Appraisal Risks – Part 2: What Do You Mean the Appraisal is “Too Good”?

[Reggie Nworie]

Appraisal Risks – Part 2: What Do You Mean the Appraisal is “Too Good”?

This is part 2 of a 2-part series on appraisal risks. In Part 1, we discussed what to do if an appraiser undervalues your property. In Part 2, we discuss what happens when an appraiser overvalues your property.

Introduction:

Fix and flip deals in the real estate market are undoubtedly enticing for both seasoned investors and those looking to try their hand at property flipping. One crucial element in these transactions is the appraisal process, where appraisers assess the value of a property to determine its market worth. While the phrase "showing love" is often associated with appraisers valuing a property higher than expected, there is a flip side to this phenomenon that deserves attention. In this blog, we'll explore the potential downsides and risks when a property gets overvalued.

1. The illusion of Value: Appraisers "showing love" can create an illusion of inflated value, luring investors into a false sense of security. In the fix and flip business, accurately assessing the true value of a property is essential for making informed investment decisions. When appraisers overestimate the value, it can jeopardize potential profits, inadvertently hurting the very borrower they were trying to help. Often, the appraiser has good intensions in their attempt to help the borrower, but overvaluation leads investors to pay more than a property is worth, or spend more on renovations than what is necessary, or expect to be able to refinance at a value that is not in line with their market. Each of these errors can significantly reduce profitability and they increase the risks associated with the project.

1. Overleveraging: An inflated appraisal can also lead to overleveraging, where investors borrow more money than they need. To be clear, we're not talking about a contingency, every investor should always have a contingency. We're talking about overleveraging. Borrowing more money than the deal can support and/or than the borrower can reasonably repay. This situation can be especially precarious in a market downturn or if the renovated property fails to meet the anticipated After Repair Value (ARV). Overleveraging increases financial risks and may result in significant losses for investors.

1. Market Distortion: Repeated instances of appraisers consistently "showing love" can distort the local real estate market. Inflated property values can contribute to a “bubble”, where prices become detached from economic fundamentals. Such market distortions may have long-term consequences, affecting not only fix and flip investors but also regular homebuyers and the overall stability of the real estate market.

Conclusion:

While an appraiser "showing love" may initially seem like a boon to fix and flip investors, the flip side reveals potential pitfalls and risks. It's crucial for investors to approach appraisals with a critical eye, seeking accuracy rather than inflated values. Striking the right balance between optimism and realism in property valuations is essential for a sustainable and profitable fix and flip business. In the ever-evolving real estate market, understanding the nuances of appraisals is key to navigating the challenges and maximizing the probability of success in fix and flip endeavors.