Purchase Price vs Market Value
“Price is what you pay. Value is what you get.” — Warren Buffet
By Julie Parker
The booming market of residential real estate we experienced nationwide in 2021 through the first half of 2022, saw buyers purchasing homes at well over list price. The buying phenomenon of that time is now causing some waves in the appraisal industry as current valuations of those properties purchased during that time period are being requested.
Many of those new homeowners are feeling the fallout of paying sales prices which exceeded the value of the property at the time of purchase. After a year+ of ownership, some homeowners are seeking appraisals or other forms of valuation of their recently purchased properties to determine value for various transactional purposes. The answer to the question, “What is my property worth?” is one that may be a bit disappointing for some. The owner’s expectation is generally that the property’s appraised value will meet or exceed the sales price previously paid.
The Key Words to Note are “Price” and “Value”
Expectation born without consideration of all elements at play, when forecasting the most probable result, can lead to disappointment.
The failed expectation in this case is the result of regarding the accelerated sales price of the property and its actual market value at the time of the sale, as one and the same; or price=value. The reality is that during the purchase frenzy of that time, buyers were knowingly paying prices well over market value. The buyer’s willingness to do so was the result of a perfect storm of low volume, high demand, and historically low interest rates. In 2022 as interest rates began to rise, sales prices continued to increase and buyers still sought to quickly purchase out of fear that interest rates would continue to increase.
A telling indicator of these noted factors at play is that realtors were educating their buyers and confirming that they were willing and able to pay an appraisal gap due to an accelerated purchase price that would be necessary to capture the sought after listed property in such a market. It became standard practice for appraisal gap clauses to be placed within purchase contracts with buyers agreeing to pay the difference between the purchase price of the property and the appraised value.
It is an interesting notion that an informed buyer, who knowingly paid the appraisal gap, would now have an expectation that the current appraised value would be equal to or greater than the accelerated sales price previously paid. Especially given market trends since that time, the second half of 2022 saw sales prices decrease; while the first half of 2023 has seen most markets stabilize and some markets have had only moderate increases reported.
Homeowner Expectations
Today, appraisers throughout the country are dealing with the brunt of delivering current appraised value results that do not meet the expectations of these homeowners when those opinions of market value are compared to the prior purchase price paid for the property. Clients and borrowers may point to market trends, i.e., the percentage of increased values within the various markets to prove their case for a higher appraised value. Regardless of the market trend since the property’s purchase, the underlying issue is that the purchase price paid during this escalated period of sales activity did not necessarily equal actual market value at the time of sale.
With that in mind, if applicable market trends were applied to the actual market value of the property at the time of sale, rather than being applied to the accelerated purchase price, the present-day market value in most cases, where significant appraisal gaps were paid at time of purchase, still would not support the prior purchase price. However, this is not to say that the property has decreased in “value”, which is typically the rebuttal from the borrower and/or client.
Their frustration lies in the belief that market trends to date do not support an overall decline in the property’s market value since the time of purchase; therefore, the subject’s current appraised value has been understated as it does not support or exceed the prior purchase price. In part, this theory is correct as there has not been an overall decline in the property’s market value. However, there has not been a large enough percentage increase in market values that would raise the property’s market value to the threshold that would now support the accelerated purchase price that was previously paid.
Again, the key words to note are “price” and “value.” The difference in purchase price and market value is significant enough that combined with a stalling of market trends since time of purchase, many of those buyers are still a bit underwater.
Oftentimes in these instances, when an expectation of value is not met, appraisers are experiencing pushback from clients and borrowers to further analyze market trends, additional market data, etc. in hopes that the additional data will provide the support needed for the appraiser to revise the appraisal report and appraised value in a beneficial way.
“Price” and “Value” are not Interchangeable
It is always the appraiser’s responsibility to communicate the appraisal and its results in such a way that it can be clearly understood by the intended users, and it is no different in these instances. The appraiser would analyze additional, relevant data presented to them by the client.
However, the primary point that must be made clear to the intended users, to fully understand what may appear at first glance to be an understated appraised value, are the terms and various factors that surrounded the prior purchase, and the accelerated purchase price of the property as a result of the bullish residential real estate market during that time period.
The distinction that the purchase price does not always equal market value is key. An obvious indicator of that would be when you, the buyer, agree to pay an appraisal gap as part of the purchase price. And for significant appraisal gaps that are paid by buyers, the time period to realize that value in the property may be extended, depending on market conditions among other factors.
The takeaway for buyers, sellers, owners, borrowers, and clients alike is that the terms “price” and “value” are not interchangeable.
