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Key takeaways:
- Appraisers discover market value. They don’t set it.
- In doing so, they’re working within the definition of market value set in federal law.
- Buyers may have circumstances or resources that enable them to offer more than the indicated market value. But that offer, in and of itself, doesn’t constitute market value.
“I am upset the X-ray tech broke my arm!”
“I wish the meteorologist would stop causing this rain!”
“That news reporter created that environmental disaster!”
What is wrong with these statements? Well, we understand causing an event is different than discovering, forecasting or reporting on the event.
So, “I am disappointed that the appraiser altered the market value of my home” doesn’t add up either.
Just as medical professionals don’t cause the injuries you ask them to diagnose and journalists don't cause the events they report, the appraiser does not control the market value of any property. As an agent, you know this. But when you’re trying to get a transaction over the finish line, an appraisal that doesn’t line up with the contract price feels like one hurdle too many.
Federal Code Guides the Result
Why doesn’t the appraiser have the power to control or change the value of a property? The value is completely controlled by the market; the appraiser is reporting the expected actions of a certain type of buyer and seller. What type? We need to look at how market value is defined to find out.
The following is the definition of “market value” used in most mortgage transactions, as found in the Code of Federal Regulations:
Market value means the most probable price a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently and knowledgeably, and assuming the price is not affected by undue stimulus. Implicit in this definition is the consummation of a sale as of a specified date and the passing of title from seller to buyer under conditions whereby:
- Buyer and seller are typically motivated;
- Both parties are well-informed and acting in what they consider their own best interests;
- A reasonable time is allowed for exposure in the open market;
- Payment is made in terms of cash in U.S. dollars or in terms of financial arrangements comparable thereto; and
- The price represents the normal consideration for the property sold unaffected by special or creative financing or sales concessions granted by anyone associated with the sale.
There are several requirements here and, to meet the definition, they must all be true. Notably, the appraiser has little power to control any of them. The appraiser does not control anyone’s motives, their level of knowledge, the marketing of a property or the financial arrangements.
Take Note of Extenuating Factors
Does that mean that buyers and sellers decide market value? Not always. They’ll set a price, but if the criteria in the definition are not met, it may not represent the value.
To illustrate, imagine 10 people want to buy a truck, but the dealership has just two. Each person has a similar income. The price of the two trucks is likely going to be set by the parties who are willing to spend the largest portion of their funds. But now, what if one of the individuals has an employer who will give them a $5,000 allowance, allowing them to pay a price premium and outbid everyone to snag the truck?
Does the value of both trucks change? Well, the $5,000 is likely either “undue stimulus,” “creative financing” or both. The market value defined above excludes circumstances like that. So no, the market value, as defined, did not change, even though there was a high purchase offer from one cash-infused buyer. In this case, the buyer’s bid won precisely because it was not “market value”—it was higher than what the typical purchasers could or would pay.
Let’s say, instead, the vehicle purchasers are home buyers and the generous employer is a bank selling below-market-rate loans, relatives helping their family or any other atypical stimulus. As we read in the definition of market value, the feds don’t want every exuberant desire to buy to be considered market value. Their own definition includes limits. They’ve legislated that appraisers are to report what a typical buyer—who is paying in cash or similar, with no creative financing, unusual concessions or stimulus, and with no other notable imprudence—would pay.
(Why does the government get involved here? Here is some reading for later: “The Origins of the Financial Crisis,” by Martin Neil Baily, Robert E. Litan, and Matthew S. Johnson. Reading the bullet point lessons on pages 44 and 45, you will likely see several places where the reported market value of residential mortgage securities played a role in the 2008 financial crisis. Also, NAR member Chris Read offers this take on the government’s critical role, particularly during times of crisis. Read, a broker from Illinois, helped shape NAR’s messaging on the future of the government-sponsored enterprises, Fannie Mae and Freddie Mac—entities that ensure a steady flow of mortgage funding and consistent lending standards in the U.S.)
Discovery, Not Invention, Is the Appraiser’s Stock in Trade
Appraisers are often viewed as the de facto arbiters of financing, but they wield less power than you may think. They must wade through all the irregularities of human behavior, follow the direction of market data and be aware of market changes, all while maintaining fidelity to the definition of market value.
Ideally, the appraiser has the time and competence to resolve all the market signals and reach a clear picture and a credible conclusion. Yet, in practice, issues like limited data, bad data, unverified data, errors, hasty work, poorly supervised work, undue pressure and many others can result in the appraiser failing to credibly report the market value of a property.
Yes, just as a diagnostician may misread a film, a meteorologist may misunderstand the signs of coming weather or a news reporter may rely on bad sources, an appraiser can mistakenly and incorrectly report an opinion that is not in line with market facts. But the appraiser’s report doesn’t change the value. It can’t because market value is a hypothetical consensus by other parties to be discovered by research—it is not something the appraiser can invent, create or alter.
Of course, we don’t want appraisers to make mistakes. Competency of appraisers, the adequacy of the industry-accepted and lender-mandated methods of appraisal and how all of this relates to, and is influenced by, the legal definition of market value are germane topics—but for another day.
So, how much power does the appraiser have? None that can change the market value of a home. Appraisers have the power to be—or not be—competent and diligent professionals who collect, verify and analyze enough data to discover what the market dictates.
