We are currently experiencing a strong seller’s market here in the Lakes Region. 2020 has presented historically low-interest rates coupled with increasing buyer demand from people relocating from out-of-state regions. Many first time buyers are also looking to purchase and find it increasingly challenging to secure housing with increased buyer competition. Understanding what is happening in the market can help buyers plan accordingly and make sound financial decisions.
First and foremost, buyers should understand the law of supply and demand and recognize how it impacts the real estate industry. If there are more homes on the market than available buyers, it is considered a “buyer’s market,” and prices tend to stagnate or even fall slightly (depending on the region, the pulse of the economy, the interest rates, stock market, jobless rates, and other factors). When there is an undersupply of homes (a “seller’s market”), prices go up, and competition among buyers can be challenging. A strong seller’s market can result in the bidding wars and escalation clauses trending today. In a nutshell, the law of supply and demand dictates a home’s equilibrium price. Average days on the market are also affected: Houses priced correctly go quickly in a seller’s market, often within days of listing.
There are many reasons this is important for buyers (especially new buyers) to understand: A property’s list price reflects the current market, with other factors taken into consideration. Mortgage lenders are keenly aware that the housing market is prone to shifts and take extra steps to protect an investment. When a buyer applies for a loan on a property they are looking to purchase, their lender will send a home appraiser to the property to evaluate the home for fair market value.
Because we have seen home sale prices increase so drastically in the last year, some banks are beginning to show extra caution in their underwriting procedures, closely examining the appraisal process and the comps that are used. Some banks have even decided to renegotiate an appraisal. This extra caution is a good thing; the banks have learned hard lessons from past mistakes and don’t want the market to get too far ahead of itself. But these extra steps may cause delays and surprises before the closing.
Buyers should consider that a bank will only give a loan up to the amount of the appraisal. If a home is overpriced or a bidding war prompts an offer higher than the list price, and the lender’s home appraisal comes out lower, one of three things happen:
- The buyer must come up with the difference, out of pocket (this would be in addition to their regular closing costs).
- The seller is willing to renegotiate, and the terms of the contract change with an addendum.
- The sales agreement contract would terminate, because the buyer could not fulfill the terms.
When there are more available homes than buyers, or in a neutral market, a seller might agree to split the difference or accept a lower offer if an appraisal comes out lower than the offer price. There is no guarantee another buyer will come around, and it sometimes makes sense for a seller to make adjustments to ensure the sale goes through. In a seller’s market, however, the seller may wish to instead put their house back on the market if the buyer cannot come up with the difference, and they are free to do so without consequence as the sales contract would no longer be binding. In this current market, we have recently seen a few sales agreement contracts where the seller accepts an offer only if a buyer agrees to come up with the difference in an appraisal should a difference apply. This clause protects the sellers, but not always in the best interest of the buyers.
Herein lies a potential conundrum for buyers: If a buyer has the funds for the difference between the appraisal value and the offer price, they are taking a financial risk by possibly overpaying for a property. If they do not have sufficient funds for the difference, and the sellers are unwilling to budge on the agreed-upon sales price, the buyers risk losing their down payment (depending on how the contingency is written and crafted), mortgage application fees, and any investments they make on home and septic inspections, and water/radon or other tests. Currently, appraisers are backlogged and are working very hard to meet deadlines due to the market’s rapid movement. So buyers should be aware that a bank appraisal might not come through until just before the closing – after the buyer has already invested time and money in the property.
So my advice to buyers, especially those applying for financing, is this:
Do your research before putting in an offer, to make sure the price does not overshoot fair market value.
Try to avoid any “low appraisal” scenarios unless you are willing and able to pay the difference.
- Research the history of the home you are considering. What did it sell for two years ago? Seven years ago? Ten? Home values tend to rise over time, but buyers should evaluate a drastic increase in the sales price, even more so if there were no major renovations made to the home.
- Research similar home sales in the neighborhood (your Realtor® can run a Comparative Market Analysis on the subject property, or you can research sold properties on most real estate websites).
- Research the town’s current assessed value on the home (this is sometimes slightly lower than both the listing price and the appraised value, but not always). A red flag would be if the assessed value were dramatically lower.
Anticipate delays, and plan accordingly.
When putting in an offer, buyers should consider that a seller is under no obligation to extend a contract deadline if the buyer fails to complete a contingency on time. To avoid losing out on a property, they should plan to leave enough time in the contract to put inspections, financing, and appraisals in place. We are experiencing an unprecedented market with significant outside factors and potential delays to consider. For example, due to the COVID-19 outbreak, there have been backlogs and shortages of building materials affecting the new construction market. The typical building period has extended out due to competition. As a result, we have seen more frequent extensions in closings lately on new constructions. And as mentioned before, banks are taking extra steps to protect their investments, and the appraisal process may take longer. It is wise to anticipate such delays and try to avoid the need for extensions in a contract.
Don’t skimp on inspections!
Lastly, even in this competitive market, we always recommend hiring a good home inspector to look for latent problems in the house, and we recommend you have the septic tank inspected as well if the home is on a private system. Water tests, radon tests, and other contingencies are small costs to you but are worth every cent. Remember that old British saying, “penny wise, pound foolish?” It applies here! Surprises down the line can be costly: septic tanks and roofs can fail, and structural damage can be a big issue down the line. Do your diligence and hire pros to look for any latent defects in a home.
As Realtors®, we understand that the current market is particularly hard for first-time buyers, who are up against second-home buyers and people trading up with funds for larger down payments. Losing a bidding war on a home you love is undoubtedly upsetting, but patience is a virtue for first-time homebuyers (especially in this market, as it may be running just a bit ahead of itself). The benefits of homeownership are many, and you can take the above actions to stack the cards in your favor. Always do your research on any properties you are considering before you put in your offer. And be sure to go with a well-seasoned broker who will protect your interest, help you perfect that offer, and steer you in the right direction based on real market conditions.
This article was written by Heather (Roche) West of Roche Realty Group, Inc.