Q: I am representing a Buyer. The Seller is willing to have a financing contingency but not an appraisal contingency in the purchase agreement. We are in a market with rising prices; lately the appraisals in the area have not matched the purchase price. My Buyer is concerned that the appraisal will come in low and they will not be able to come up with the necessary cash to make up the difference. Is there anything we can do?
A: You have described the problem that occurs in every real estate cycle where there are rising prices. Appraisers base their opinion of the Fair Market Value (“FMV”) on recent comps which are, almost by definition, below the current pricing due to supply and demand. If the Buyer does not have an appraisal contingency, the existence of a low appraisal can have significant financial consequences for the Buyer.
In the CAR Residential Purchase Agreement Paragraph 3.J.(2), it is clear that if there is a financing contingency but no appraisal contingency and the Property does not appraise (and this is the only reason that the Buyer cannot get loan approval for the specified loan), then the Buyer CANNOT use the lender’s refusal to fund as a good faith basis to cancel the contract.
(Note: The PRDS Purchase Contract (“REPC”) takes just the opposite approach and a Buyer in those sane circumstances could cancel the contract. The SFAR Purchase Agreement is silent on this point and thus it is unlikely that the Buyer can use the SFAR Financing Contingency to cancel due to only a low appraisal.)
What Agents can do in the Purchase Agreement is dependent upon the answers to 4 critical questions:
- What does the Buyer want? If the Buyer wants to be assured that the sale price equals FMV, then the Buyer needs to have an appraisal contingency in the Purchase Agreement.
- How much is the Buyer willing/capable of spending over FMV? Depending upon how low the appraisal comes in, there may well be a certain point where the Buyer will believe that they are “over-paying.”
- What does the Buyer want if the appraisal is very low? Does the Buyer want the sale price dropped, and, if so, by how much? Does the Buyer want to cancel? If so, then the Buyer will need a special contingency.
- What concessions will the Seller agree to make if the appraisal is low? If there were multiple offers and/or the Seller would not agree to any contingencies, then it is unlikely that the Seller will make any concessions.
PRACTICE TIPS:
BUYERS’ AGENTS:
- Send the Buyer an email detailing the three options/risks when using the CAR RPA:
A. For Buyer’s financial protection, include an appraisal contingency in the offer notwithstanding the market and the likelihood that the offer will be rejected;
B. Take the financial risk of a low appraisal and do not include an appraisal contingency which would either necessitate the Buyer bringing in more funds or potentially being in default and losing the deposit;
C. Add a special contingency in an Addendum to the offer dealing with how the Parties will handle a low appraisal. For example:
Paragraph 3.I of the Purchase Agreement is modified as follows:
(A) In the event that the Property appraises for an amount that is between $________ (the agreed upon Purchase Price) and $________, (the appraised value) Buyer agrees to proceed with the purchase at the stated Purchase Price; and
(B) If Buyer receives a loan commitment that is less than the amount specified in Paragraph 3D of the Purchase Agreement as a result of that appraisal, Buyer agrees to bring cash to close the escrow to cover the difference between the Purchase price and the loan amount; but,
(C) If the Property appraises for an amount that is below the appraised value specified in A above, then Buyer shall have the right to cancel this Agreement within _____ Days of Acceptance.
NOTE: The Buyer may want to consider including this option in the offer even when using the PRDS or SFAR forms (but without referencing CAR Paragraph 3.I) to strengthen the offer so that the Seller will know the Buyer will still stay in the transaction and bring cash for the difference.
- Send the Buyer an email detailing the risks of a low appraisal when the Buyer does not have an appraisal contingency. The degree of risk depends upon which purchase agreement form is used:
A. CAR Purchase Agreement: If there is a loan contingency but the appraisal contingency has been removed, or waived, the Buyer will NOT be able to cancel based on a low loan commitment if the sole reason for that low commitment is the lender’s appraisal. The Buyer will be obligated to bring sufficient cash to close over the amount of the loan received or could face the potential of a default.
B. PRDS Purchase Contract: If a Buyer has a loan contingency but no appraisal contingency, the Buyer may still be able to cancel if Buyer receives a low loan commitment based solely on a low appraisal.
C. SFAR Purchase Agreement: How the lack of an appraisal contingency impacts the existence of the financing contingency is not addressed in this contract at all. It is thus not clear whether Buyer has a right to cancel with no appraisal contingency due to a low loan commitment based on a low lender appraisal.
LISTING AGENTS: If a Buyer uses either the PRDS or SFAR forms to make an offer and it includes a financing contingency but no appraisal contingency, Agents should advise Sellers about their three options, preferably in an email:
- Seller could accept, but the absence of an appraisal contingency might still enable the Buyer to cancel depending upon the Lender’s response (and depending upon how the SFAR form is interpreted);
- Seller could counter out the appraisal contingency or counter by establishing an upper limit for a low appraisal that obligates the Buyer to proceed depending upon the differential (such as using 1C above.)
- Seller could reject the offer.
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