How To Negotiate When The Appraisal Comes In Low

Introduction:

As the real estate market has slowed due to high interest rates and other factors, the likelihood of appraisals coming in below the purchase price has increased. This can be a challenging situation for buyers, sellers, and real estate professionals alike, and, as low appraisals can be a common friction point in transactions, it’s crucial that agents have a game plan and strategy for how to handle and deliver the best outcome for their clients. 

Imagine a scenario where your buyer finally got under contract after many offers having been written. Or perhaps it’s your tired listing that was sitting on the market for weeks that finally got an offer and went under contract. Everything seems to be going smoothly, but down the stretch towards closing the appraisal valuation comes in $10K under the offer amount. What does this mean? What are the potential ramifications for your clients and the transaction? How best to navigate successfully? 

The Importance of Negotiation:

Negotiation is one of the key areas where real estate agents earn their stripes and go to bat for their clients. Thousands of dollars can sometimes hang in the balance, and a conscientious agent can make a significant difference compared to a subpar one. Appraisals coming in short is one of the most common negotiation scenarios agents will encounter repeatedly throughout their careers. Here's some insight and context to help you make the most of these situations.

Understanding Low Appraisals:

When an appraisal comes in low, it means that the lender will only lend up to the appraised value. For example, if the offer price is $500,000 with a 3.5% down payment and the appraisal comes in at $490,000, the borrower is responsible for making up the $10,000 deficiency between the offer amount and the valuation, and also important to note the additional $10K does not get added to the down payment. In this scenario, the buyer is responsible for making up the difference, and can either cover the shortfall in full, try to negotiate to have the seller cover part or all of the cost, or potentially walk away (depending on how contract terms and “outs” are structured in your state.

Strategies for Buyers' Agents:

1. Assess Buyer's Ability/Willingness to Cover the Shortfall:

The first step is to determine your buyer's willingness and ability to cover the shortfall. Assuming they want to stay in the transaction, they'll likely want to explore options to minimize or eliminate their out-of-pocket burden. This may involve pushing back on the appraisal or negotiating with the seller to cover all or part of the shortfall. It's important to have a clear understanding of the buyer's financial capacity and motivation to proceed before pursuing other strategies.

2. Review the Appraisal:

Thoroughly examine the appraisal to ensure the work is sound and there are no errors in the calculations. Look for better sold comparables that might further justify your price. If you find compelling evidence for reconsideration, work with your lender to contact the appraisal management company. Remember, agents should not directly contact the appraiser. While this approach occasionally succeeds, it's best to manage expectations, as appraisal adjustments are relatively rare.

3. Negotiate with the Seller:

If the appraisal cannot be adjusted, the next step is to negotiate with the seller to reduce the purchase price, either fully or partially, to minimize the shortfall the buyer must cover. The success of this approach largely depends on market conditions and the seller's motivation. In a slower market, sellers may be more willing to compromise, especially if their listing has been on the market for an extended period. They might be concerned that if they don't work with the current buyer, they'll have to relist the property with uncertainty about future prospects.

Throughout this process, maintain open communication with your buyers. This can be a tense time, as the outcome of the negotiation can have significant consequences, including the possibility of falling out of contract if the shortfall cannot be resolved. Be prepared to explore alternative options or, if necessary, terminate the contract if your buyers are unable or unwilling to cover the remaining shortfall after exhausting these strategies.

Strategies for Listing Agents

1. Evaluate Market Conditions: 

In a strong seller's market, you may be less inclined to negotiate on price, as you likely have the upper hand. You can put the onus back on the buyer to cover the shortfall, or if that doesn't work, you may already have back-up offers or have confidence in finding the next buyer relatively quickly if the deal falls, and you find yourself back on the market. 

2. Consider the Consequences of Losing the Buyer: 

If it took a considerable amount of time to secure a buyer, weigh the risks of losing the current buyer against the potential of finding a new one quickly. In a slower market where inventory is piling up, it may be worth compromising on price to keep the transaction on track, ultimately adjusting the price to meet the buyer's needs and expectations.

Negotiation Tactics & Pro Tips:

Don’t unnecessarily squander goodwill in a transaction. Too many agents want to come across like a big-shot negotiator without remembering there is plenty of back and forth in a transaction during the under contract phase, like this surprise low appraisal situation we’re discussing. It's always easier to work things out when the other side isn't digging their heels in out of spite. Sometimes there is good reason to be a bit more combative with the other side, but too often agents create unnecessary obstacles and head winds by trying to act like John Wayne right off the bat. 

When discussing negotiation strategies and tactics with either buyers or sellers, focus on understanding what constitutes a win for them and what's a no-go. This collaborative approach gives you a lot more context on how to manage your clients and keep them happy, uncovers any misnomers or misunderstandings, and demonstrates that negotiations involve give-and-take and likely compromises. By setting realistic expectations and involving your client in the process, you create a sense of teamwork rather than leaving them expecting unrealistic miracles. This strategy ensures you're "in the foxhole together," working towards the best possible outcome within the constraints of the situation.

When negotiating an appraisal shortfall, it may benefit you to start by asking for a slightly higher reduction than you expect to receive, giving you room to be negotiated down. Come prepared with solid market data and compelling reasons for the price reduction, aiming for a win-win scenario. While sellers may be more likely to work with you in some markets, be aware that factors like higher back-up offers or other circumstances might make them less flexible. Communicate clearly with your client that your goal is to address all costs, but realistically, only a portion may be covered. 

Conclusion:

Negotiating low appraisals is a common occurrence in real estate transactions, and having the knowledge and strategies to handle these situations effectively is crucial for success. By understanding the process, reviewing the appraisal, and working collaboratively with all parties involved, you can navigate low appraisals with confidence and achieve the best possible outcome for your clients. Remember, this is a situation you will encounter regularly as an agent, so having the context and go-to strategies on how to handle it will be key to your success.