We continue to see a red hot market with little inventory and plenty of competition. This means that buyers are still making above asking price offers. It also means that you have to figure out how to bridge the appraisal gap. This podcast examines the market stats that create this market. I also discuss the difference in appraisal contingencies and appraisal gap clauses. Lastly, I discuss issues that could kill your deal as well as how to draft language to covers all aspects of the appraisal gap transaction.
Also, another episode of Gary's Good News Only!
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Gary serves on the South Carolina Real Estate Commission as a Commissioner. The opinions expressed herein are his opinions and are not necessarily the opinions of the SC Real Estate Commission. This podcast is not to be considered legal advice. Please consult an attorney in your jurisdiction for applicable legal advice germane to your issue.
Dirt with Gary Becker in South Carolina's only podcast dedicated to the real estate agents crap. And welcome back to another episode of deshon dirt I am your often opinionated, but rarely wrong host Gary Pickering. And I am coming to you again from Blair Cato Pickering caster lon, in downtown Columbia, South Carolina. Well, guys, I'm very excited about our topic this week. You know, last week I had the pleasure of being on a panel or the Central Carolina realtors Association. And the topic we're going to talk about today was raised and listening to that question, as well as the numerous comments we got on it. I realized it was time for a podcast on this very topic. I think so because this is a very timely issue in our market, just like escalation clauses are. And of course, what I'm talking about is the appraisal gap issue. How do we cover the appraisal gap issue when the appraisal and the sales price are two different numbers. Of course, Gary's good news only is going to be full of stats and facts on COVID, particularly this new Delta variant, and you're going to hear what you'll never hear from your media. So I hope you will stay tuned for that at the end of our show. But before I start, I would like to ask you, please do me a favor to like us, subscribe to us and share us with as many agents as you can. before the show, I went and I checked Apple podcasts, and we have 43 five star ratings. If you're listening on Apple, go out there and click that five star rating button for me because of course, that would be the only number of stars this show would deserve to be five stars, the more of these five star ratings I can get and the more downloads we get, the better content I can provide you. So let's jump right into our topic because there's a lot to talk about today is the appraisal gap. And what we're talking about is the difference between the purchase price and the appraisal that the lender does. And how do we handle that gap especially when the the appraisal price is less than the purchase price. And before we start with that I do want to give a little market news because I think the market news and where we are in the market explains why this is in fact an issue. This is only coming from the Central Carolina area. This is from the consolidated Multiple Listing services or the their stats, but this is from June. And I think this is indicative of the entire state of South Carolina and probably for the entire country. So the average sales price of the central Midlands area is up 15% I think we are all seeing that happen as to inventory. Let's look at it in two different ways. We'll look at my price range as well as by months of inventory for all types of houses and all types of price range. We are at 0.8 months of inventory this time last year we're at 1.7% down 52.9% since last year for single family houses. Last year, we were at 1.7 months of inventory, we're now to 0.7 months of inventory that is a 58.8% decrease. condos were at two months of inventory. We're now down to 1.4, which is a 30% decrease. The bigger problem is when you look at it based on prices, they $150,001 to $200,000 price range, we were at 1.2 months of inventory, we're now down 2.5 months of inventory, that's a 58.3% decrease. If you look at just single family housing 1.1 month last year, we're down 2.4 months of inventory half not even half a month of inventory. And that price range that's like a two and a half week of inventory. That 63.6% decrease. When you look at the 200 to 300 range. We had two months of inventory this time last year we're now down to point six so barely half a month a little over half a month you're talking to two and a half weeks of inventory 70% decrease for single family housing it was two months and it is also at point six. That's bad. Now let's look at my housing units and all price range in the Midlands. We had 2056 houses on the market this time last year. We're down to 1000 109 for the month of June. That's a 46% point 1% decrease 1800 96 family single family houses on the market this time last year for the month of June. Now we're down to 956 that is a 49.6% we had 151 condos last year 147 this year that's a down that's down 2.6% so condos are holding steadier than single family housing, boil it down even farther and look at that $100,000 and below price range. We went down from 192 to 113 houses that's a 41.1% decrease for the 101,000 $100,001 to 150,000 market. We went from 219 houses down to 134 houses a 38.8% and then we had $150,001 200,000 we went from 350 houses to 150 houses as a decrease of 57%. So across the most soul price ranges in the in this day, the median house price in this day. As you can see here in the Midlands, we are down 38 to 57% depending on that price range. I mean we are way down. And then when you look at percentages of list prices received this is what the list price was and what percentage of that listing did they receive all price ranges Last year 97.9% of the list price was received as a final sales price. This year we're at 99.3%. That's up 1.4%. for single family housing it went from 98% to 99.4%. Which is up 1.4%. But again when you look at the markets that are most sold in Columbia, South Carolina and this Midlands area, the $150,001 to 200,000 range, last year we sold at 98.9% of the list price today 100.1%. That's up 1.2%. That is point 1%. Over listing price, the single family housing under that is 99% of sales price now is at 100.2% of list price, which is also a 1.2%. And then lastly, when you look at the $200,001 to $300,000. Market, that was 98.9% of list price today is 99.9%, which is up 1.1%. But for single housing, it is 98.9% last year to 100%. For this year, so that is telling us houses are on average are selling for less price, but most of them are half at least are selling over list price. This is a problem we have no inventory, and everybody is selling their house for less price or more. What this means is it continues to be a seller market buyers have few if any choices they have multiple multiple buyers are competing against and it means that buyers and sellers are now having to get creative. So how are they getting creative? Well, we're seeing strategies that our agents are using all over the place escalation clauses we've talked about that I'm not very big fan of them. You listen to my podcast on that and understand why we've seen appraisal gaps. That's what we're talking about today, waiving of appraisal contingencies, we'll talk about that we've all seen non contingent contract contracts as clean as they can be, we are also starting to see sellers do a lot of reverse contingencies on the contract being contingent on them being able to find a house and closed today, what we're gonna look at is the appraisal gap. And as it is often done incorrectly, and putting a deal in jeopardy, we're going to talk about the biggest issues with it and things that you need to understand and things that you need to be careful of as a real estate agent, as well as talk about some language that you might be able to use. So as you know, an appraisal is merely an opinion, one person's opinion of the value of a real estate. And this is done by a real licensed real estate appraiser randomly selected through a process through the lending institution, they do not determine value for any other reason other than determine the exposure of the lender and making this loan the lender is going to loan $100,000 the lender wants to make sure that the house is worth is worth at least the $100,000 and in most cases, at least that and the down payment, they're going to do a 95% loan and 95,000 they want to make sure that the house appraises for at least 100 grand. It is basically a tool to ensure that the lender is not overexposed. The lender does not want to give you a $200,000 house on $100,000 value because they would be upside down by double what is an appraisal contingency? And how's that playing into what we're doing today? Well, most real estate contracts including the Midlands contract that we use a Central Carolina realtors Association contract when we use here as well as the South Carolina realtors Association contract, they all have the option of the buyer selecting the contract being contingent on appraisal. And what this basically means is that if the house does not appraise for the purchase price, then the buyer has a right to terminate the contract is important to understand that that contingency is not for the seller's benefit if the house appraises for more than the sales price. This is not giving the seller the option of terminating the contract. It also does not in either one of these contracts, give the seller the option of terminating the contract if the house fails to appraise and I have had that several times in the past where agents have called me saying hey, the house didn't appraise the seller wants to terminate the contract. And I'm like, well, the contract does not require the seller to lower the price. So the seller, the buyer, the seller can't come to an agreement or the buyer doesn't want to buy regardless based on the appraised value, then what does it matter the seller? Well, they have another offer they want to terminate the contract and take the other offer as cash is not subject to appraisal doesn't matter. The buyer still has the unilateral right to accept the property regardless of the price. So let's talk about example the house appraises for $20,000 less than the contract sales price. The lending company is not going to want to lend based on the sales price they go on and want to land based on the appraised value and this means that the buyer and the seller or the seller will have to provide the money to fill in the gap. Now what do you mean by the seller would have to provide it well, one of two things can happen the buyer can pay the difference in cash or the seller can lower the price of the house essentially providing the money to fill the gap. When this doesn't happen when the contract doesn't appraise and the parties don't want to pay more than the appraised value or the seller refuses to lower the price. Obviously the deal is going to fall apart. Let's discuss for a moment the waving of the appraisal contingency. So one of the strategies that is used in a very tight market today is for the buyer to waive the appraisal. This is a very good strategy in a lot of cases, but it's also very dangerous not only for the buyer but also for the sell an offer without an appraisal contingency basically means that the buyer has contracted to purchase the house, regardless what the house appraises for. For example, if the contract is for $200,000, and the house appraises for 175, the buyer is still contractually obligated to purchase price. So this strategy is good for a seller because the seller knows that the buyer is going to move forward with this contract regardless of the appraised value. So the offer is often more attractive than other offers that may be for even more money if it's contingent on an appraisal. Secondly, a good real estate agent should already have a pretty good idea what the house is worth not only for the seller, but for the buyer. If you've done your job and done a comparative market analysis, you should have within a range know what this house is worth. That does not mean that that is what it's going to appraise for. I understand that because appraisers take in other factors that you may not have access to in a comparative market analysis, but you should be relatively close. Additionally, a cash buyer or a buyer who's putting down a significant amount of money might also have little risk here, because it should not affect their loan in terms of loan to value ratio should not change their pricing or their crop their mortgage insurance, which we'll talk about a little bit later. Lastly, if we're talking about a resale of a relatively newly constructed house, that is a houses maybe one two or three years old, it's very unlikely in today's market that the value of that house is gone down. So we know we can at least start with a baseline of what that person paid for. In fact, you probably could do that on any house, it's unlikely that any house in Columbia, South Carolina or in the state of South Carolina, has gone down in value in at least the last year or so. So any house that has been sold to your seller within the last year. So that's a pretty good baseline to know that that property is unlikely to have decreased from that. But now the question is, how much did it go up? Did it go up as much as the seller truly believed it went up. But again, you can usually look at comps in the neighborhood and see particularly in a new neighborhood, or the new houses still selling at the price that the seller is seeking to get. So if the seller paid 170 for the house and houses in the neighborhood, now we're being sold for 181 90, it's pretty good chance that the house that he's selling is going to appraise for that same amount. However, there is downside to this offer. And that downside is the borrower must or the buyer must understand that the house does not appraise for the purchase price there is really no renegotiation of this purchase price, regardless how low the value comes in. And they may have to make up this difference in what the lender is going to loan them on the house and the purchase price. And this is going to have to be made up by cash or cash equivalent. And not all buyers are going to have the cash to do that, particularly if you're looking at a buyer who is borrowing three putting down only 3% or 5% or a borrower who is doing a State Housing loan, or even in situations where there may be doing a VA loan and things of that nature. It can also change the borrower's loan terms in terms of pricing if they were planning on putting down say 20%. But now the house does not appraise. So they're, they're not going to be able to put down the 20% because part of their down payment is going to have to pay this gap. Now they may no longer be in that band of pricing, which means their loan pricing may go up in terms of interest rate, but it also could bring in the requirement to pay purchase mortgage insurance, or could even increase the cost of the purchase mortgage insurance. Remember, the pricing of mortgage insurance goes down with the more down payment that your borrower puts down before the buyer borrower decides whether or not they want to waive an appraisal contingency. They really need to do two things. One is really have you look at a comparative market analysis to determine if in fact this property is going to appraise and arrange that y'all are comfortable with. They need to talk to their lender to discuss potential issues. Is it going to affect their pricing? And could it affect whether or not they're going to have to have mortgage insurance? And if so how much? Now on the seller side, the seller needs to understand that the issues that just that I just mentioned, they also need to understand that the buyer may not be able to pay these additional monies. If the buyer can't pay the additional monies and defaults. What is their likely recovery going to be we've done podcasts on this as well likely it's going to be the earnest money your seller is most unlikely to follow also in fight this out over the next 18 months over damages more than likely she's going to accept the earnest money. So is there enough artists money to satisfy the seller if the buyer backs out in defaults? Also, what effect is that going to have or putting the house back on the market? In a lot of cases they may get more money and it might not be a problem at all. But could it put present a stigma on this property? Could it present questions as to Oh, this person is not going to appraise. So it's overpriced, could it have a negative effect on the market, and those are things I need to discuss with you as their agent. Now let's discuss the other option called the appraisal gap clause. So how does an appraisal gap guarantee clause work? Well, an appraisal gap clause states, the buyer will cover the gap between the contract sales price and the appraised value is essentially guarantees the seller that the buyer is going to cover the difference in the appraised value and the contract sales price. So let's do a little deeper dive into this, the results of how this works very differently on different scenarios. Here's example number one, and you may have to write these down to see what I'm saying. But I think you can follow along, let's say they offer a purchase price is $450,000. And your buyer is going to put down $250,000. So they're going to borrow 300,000. Essentially, they have a loan to value ratio of 67%. But let's say this appraisal comes in at 430,000. Now based on them putting down 150,000, they're gonna have to use 20,000 to cover the gap. So they're only putting $130,000 down to the purchase price. It's a 70% loan to value ratio. But the good news is, what does this mean for the buyer really not much, because the downpayment they're putting down is so large, it essentially won't change much. So lender is still going to be making a $300,000 loan, so it's not gonna change the loan amount, the price is probably going to stay the same, because the loan to value ratio only changed 3% in the buyer was already putting down $150,000, they're still gonna put down 150,000, the only difference is 130 is going to go as equity in the house and 20,000 to pay the difference in that gap. So theoretically, the only difference is they have less equity in the house after they close, assuming that the appraisal is what everybody else assumes that the value of the house is 430. Now another appraiser will come in and come in at 450. The next day, you never know, that's the only difference is the house is worth $20,000 less, and they have $20,000 less equity. Now let's give you an exact second example. Let's say you have a contract for $470,000. And you put down 15%. So your loan would be $399,500. So you're bringing cash at $70,500. But now let's say the house appraised for $20,000, less at 450. So now you only are going to put down, let's say 10%. So you're going to borrow $405,000. In this scenario, because the house didn't appraise. Well, now what you're doing is you're bringing $65,000 to closing versus putting down 7000 70,500. So you're putting down 5500 less money, but you're borrowing $5,500 more money. So the terms are not really all that difference, the loan pricing may be a little bit different in it because of the loan to value ratios. And PMI could cost you a little bit more because you are putting down but essentially, it's the same situation. So now let's talk about one vastly different scenario $450,000 contract 5% down means you're bringing 22,500 to the purchase price. So your loan in this situation is gonna be $427,500. But this changes everything when the property only appraises at 430. Because the lender is not going to loan you $427,500 on a $437,000 valued house, it's just not going to do it. So the 420 2500 that you were going to bring to closing is your down payment, now essentially is the money you're going to be using to pay the difference in the appraised value in the contracted value. So this would mean the lender would be lending 100% of the value, which just isn't going to happen again, because this is a 2007. So the borrower is going to have to bring to this deal, the VA percent money and the difference in the loans. We're talking about another $20,000. So now they're going to put down $42,500. Question is, does your client the buyer have this money to make the payment and as a listing agent you want to make make sure these proof of funds before you agree to accept this offer. So when you're dealing with these situations, as a listing agent, you need to understand and ask what's your loan to value ratio going to be? How much are you planning on putting down so that your client the seller has all that information so they can determine whether they believe this is going to be more like situation one and two, and less like situation number three. So this goes back to what I did in the podcast a few months ago on buying contracts, if you remember I talked about when there's offers are so high over asking price that they're going to use the appraisal as a way to basically renegotiate the contract. So that's been our second most listened to podcast and so you need to take a listen to that because it explains how buyers are doing this and that sellers need to be very careful about these outlandish offers and understand how this appraisal situation works. This is also where the appraisal gap coverage language can come in. But the point being is if the buyer is putting down 25 or 30 or more percent of this on the on the purchase price and has a loan to value ratio is 75 to 7580 90%, you're probably going to be okay. It's not going to be that big of a problem. But when the buyer is putting down 3% 5% doing a VA doing an FHA loan doing State Housing, this is when it becomes a huge issue for yourself and we're gonna discuss language to talk about that in just a minute. Now, how do you write a pays appraisal gap coverage into a real estate contract? There are many different ways to write this appraisal gap coverage. The main thing that needs to be noted is that the monetary value of your appraisal gap guarantee, it's not wise to state if you're representing a buyer that you will cover an unlimited amount between the sales price and the appraised value, because appraisals and the sales price can be vastly different things. The agent should always want to put a maximum amount if you're that the buyers willing to cover. But before I give you the examples of the language, you understand, the biggest problem that I see is that these things are being written so poorly, that neither the agents know that nor the buyer or the seller have any understanding as to what the other party is willing to do or not do. And there's so often written one sided and not what the other party intended that it becomes a huge problem. So there are many different provisions that could be used depending on the agreement and the appraisal contingencies, for example, is it says it for a set amount above the appraisal that the buyer is willing to pay? Or is it an agreement to pay just the difference between the sales price and the appraisal? It comes down to what the buyer is agreeing to pay? Are we talking about an amount over the appraised value? Or are they paying no more than a sales price? Is the amount over the appraised value but no more than the purchase price is an amount over appraised value? What could be less than the purchase price? Is the seller obligated to reduce the sales price? Is the buyer obligated to always bring the difference between the appraised value and the sales price? For example, let's say we go back to our $450,000 purchase price. The clause obligates the buyer to bring $10,000 to pay for an appraisal gap is the house if the house appraises for $440,000. It's not a problem, right? Well, maybe depends on how you wrote it. Is the borrower paying $450,000 or $10,000 over the appraised value at $454,000? Hmm, well, it depends on how you wrote it. Well, how about a $450,000 purchase price with $10,000 appraisal gap, but it appraises at 430. Now what is the sales price for 440? The 430 sales price plus the $10,000? Is the seller obligated to lower this price? What happens if it appraises at 400? Are we now talking for 10? is a seller again obligated to lower the price? In most cases based on the way I see the language written? The answer is No, they're not. But it's been so poorly written in the past that I don't know sometimes it could be or the party's putting a floor in there. The provision could have an obligation for the seller is all depends on what the parties agreeing to what we're going to put in this this language. But what happens again, if it appraises for 455 what is the buyer obligated to pay it sales price is 450. But they've agreed to pay $10,000 over the appraisal. It appraises for 455. So is it 465? Is it 450. The language in the provision matters now the provision language I see the most is if the party does not appraise for the purchase price the borrower agrees to pay up to $20,000 above the appraised value but not to exceed the purchase price. That may cover sometimes may not. My good friend Eric asked me to write a clause that I started writing this and I became across a lot of problems. There's just so many variables to this. So I'd come up with things such as this, the parties acknowledge that the subject property is unlikely to appraise for the purchase price set forth in the contract. While the contract is contingent on appraisal, the parties agree that the purchaser shall pay the difference between the appraised value of the property and the purchase price regardless of the loan the purchaser receives. This provision shall be in effect notwithstanding the appraisal financial contingency, and the purchaser shall not be able to terminate the contract under the appraisal or financing provision due to the amount of appraisal gap. But really, the contract in this case is just not be subject to an appraisal. The second one I came up with was the parties acknowledge that the seller property or the subject property is unlikely to appraise for the purchase price set forth in the contract. While the contract is contingent on appraisal, the parties agree that the purchaser shall pay the $5,000 above the appropriate appraised value of the property not to exceed a final purchase price of 300 grand this agreement is regardless of the loan amount the purchaser receives. And then I went ahead and as said that the purchaser acknowledges the lender may require the purchaser to pay the difference in cash or cash equivalents, and so forth. So the problem is there's so many different variables here, that one clause doesn't cover at all. So you're really going to have to figure out what is it your buyers willing to do? What is it your sellers willing to do and write each and every one of those terms? And then what you need to do is look at it and make sure you cover them all. Lastly, I need to quickly go over the amendatory clause. How does it affect things under a VA or an FHA loan, the parties are required by federal law to sign a statement acknowledging that the property does not appraise the buyer may terminate the contract. What you need to understand is this is federal law and it cannot be waived period can't be waived. However, there's nothing in the mandatory clause it says the seller has to lower the price of the house to the appraised value, and nothing under the law prohibits the buyer from paying the difference in cash equivalency. In these situations. The seller has already said they will not take less than a certain amount when they're asking for a price over appraised value even under a VA loan, the buyer knows that if the property does not appraise which is unlikely to the seller is not going to be required to lower the price. And the seller has already told them, they're not going to lower it and what the buyer is going to be required to pay as a minimum if they want to buy the house. So everybody is in clear understanding there. So even though we have the amendatory clause all is doing is allowing the buyer to get out if the house doesn't appraise. It's the same thing as an appraisal contingency. And the buyer already knows that likely the house will not appraise and it's also likely, if not, certainly the seller is not going to sell it for that. So I don't see that there's a lot of risk in that amendatory clause as people believe there is in this situation. Not all appraisal gap clauses are going to be satisfactory for you. You have to understand what each party wants. And you're truly going to have to go in and dig through what they're going to do and what they're not going to do. And think of the different scenarios on how this is going to play out. And moving over to Gary's good news only. The army is also adopting a new policy to help soldiers move as housing markets fire up, they have recognized that with the soldiers getting new orders that in COVID restrictions being listed truck troops are having trouble finding adequate housing and new location. So the army is actually taking positive steps to accommodate the 54,000 soldiers that are going to new areas this summer. Good news 54,000 soldiers are PCs and that means people are moving in and out which is good for sales. And it also means more houses Michael in the market is also good to see the army has recognized they need to work on that. Now let's talk about COVID morti mcherry, as you all know, I've talked about before is a brilliant Doctor Who has been right almost everything he says about COVID more than pretty much anybody else. He says it's important to understand that the positive test is not a clinical diagnosis of an illness, adding that the important thing is that people don't come down with severe illness. The crux here is that there is a difference between a virus and the disease it can cause in this new phase of battle in the pandemic, we need to start talking more about viral loads and quit tabulating cases, which are super sensitive to the testing. And we need to start worrying about viral load. Because it's important to understand that people can fight off the infection is still being considered positive and that skewing our numbers. According to the CDC, if you're under the age of 29 95% of those fatalities, which are very minimal to begin with, are from people who have severe co morbidities. In fact, the average number for all ages is two to four for people who are dying. Now the median age of someone dying with COVID now is at life expectancy in the United States is 78. From cow lamb, concerning the Delta vary that everybody's freaking out about, he says are very few exceptions. But the general rule is that the Delta variant usually lasts about 45 days from the onset to its peak. And we are already seeing that across the world. seven day moving average for cases is still at 4.2% lower than it was at SP We are now at 163 million Americans fully vaccinated which is 49.1% of the population continue here the media a lot of you and tell you that United States is failing it at vaccination. Well, in fact, we are actually one of the highest vaccinated country in the world. 68.4% is the UAB Israel's at 61%. Canada is at 54.7. UK is at 54.4. Germany's at 48.7. As is United States, France is at 44.1. Sweden's at 39, Japan of all places 23.2. Mexico's at 18.3. Russia's at 15.6. Australia's at 12.8. India is at 6.7. Taiwan is at point nine. So it's not true that we're following and trailing the rest of the world. We're actually one of the leaders. It's interesting also to note that there's been 11 straight days in Sweden with zero deaths, and they have 10 point 2 million people 9% mass compliance in that country and only 39% of their people are vaccinated. So natural immunity is a real thing that no one likes to discuss in the United States as on July 24. We have 108 consecutive days of under 1000 daily deaths. We've had 44 consecutive days of under 500 deaths, and this is a nation the size of 329 million people. Lastly, not sure where this pan is coming from with Delton. I think the most telling thing is even in Israel and the UK, which is a highly vaccinated place. Both of those are the Delta variant death at transmission date case fatality is point 1% in Israel is point 2%. So they may have breakthrough cases but the death line is not coupled with the infection rates. And finally, the daily death rate has dropped 89% since January. And before I get out here today, a big shout out to all the people in Denver area who are listening to dition dirt appreciate you guys listening over in the Mile High City and we hope that Joe will continue to do so hope everybody has a wonderful weekend and we will talk to you real soon.