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Why Waiving Appraisal Contingencies Strengthen Offers

Posted · 2 Comments
Man using exit as if contingency.

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.

Appraisal Contingency Clause in Contract

Example of the appraisal contingency clause in the California Association of Realtors contracts (click to expand).

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

Signpost with "The Past"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.

Picture of multiple bidders.

In today’s market, multiple offers and back-up offers are commonplace.

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.

  • Craig Blackmon

    Kevin, thanks for inviting me to stop by. I suspect that the difference in our opinions is due mostly if not entirely to the different contractual terms used in CA and WA. While I did take a look at the appraisal contingency that you provided, it is merely one paragraph of a larger form, and that form is in turn one part of a multi-page contact. So there’s no way I can determine whether I agree with your analysis or not as to CA.

    However, I can explain why I think you’re mistaken as to the appraisal contingency in WA. Remember that ultimately what we’re talking about is a return of the earnest money to buyer. The buyer can always walk, but she will forfeit her earnest money unless she has a contractual “out.” And so what we are discussing here is whether the buyer will forfeit the earnest money as a result of a low appraisal.

    You note:

    “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.”

    That is incorrect. In WA, under forms used here, if the buyer includes a financing contingency (I assume similar to your “loan contingency”) then the buyer will be relieved of the obligation to buy if financing fails. In WA, the financing contingency form includes the appraisal contingency. If buyer strikes just the appraisal contingency, then there is no mechanism for the parties to address a low appraisal. Rather, a low appraisal means buyer’s financing fails, and because buyer has a financing contingency then buyer has the option of walking with a return of the earnest money. If buyer WANTS to move forward notwithstanding the low appraisal, the buyer can do so.

    In other words, seller may INTERPRET the offer with a stricken appraisal contingency as a “promise” by the buyer to make up the difference between the appraised value (upon which the loan will be funded, typically 80% of appraised value) and the sale price. Indeed, I believe many agents and their clients reach this mistaken conclusion. But in fact buyer makes no such promise at all.

    Rather, if the buyer wants to contractually promise to make up the difference, the buyer needs to forego the financing contingency entirely. In WA, the buyer would still need to include a term in the contract noting that buyer will be financing a portion of the purchase price (because absent such a term, the form contract includes a promise from buyer to seller that buyer has the cash on hand necessary to complete the purchase). But if buyer informs seller of the intent to finance (with of course a pre-approval letter showing the ability to do so) and does NOT include a financing contingency, then yes, at that point buyer has promised seller that buyer will make up the difference. And if buyer does not do so, then buyer forfeits the earnest money.

    • Hi Craig,

      Thanks for visiting.

      It sounds like our difference of viewpoint may be inspired almost entirely by the differences in our contracts. When you state that the buyer needs to have “a contractual ‘out'” to walk, I find the first difference. With the California Association of Realtor forms, a buyer is entitled to a refund of their earnest money deposit for any reason until they remove all of their contingencies (generally the inspection, loan, and appraisal contingencies). How is it in WA?

      Also, in WA, do sellers generally perceive one offer to be stronger than another offer if the buyer has removed their appraisal contingency? At least in CA, the less contingencies an offer has, the more motivated the buyer appears to be.

      Second: when a buyer defaults on the terms of their contract with the seller in WA, is their earnest money deposit automatically retained by the seller? In California, if there is a default in the contract and the buyer and seller don’t come to terms, then the seller generally has to win an arbitration against the buyer in order to then be able to retain the deposit — unless the buyer signs a cancellation form forfeiting the deposit.

      Furthermore, our appraisal contingency is also nested under the loan contingency. While yes, a buyer could argue that the loan/financing contingency because their out if the appraisal comes in low, we generally see offers with a waived appraisal contingency as an implicit promise that they are prepared to pay the difference between the appraised value and the purchase price. Wouldn’t that same implication be true in WA?