Affordability Drives Value: Insights from a Seasoned Appraiser

Affordability Drives Value: Insights from a Seasoned Appraiser

It can be said that housing prices determine affordability, but it is also true that affordability can drive prices, and prices in turn can drive value.

Due to rising interest rates, many potential home buyers are currently unable to qualify to buy the properties they want. Some have been pushed out of the market entirely. After speaking with two individuals in the mortgage business recently, I discovered that they suddenly have a lot of free time since the number of mortgage applicants has declined significantly. At the same time, I’m seeing some listing prices being reduced, and the number of days on market is gradually increasing. All of these are signs which indicate a gap in affordability.

Are we on the cusp of a market correction?

Last year, in another McKissock blog post called “Is There a Market Correction on Its Way?” I discussed the signs that would indicate the next market correction. Among them are the above signs.

Sometimes we hear the phrase, “The appraiser appraised it too low,” or something similar—blaming the appraiser for the final value determination. It is possible that there was an error. We aren’t perfect, and as I’ve written before: “There is no correct answer in appraising, and seldom would several randomly selected appraisers come to the exact same dollar amount conclusion.”

The comparables as adjusted yield a range of indicated values. The lending industry and our clients in general ask us to reconcile that range into a single number. Assuming they are properly adjusted, the market yielded a range of potential results, not a single figure. Buyers are inconsistent in what they offer for a property, which is typically a combination of wants, needs, and you guessed it…affordability. 

What do appraisers really do?

On the first day of class, I often tell pre-licensing students, “Appraisers don’t create value; they just read the tea leaves in the cup.”  We learn to analyze market data and report what the market says the subject property would likely sell for, under normal circumstances, as of the effective date. (If you read the definition of market value on the standard forms, that is essentially what it says.)

Affordability plays a large role in driving home prices, and in turn property values, in an area. Lenders often have to tell potential buyers that they are not approved because the affordability factor disqualifies them.

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Qualified buyers and listing prices

Before specializing in appraising, I owned and operated a sizable full-service real estate brokerage company. It was not common for real estate salespeople to pre-qualify buyers back then, but we did. Once buyers were pre-qualified, they were shown properties within their budget. Many times, on the way to a home the buyer could afford, they’d see a house that appealed to them and ask, “What about that one?” Unfortunately, the answer was simple: They couldn’t afford it.

We learned early on that listing a property unrealistically high is one of the worst things you can do as a real estate agent. Why? Because the wrong people look at it.

For example, a few years ago before the pandemic, a relative of mine pre-qualified for a loan of $350,000. While on the hunt for a home, they pressured the Realtor to show them the inside of a house listed for $450,000 even though they couldn’t afford it, because they liked its exterior. As it turned out, the seller had insisted on that price, and the listing agent had taken the listing knowing that it was more like a $350,000 house. As a result, those who could afford a $450,000 house looked at it and recognized it was not a $450,000 house and weren’t interested. Moreover, buyers of $350,000 houses (except my relatives) did not look at the house because it was out of their price range.

In what was a fairly active market, the house had been on the market for nearly two years. When the listing agent finally convinced the seller to reduce the price to $350,000, the agent working with my relatives called to inform them of the price reduction, and 20 minutes later they were under contract.

What is a comparable?

To find comparable sales, appraisers search the market for similar sales that potential buyers of the subject property might have considered as alternatives to the subject property. Searching by a predetermined price range is a dangerous and unacceptable option. The number of alternatives can be narrowed by searching by location and relevant physical characteristics. The search results in an affordability range for potential buyers of the subject property.

Although a seller has the right to accept or reject an offer, it’s the buyer—and what that buyer can afford—that drives the eventual price paid. Those affordable prices are what appraisers use to extract values from market data.

Lack of affordability impacts the market

As interest rates and inflation rise, but incomes do not rise at the same level, this could very well trigger a market correction. I’m reading lots of predictions from people in high places in the real estate and lending worlds saying that the correction is underway, and it’s all about affordability.

Learn more with McKissock’s CE course, Market Disturbances: Appraisals in Atypical Markets and Cycles.

Written by Steven W. Vehmeier, Appraisal Educator Emeritus. Steve retired from his appraisal and appraisal education practices after a long career specializing in writing and teaching pre-license and continuing education courses, including twenty-two years doing so for McKissock. He continues to write articles and blogs to share his knowledge and experience.

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