In today’s competitive real estate market, buyers are doing whatever they can to be more competitive to win the deal. One of those strategies involves waiving the appraisal contingency.
What is the Appraisal Contingency?
In essence, the appraisal contingency is an exit for a buyer. If a property is under contract for $600,000 and the appraisal comes in at $590,000, then the buyer has an option (in addition to other contingencies) to exit the deal. At this point, the seller has the option to cure the buyer’s objection by reducing the purchase price to $590,000. Others involved may also contribute to get a deal done.
A Brief Look Back
In early to mid 2011, when the market was saturated with inventory, buyers were using the appraisal contingency to grind sellers down even further on sales prices. They could do this primarily because there were few qualified buyers and most sales had only one offer. In these cases, the appraisal contingency gave the buyers a strong source of leverage.
Waiving the Appraisal Contingency
Today, we’re in a seller’s market (for most markets). Sellers are receiving multiple offers and are accepting offers with the greatest likelihood of closing. As a result of this appreciating market, appraisers are having a hard time bringing appraisals in at value (the contracted price). Sellers know that an appraisal means the possibility that the valuation will be lower than the contracted price. As a result, sellers are leaning towards buyers who have removed this contingency.
Craig Blackmon at Rain City Guide mentions that waiving the appraisal contingency may not strengthen an offer. Craig’s reasoning for this is the financing contingency. If a buyer needs to procure financing to close a deal, then waiving the appraisal contingency is arguably a worthless waiver given the fact that the lenders won’t fund a loan for a price that the property hasn’t appraised for. This essentially puts the appraisal contingency under the umbrella of the loan contingency. Further, Craig discusses that removing the appraisal contingency removes the seller’s “contractual right to ‘massage’ the issue and to keep the sale on track.”
Why I Believe Removing the Appraisal Contingency Helps
First, I agree with Craig that the removal of the appraisal contingency is merely a gesture, given the likely inclusions of the loan contingency and/or inspection contingency, both major exits for buyers. However, here’s where we differ.
When a buyer removes their appraisal contingency in a competitive market, they are essentially promising the seller that the buyer will close the deal whether the appraisal comes in at value or not. If an appraisal comes in at $590,000 for a $600,000 contract, a buyer with a removed appraisal contingency would likely anticipate this possibility and be prepared to come up with the difference. The buyer’s lender will (likely) still lend on $590,000, but someone needs to bring in the additional $10,000. Due to the competitive market, sellers are rarely reducing the price or kicking back cash to buyers when the appraisals come in low, especially when there have been multiple offers. Most sellers figure that they’d rather put the property back on the market or choose a back-up offer and be rewarded with extra cash while another buyer attempts to perform their contract. Note: sellers do still have the option to kick in, they just tend not to in a competitive market.
Thereby, when sellers review multiple offers, the offers without an appraisal contingency stand out. Sellers will often ask these buyers for a proof of funds to ensure that they have the funds available (down payment and closing costs) to not only close the deal at the agreed price, but additional funds set aside in the event the appraisal comes in low. As a result, it is not uncommon to see listing agents suggest that buyers remove their appraisal contingencies.
The market is competitive and there are many buyers who are dying to get into real estate. Of course, buyers generally maintain other rights to cancel the contract, if — for instance — the appraisal came in obscenely low; buyers could theoretically argue their right to cancel due to their loan contingency or could all of a sudden discover something wrong in the inspections. While I don’t condone this, it happens.