New Approach to Appraisals May Chill Market

Decisions about mortgages are made on a property’s fair market value, which is defined as the market value of an interest in land at the highest price reasonably expected when sold by a willing seller to a willing buyer after an adequate amount of time and exposure to the market.

So who determines the value of that property? One could argue that the market itself determines the value, which is true, but from a lender’s perspective an appraiser who is specially trained and who has sufficient experience is best suited to provide an independent, impartial written opinion of the property’s value.

As you may know, appraisals are done for a specific client – in this case, the lender. Because real estate is the major security for mortgages, it’s important that the market value estimate be as accurate as possible.

There are a few different types of appraisals

• The sales-data-only report is based solely on MLS sales and listing data. No physical inspection is performed on the property.

• A drive-by appraisal is an exterior examination only and used for mixed-use neighbourhoods and higher-risk transactions.

• The full-appraisal report includes a detailed interior and exterior inspection of the property and the neighbourhood.

Not all residential properties are subject to a traditional appraisal. If the property is in an established area with similar properties surrounding it, then the price can be validated electronically. This mode of appraising property, called automated valuation models (AVMs), has become quite popular in the last 10 years. The unexpected result from this type of appraisal has been higher valuations for residential properties.

These higher valuations have allowed many homeowners to access more equity during a refinance or while applying for a home equity line of credit. However, one of the downsides to this is that homeowners’ increased debt load has triggered the Government of Canada to make mortgage changes to slow down the pace of that debt.

What the industry is now starting to see is a situation where lenders are stepping away from AVMs and moving to live appraisals, which by their nature lower the valuation of the property. Not surprisingly, this comes on the heels of Canada’s largest mortgage default insurer coming close to reaching its funding cap. Now the mortgage industry is seeing valuations drop on properties where nothing has changed.

The move toward live appraisals doesn’t bode well for buyers or sellers. Sellers will have to lower their asking prices or buyers will have to come up with higher down payments to make up for shortfalls if the appraisals come in lower than the purchase prices.

As a result, sellers may decide to wait out the market, holding on to their property until times are better. This puts another dent in an already depleted inventory. The ultimate result of lower valuations, along with the most recent changes to mortgage rules, is likely to be a slowdown in the real estate market. We are already starting to see it, especially among first-time home buyers.

Randy Bett www.BetterGroupRealEstate.ca