One of the greatest challenges for a real estate property appraiser is balancing the expectations of your clients. Sometimes challenges arise because a client asks for an appraisal, but they don’t understand the difference between that and a valuation.
Here’s what can potentially go wrong – along with tips for appraisers to avoid a lawsuit.
What Can Go Wrong
Seller Side Appraisals
Sellers often request an appraisal before putting a house on the market. It’s not uncommon for a seller to use that appraisal as a basis for ‘shopping’ for their next house. However, they need to understand that an appraisal is an educated guess based on the current market and: a) It can change as the market changes and b) It’s not a valuation (which may in fact be lower).
Here’s an example scenario of what can go wrong:
The disgruntled seller
Clients are ready to place their house on the market, and they order an appraisal. The appraiser appraises the property at $450,000. The sellers then quickly decide to sell and start advertising the home while also shopping for their new property.
They find a property valued at $600,000 which they feel is tight with their current budget, but doable given their $450,000 appraisal. They put in an offer on the new property, and it’s accepted.
Meanwhile, the home they’re selling sits stagnate on the market for months. Since the appraisal, a few comparable homes in the neighborhood have sold for only $420,000-$430,000. Potential buyers are interested, but they keep getting declined for financing, because the official bank valuation of the home only came in at $400,000.
The sellers have to cancel the purchase of their new home, because they don’t have sufficient funds without a $450,000 sale price. They lose their deposit. Then the sellers decide to sue the appraiser, because they’ve lost money allegedly due to a bad appraisal.
Buyer Side Appraisals
A homebuyer may (wrongly) rely on an appraisal, thinking it will be enough to get the mortgage they so badly want. However, they need to understand their finance provider, bank, or insurer may actually value the property much lower than the appraisal. So, while an appraisal is a guide, it cannot be used to make financial decisions.
Here’s an example scenario of what can go wrong:
The disgruntled homebuyer
Prospective buyers find a home they love. It’s a hot real estate market, and they have to act fast to get their offer in. Otherwise, they might miss out on the home. They feel if they wait for the bank property valuation, it will be too late, so they request an appraisal. The appraisal comes back at $695,000, but the appraiser didn’t make it clear that the bank valuation would likely be different (and possibly less).
The buyer immediately puts in an offer slightly over-ask at $705,000 to secure the property. The offer is accepted. However, when it comes to their mortgage approvals, the bank values the home at just $650,000. This means the buyer has to find another $55,000 on top of their already sizable deposit. They didn’t make their offer on the home contingent on financing approvals, so if they cancel, they will likely lose their deposit too. The buyers decide to sue the appraiser for the inconvenience and extra costs they need to pay.
Tips for Appraisers to Ensure the Difference Between an Appraisal and a Valuation is Clear
Be clear about what you’re offering
Be clear from the outset that the appraisal is an educated assessment of the property’s selling potential based on these main factors:
- The property’s age, size, structure, condition, and location
- The real estate market
- Recent sales in the neighborhood
This comparative market analysis is useful to give an estimate of a property’s potential market value. But, it is not a valuation.
Explain the difference between an appraisal and a valuation upfront to clients
A valuation is very much based on the facts and not so much on the less concrete factors of the home’s appeal. Valuations are typically ordered by banks, financial institutions or insurers and they will normally take a conservative view of the property’s value. Through valuation, the banks are looking for an estimated price they would get if the property had to be sold. Foreclosures can happen in the event a buyer defaults on mortgage payments. Insurers are looking for a realistic price for replacement should a property be severely damaged or destroyed.
Ensure your clients understand that an appraisal is a ‘point in time’ assessment
An appraisal in November 2022 will likely be quite different to an appraisal in May 2023. The client needs to understand that real estate appraisals are a ‘point in time’ assessment using the current market information. Changes in the market will mean the appraisal will change. On the other hand, a valuation ordered by a bank or insurer may be valid for a longer period.
Make sure you have adequate insurance
Real estate appraisers should have an Appraiser Errors and Omissions insurance policy. This protects you and your business if a client sues you for an incorrect appraisal, an oversight, or even just because they’re a disgruntled client.
CRES has access to more appraiser E&O options than just about anyone else (we’re part of one of the largest insurance brokers in the world). We’ll do the shopping for you – to ensure you get the best protection for the best price.
Every CRES E&O + ClaimPrevent® insurance policy includes access to qualified real estate attorneys to help you prevent claims. Contact the CRES team at 800-880-2747 for a confidential discussion today.