How to Bridge the Appraisal Gap in Today’s Real Estate Market

If you’re searching for drama, don’t limit yourself to Netflix. Instead, tune in to the real estate market, where the competition among buyers has never been fiercer. And with homes selling for record highs,1 the appraisal process—historically a standard part of a home purchase—is receiving more attention than ever. 

That’s because some sellers are finding out the hard way that a strong offer can fizzle quickly when an appraisal comes in below the sales price. Thus, many sellers favour buyers who can guarantee their full offer price—even if the property appraises for less. For the buyer, that could mean a large down payment or extra cash on hand to cover the gap.

Whether you’re a buyer or a seller, it’s never been more important to understand the appraisal process and how it can be impacted by a quickly appreciating and highly competitive housing market. It’s also crucial to work with a skilled real estate agent who can guide you to a successful closing without overpaying (if you’re a buyer) or overcompensating (if you’re a seller). Find out how appraisals work—and in some cases, don’t work—in today’s unique real estate environment.

APPRAISAL REQUIREMENTS

An appraisal is an objective assessment of a property’s market value performed by an independent licensed appraiser. Mortgage lenders use appraisals to lower their risk of loss in the event a buyer stops paying their loan. It provides assurance that the home’s value meets or exceeds the amount being lent for its purchase.

In certain circumstances, an appraisal can be avoided. For example, when a buyer purchases mortgage insurance because they have a down payment of less than 20%. In that instance, the mortgage insurance would cover the lender’s loss in a case of default. Or, if a buyer makes a large down payment, a lender may waive their right of appraisal.2

Additionally, sometimes a lender will use an automated valuation model (AVM) to estimate a property’s value. According to the Appraisal Institute of Canada, “AVMs are computer programs that provide real estate market analysis and estimates of value.” If the sales price falls comfortably within the AVM’s range of value, a lender may skip the formal appraisal.3

However, in the event a formal appraisal is required, it will need to be conducted by a licensed and authorized appraiser. In most cases, the appraiser will analyze the property’s condition and review the value of comparable properties that have recently sold. Using this information, they will determine the home’s current market value. Mortgage borrowers are usually expected to pay the cost of an appraisal.2

APPRAISALS IN A RAPIDLY SHIFTING MARKET

Problems can arise when the appraisal comes in lower than the sales price. And while low appraisals are not common, they are more likely to happen in a rapidly appreciating market, like the one we’re experiencing now.4 That’s because appraisers use comparable sales (commonly referred to as comps) to determine a property’s value. These could include homes that went under contract weeks or even months ago. With home prices rising so quickly, today’s comps may be lagging behind the market’s current reality. Thus, the appraiser may be basing their assessment on stale data, resulting in a low valuation.5

According to Kevin Lonsdale, Executive Director of the Canadian National Association of Real Estate Appraisers, the best valuations should be based on “data, not emotion. This emotional process where people are outbidding each other creates a disconnect and that then becomes a comparable six months down the road. It’s very difficult to value properties based on what the market wants to pay for them.”6

HOW ARE BUYERS AND SELLERS IMPACTED BY A LOW APPRAISAL?

In a balanced market, a financing condition is a standard inclusion in a home purchase offer. It enables the buyer to make the closing of the transaction dependent on their ability to secure a mortgage. And in many cases, the loan is contingent on a satisfactory appraisal, wherein the value of the property is at or near the purchase price. 

But in today’s market, sellers often hold the upper hand because the current demand for homes exceeds the available supply. That’s why many buyers are choosing to exclude the financing condition altogether, as a way to sweeten their offer in a competitive bidding process.5 

However, this approach can leave a buyer vulnerable if the appraisal comes back lower than expected. Without a financing condition, the buyer will be obligated to come up with enough cash to bridge the gap between the contract price and the appraised value—or be forced to walk away from the transaction and potentially lose their deposit.

It may seem, then, that a buyer carries the sole risk of a low appraisal. However, the sellers will have wasted time and money with little to show for it. And they run the risk that the market may have cooled or interest in their home may have waned by the time they relist.

Sellers should keep this in mind when evaluating offers. The offer price should never be the sole consideration. We weigh a range of factors when advising our clients, including a buyer’s conditions, mortgage qualifications, financial resources, and deposit size, among others.

According to Lonsdale, overheated blind bidding in Canadian real estate means that there is additional pressure on everyone involved in the transaction. With a tight timeline, there’s not always enough time for proper due diligence, putting stress on the transaction and on the buyer and seller involved.6

MITIGATE YOUR RISK WITH THE BEST REPRESENTATION

There’s never been a market quite like this one before. That’s why you need a master negotiator on your side who has the skills, instincts, and experience to get the deal done...no matter what surprises may pop up along the way. If you’re a buyer, we can help you compete in this unprecedented market—without getting steamrolled. And if you’re a seller, we know how to get top dollar for your home while minimizing hassle and stress. Contact us today to schedule a complimentary consultation.

Sources:

1. Financial Post -
   https://financialpost.com/real-estate/canadian-home-sales-prices-surge-to-new-record-in-march
2. Mortgages.ca -
   https://mortgages.ca/what-you-should-know-about-home-appraisals
3. Appraisal Institute of Canada -
   https://professional.sauder.ubc.ca/re_creditprogram/course_resources/courses/content/452/AVMPositionPaper.pdf
4. Teranet–National Bank House Price Index™ -
   https://housepriceindex.ca/#maps=c11
5. The Globe and Mail -
   https://www.theglobeandmail.com/business/article-rapid-increase-in-home-prices-puts-buyers-in-bind-when-appraisals-dont/
6. Personal Interview: Kevin Lonsdale, Executive Director, Canadian National Association of Real Estate Appraisers. 4 Jun 2021.

Could Rising Home Prices Impact Your Net Worth?

Learn how to determine your current net worth and how an investment in real estate can help improve your bottom line.

Among its many impacts, COVID-19 has had a pronounced effect on the housing market. Low home inventory and high buyer demand have driven home prices to an all-time high.1 This has given an unexpected financial boost to many homeowners during a challenging time. However, for some renters, rising home prices are making dreams of homeownership feel further out of reach.

If you’re a homeowner, it’s important for you to understand how your home’s value contributes to your overall net worth. If you’re a renter, now is the time for you to figure out how homeownership fits into your short-term goals and your long-term financial future. An investment in real estate can help you grow your net worth, build wealth over time, and gain a foothold in the housing market to keep pace with rising prices.

What is net worth?

Net worth is the net balance of your total assets minus your total liabilities.Or, basically, it is what you own minus what you owe.2

Assets include the cash you have on hand in your chequing and savings accounts, investment account balances, salable items like jewelry or a car and, of course, your home and any other real estate you own.

Liabilities include your total debt obligations like car loans, credit card debt, the amount you owe on your mortgage, and student loans. In addition, liabilities would include any other payment obligations you have, like outstanding bills and taxes.

How do I calculate my net worth?

To calculate your net worth, you’ll want to add up all of your assets and all of your liabilities. Then subtract your total liabilities from your total assets. The balance represents your current net worth. 

Total Assets – Total Liabilities = Net Worth

Keep in mind that your net worth is a snapshot of your financial position at a single point in time. Your assets and liabilities will fluctuate over both the short term and long term. For example, if you take out a loan to buy a car, you decrease your liability with each payment. Of course, the value of your asset (the car) will depreciate over time, as well. An asset that is invested in stocks or bonds can be even less predictable, as it’s subject to daily fluctuations in the market.

As a homeowner, you enjoy significant stability through your monthly real estate investment, also known as your home mortgage payment. While the actual value of your home can fluctuate depending on market conditions, your mortgage payment will decrease your liability each month. And unlike a vehicle purchase, the value of your home is likely to appreciate over time, which can help to grow your net worth. Right now, your asset may be worth significantly more than it was this time last year.3

If you’re a homeowner, contact us for an estimate of your home’s market value so that you can factor it into your net worth calculation. If you’re not a current homeowner, let’s talk about how homes in our area have appreciated over the last several years. That way, you can get an idea of how a home purchase could positively affect your net worth.

How can real estate increase my net worth?

When you put your real estate dollars to work, it’s possible to grow your net worth, generate cash flow, and even fund your retirement. We can help you realize the possibilities and maximize the return on your investment.

Property Appreciation

Generally, property appreciates in one of two ways: either through changes to the overall market or through value-added modifications to the property itself.

1. Rising prices

This type of property appreciation is the one that many homeowners are enjoying right now. Buyer demand is at an all-time high due to a combination of low interest rates and limited housing inventory.4  At other times, rising home prices have been attributed to different factors. Certain local conditions—like a new commercial development, influx of jobs, or infrastructure project—can encourage rapid growth in a community or region and a corresponding rise in home values. Historically, home prices have been shown to experience an upward trend punctuated by intermittent booms and corrections.5

2. Strategic home improvements

Well-planned and executed home improvements can also impact a home’s value and increase homeowner equity at the same time. The type of home improvement should be appropriate for the home and in tune with the desires of local buyers.

For example, a tasteful exterior remodel that is in keeping with the preferences of local home buyers is likely to add significant value to a home, while remodelling the home to look like the Taj Mahal or a favourite theme park attraction will not. A modern kitchen remodel tends to add value, while a kitchen remodel that is overly expensive or personalized may not provide an adequate return on investment.

Investment Property

You may be used to thinking of investments primarily in terms of stocks and bonds. However, the purchase of a real estate investment property offers the opportunity to increase your net worth both upon purchase and year after year through appreciation. In addition, rental payments can have a positive impact on your monthly income and cash flow. If you currently have significant equity in your home, let's talk about how you could put that equity to work by funding the purchase of an investment property.

1. Long-term or traditional rental

A long-term rental property is one that is leased for an extended period and typically used as a primary residence by the renter. This type of real estate investment offers you the opportunity to generate consistent cash flow while building equity and appreciation.6

As an owner, you don’t usually have to worry about paying the utility bills or furnishing the property—both of which are typically covered by the tenant. Add to this the fact that traditional tenants translate into less time and effort spent on day-to-day property management, and long-term rentals are an attractive option for many investors.

2. Short-term or vacation rental

Short-term rentals are often referred to as vacation rentals because they are primarily geared towards recreational travellers. And as more people start to feel comfortable travelling again, the short-term rental market is poised to become a more popular option than ever in certain markets. In fact, with travellers continuing to seek out domestic options in lieu of international travel, this may be the perfect time to consider an investment in a short-term rental property.7

Investing in a short-term rental offers many benefits. If you purchase an investment property in a top tourist destination, you can expect steady demand from travellers while taking advantage of any non-rented periods to enjoy the home yourself. You can also adjust your rental price around peak demand to maximize your cash flow while building equity and long-term appreciation. 

To reap these benefits, however, you’ll need to understand the local laws and regulations on short-term rentals. We can help you identify suitable markets with investment potential.

WE’RE HERE TO HELP

Ready to calculate your personal net worth? Contact us for an easy-to-use worksheet and to find out your home’s current value. And if you want to learn more about growing your net worth through real estate, we can schedule a free consultation to answer your questions and explore your options. Whether you’re hoping to maximize the value of your current home or invest in a new property, we’re here to help you achieve your real estate goals.

The above references an opinion and is for informational purposes only.  It is not intended to be financial advice. Consult the appropriate professionals for advice regarding your individual needs.

Sources: 

1. Financial Post -
   https://financialpost.com/real-estate/canadian-home-sales-prices-surge-to-new-record-in-march
2. Forbes -
   https://www.forbes.com/advisor/investing/what-is-net-worth/
3. Global Property Guide -
   https://www.globalpropertyguide.com/North-America/Canada/Price-History
4. Canadian Real Estate Association -
   https://creastats.crea.ca/en-CA/
5. Trading Economics -
   https://tradingeconomics.com/canada/housing-index
6. Canadian Apartment - https://www.reminetwork.com/articles/hopeful-outlook-for-canadas-rental-market/

7. MoneySense -
   https://www.moneysense.ca/spend/real-estate/is-now-the-time-to-buy-a-vacation-home/