For multiple years now, insufficient supply on the residential real estate market has made buying property a relatively competitive process. Buyers often need to come to the table with their best offers if they have any hope of the seller selecting their offer from the multiple offers they may likely receive.
Buyers, under the instruction of their agents, often lead with the highest purchase price that they think is reasonable given the current market and the condition of the property. Those making more generous offers obviously stand out from the crowd, but they also put themselves in a risky position.
The more people offer when acquiring real property, the greater their chances of an appraisal gap. An appraisal gap could potentially prevent a transaction from going through in the worst-case scenario.
What causes an appraisal gap?
When buyers make a generous offer on a property, the amount they agree to pay is a reflection of both what they think the property is worth and how much financing they have available. Mortgage companies can offer financing to those who meet certain credit standards, but they also want to ensure that the property meets certain standards.
In addition to requiring inspections, it is common practice for lenders to require an appraisal as well. An appraiser is a professional with training to determine the fair market value of a property. They look at the sale price of comparable properties and the details of a property’s condition to determine what it is truly worth. If the appraisal returns a lower value for the property than the amount offered by the buyer, that is an appraisal gap. Buyers typically only have a few options when an appraisal gap causes issues in a residential real estate transaction.
They can either renegotiate with the seller based on the difference in value or cover the difference in value themselves. Otherwise, they may end up needing to cancel the purchase. Depending on the circumstances, a buyer’s earnest money could be at risk if they overextend themselves when making offers. It is, therefore, important to include the right contingencies when submitting offers to sellers and to ensure that the price offered for a property is a realistic reflection of what it may be worth on the current market.
Identifying potential issues before they arise can take some of the risk out of residential real estate transactions. Buyers who know an appraisal gap could be an issue can use that knowledge to mitigate their risk when making offers.