What Is an Appraisal Gap in Real Estate? Everything Sellers and Buyers Must Know!

You've found your dream home, made an offer, and crossed your fingers, only to discover that the appraised value falls short of the agreed-upon purchase price. Cue the confusion, frustration, and frantic negotiations. But don’t worry! In this article, we dive deep into what an appraisal gap is in real estate, empowering you with the knowledge and strategies to navigate it like a seasoned pro.

What Is An Appraisal Gap?

An appraisal gap is the difference between the appraised market value of a property and the price agreed upon by the buyer and seller. 

The appraised value is an unbiased estimate of what the property is truly worth, determined by a professional appraiser. This figure is meticulously calculated based on a variety of factors, including the home's condition, location, and the selling prices of comparable homes nearby. 

On the flip side, the purchase price is the amount the buyer agrees to pay for the property, often a figure reached after negotiations with the seller.

In the upcoming sections of this blog post, we’re going to explain the causes of appraisal gaps and what to do if you’re facing one.

If you want more information about home appraisals, check out our Property Appraisals 101 guide.

Causes of Appraisal Gaps

Now that we’ve answered the question “what is an appraisal gap in real estate?”, let's delve into the factors that lead to appraisal gaps. 

Hot Real Estate Market

In a hot or competitive real estate market, demand outstrips supply, pushing property prices to soar. Buyers, caught in the fervor of finding their dream homes, are often willing to pay premium prices to outbid the competition. 

However, appraisals are grounded in data, including recent sales of comparable properties, which may not keep pace with these rapidly escalating market prices. As a result, a significant gap can emerge between the heated market price and the cooler, data-driven appraised value.

Bidding Wars

Bidding wars are common when multiple buyers set their hearts on the same home, the competition can drive the purchase price well beyond what might be considered reasonable based on comparable sales. This frenzy, while beneficial for the seller in the short term, often leads to appraisal gaps.

Limited Housing Inventory

Sellers play a pivotal role in setting the stage for appraisal gaps through their expectations and listing prices. In some cases, sellers might set their listing price based on what they believe their home is worth, which can be influenced by emotional attachment, improvements made to the property, or even the need to cover their own financial obligations. 

However, if these expectations are not aligned with the market reality—represented by the appraised value—an appraisal gap is very common. 

Seller Expectations

Sellers play a pivotal role in setting the stage for appraisal gaps. Their expectations, whether realistic or inflated, often shape the trajectory of real estate transactions. In a seller's market, where demand outpaces supply, it's tempting for sellers to set lofty listing prices in the hopes of cashing in on the frenzy. 

However, when appraisers deliver their verdict, sellers may be faced with a sobering reality – their property's value may not align with their expectations, leading to appraisal gaps and renegotiations.

The Impact of Appraisal Gaps on Buyers and Sellers

So, what does all this mean for buyers and sellers during their real estate transactions?

For buyers, the primary issue will be the need to bridge the gap between the appraised value and the purchase price with additional funds. Since lenders base the loan amount on the appraised value, a lower-than-expected appraisal means the loan might not cover the agreed-upon purchase price. 

This leaves buyers with a few options: they can either renegotiate with the seller about the sale price, pay the difference in cash, or even walk away from the deal, especially if the appraisal gap is too significant to bridge through available financial means.

Sellers face their own set of challenges when an appraisal comes in lower than the agreed sale price. They might need to lower the sale price to match the appraised value, which can be a tough pill to swallow, especially if the seller has financial goals tied to the sale proceeds. Lowering the price not only affects the seller's return on investment but may also influence their future real estate or financial plans.

An appraisal gap can also put the entire deal at risk. Buyers might not be able, or willing, to cover the difference, leading to renegotiations that can fall through, thus putting the seller back at square one.

If you’re a seller and want to learn more about home appraisals, check out this blog post.

Strategies to Address Appraisal Gaps

Navigating through an appraisal gap requires strategic thinking from both buyers and sellers and sometimes creative financing solutions.

Renegotiation:

Renegotiating the purchase price is a common strategy to bridge the appraisal gap. Here are some tips for both buyers and sellers:

• For Buyers: If the appraisal comes in lower than expected, present the appraisal report to the seller as a basis for renegotiating the price. It's important to approach this conversation with empathy and facts, understanding that sellers have their expectations.

• For Sellers: Be prepared to consider lowering your price to keep the deal alive, especially if the buyer cannot cover the gap or obtain additional financing. Review the appraisal report carefully to understand the valuation.

Challenging the Appraisal:

Sometimes, the appraisal might not accurately reflect the market value due to overlooked comps, incorrect information, or other factors. Here’s how to challenge an appraisal:

• Gather Evidence: Collect data on recent comparable sales that were not included in the appraisal report, evidence of errors in the report, or information on unique features of your property that add value.

• Request a Review: Contact the lender or company to request a review of the appraisal. Provide the evidence you've collected to support your case for a higher valuation.

• Consider a Second Opinion: If the first appraisal cannot be contested or if you strongly disagree with its findings, you may ask the lender if a second appraisal is allowed, though this may come at an additional cost if permitted.

Alternative Financing:

When renegotiation and challenging the appraisal are not viable or successful, exploring alternative financing options can be a solution for buyers:

• Contingency Clauses: Some contracts include appraisal contingency clauses that allow buyers to renegotiate or exit the deal if the appraisal comes in low. 

• FHA 203(k) Loans: For properties needing repairs or renovations, an FHA 203(k) loan can provide funds for both the purchase and the necessary improvements, potentially addressing the appraisal gap.

• Personal Loans or Gifts: Buyers might consider securing a personal loan or receiving a monetary gift from family to cover the gap, though this depends on individual financial situations and the willingness of lenders to accept such arrangements.

• Seller Financing: In some cases, sellers might be willing to offer financing for the gap, creating a note payable to them by the buyer over a set term.

What is an Appraisal Guarantee in Real Estate?

An appraisal guarantee, or appraisal gap coverage, is a commitment usually made by the buyer to the seller, indicating that the buyer will cover any shortfall between the appraised value of the property and the agreed-upon purchase price up to a certain amount. This guarantee is often included in the offer to purchase a property or the purchase contract as a way to make the bid more attractive to sellers, particularly in competitive markets where appraisal gaps are more likely to occur.  

The mechanics of an appraisal guarantee are straightforward but require careful consideration and negotiation. For instance, if a buyer offers $300,000 for a home and includes an appraisal guarantee of $20,000, they are essentially promising to cover any appraisal gap up to $20,000. If the home is then appraised at $290,000, a $10,000 gap exists. Thanks to the appraisal guarantee, the buyer agrees to bring the additional $10,000 to closing, thereby ensuring the deal proceeds without requiring a renegotiation of the sale price.

An appraisal guarantee can be a powerful tool in a real estate transaction. However, like any financial decision, it requires thorough analysis and prudent consideration of one's financial situation and the dynamics of the local real estate market.

If you want to learn more, check out these 4 things to know before your real estate appraisal.

Empower Yourself with Knowledge

Successfully navigating an appraisal gap often requires openness to negotiation, a willingness to explore all options, and, importantly, clear communication between all parties involved. 

Ready to embark on your real estate journey with confidence? Schedule a consultation with our team of experts today and equip yourself with the knowledge and insights you need to navigate the complexities of appraisal gaps like a seasoned pro. Don't let uncertainty hold you back – take the first step towards your real estate goals today.