

Malkin recently listed one client’s home for $210,000 and was immediately bombarded with 22 offers, topping out at $280,000. Her sellers chose one at $239,000, and the lucky buyers had to come up with an “extra” $29,000 to cover the appraisal gap. 

Creative, yet risky, ventures

Here’s where buyers need an agent who knows the area, the market and how to get creative: For another recently closed sale, Malkin’s buyer clients found a particular home that fit their specific and urgent needs, so Malkin reached out to the seller’s agent, who she’d worked with for many years, and found out what the sellers had to have. In this case, the home needed some work, and Malkin’s buyers were willing to do the manual labor before signing a sales contract — essentially improving someone else’s property with no solid promise the deal would go through (it did).  

Preparing buyers to come immediately with their highest-and-best offer and be ready to back up their offer with actual cash (or sweat equity, as it were) is essential right now, Malkin said. As is making sure buyers understand that appraisal gap cash is essentially gone. She said she’s been asked several times by buyers when they can expect equity gains in their purchased home to make up the difference in what they paid the sellers. “I tell them no one knows, and they need to decide if getting this house is worth it to them.” 

Eli Tene, managing director of CENTURY 21 Peak Corporate Network in Woodland Hills, Calif., agrees with Malkin that agents need to make sure their buyer clients know exactly what they’re signing up to pay for, and are only offering what they can truly afford.

“Appraisals aren’t an exact science, and they’re not always fast enough to catch up with the market value … the price someone is willing to pay for a property,” Tene said. “The appraisal process can’t calculate the emotional value of homeownership, nor the current appreciation in value.”

Tene is referring to the appraisal gap that occurs when home values increase faster than the comps can keep up, which is another issue that’s complicating transactions for both buyers and sellers. Malkin said appraisal values, and therefore comparable sales, in her area are “catching up” to market values, but “buyers keep offering even higher than that,” which will likely continue while demand outpaces inventory at such remarkable rates.

Buyers right now have a few options in the Denver, Colo.-area, market, said Angelica Olmsted, an agent with RE/MAX Professionals Cherry Creek: They can come with cash and bid (appropriately) high, look at “less-desirable” properties — condos with no outdoor space, for example — or look at new builds. Olmsted said the Denver-area buyers’ market is especially cutthroat for single-family homes listed at $650,000 and below, and says she’s consistently telling her clients to be ready to pay 10 to 15% more than list price, and to have that cash on hand to cover the appraisal gap.

Pick up the phone

“What buyers’ agents need to be doing right now is picking up the phone and calling sellers’ agents instead of just relying on comps,” Olmsted said. “Appraisal gaps can be confusing. I have clients repeat back to me exactly what they’re agreeing to do to make sure they understand.”

Managing buyer expectations, researching the most recent area comps and helping clients “be 75 to 80% sure” they want a house before they even walk through the door is how Laura D’Ardenne, broker/co-owner of RE/MAX of Cherry Creek in Denver is keeping her buyers’ best interests in mind while meeting them where they’re at.

“It really depends on the type of buyer and where they’re coming from,” D’Ardenne said. “Have they been saving for years and years and this is really cutting into their budget? Or, are they recent sellers taking advantage of a large gain? I don’t make any assumptions about the financial position a client is in, and just give them up front the reality of the market.” 

And the reality is that some buyers are going extreme routes to get the money they need to outbid the hordes of other buyers and cover a sometimes-gaping appraisal gap.

“I don’t want my clients to be overpaying,” D’Ardenne said. “But that’s where we are.” 

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