Understanding Real Estate Contracts: What You Need to Know
Providing a copy of the real estate sales contract to an appraiser is mandatory as per Standards Rule 1-5 under the Uniform Standards of Professional Appraisal Practice (USPAP). This rule requires the appraiser to examine all agreements pertaining to the sale. Therefore, it is imperative to provide a copy of the sales contract.
Moreover, supplying a copy of the real estate sales contract can offer additional benefits. The appraiser may already be familiar with local real estate contract forms, customary terms and conditions in real estate transactions in that area. This familiarity can help them identify any irregularities and provide insightful comments on them.
When appraising a property, it’s important to thoroughly examine the real estate sales contract. This document may contain provisions that identify concessions, non-real property items included in the sale, or other unusual conditions that could impact the appraised value of the property. In such cases, the appraiser must comment on or explain in their report why there is a difference between the indicated market value of the subject property and the contract price.
Questions we should ask ourselves
When should we analyze the contract?
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When it comes to real estate appraisal, it is essential to review the sales contract early on. This enables appraisers to identify any “subject to” items or other conditions that could potentially influence the value conclusion. However, it is worth noting that reviewing the contract early may inadvertently lead the appraiser’s mind towards the sales price which might influence their comparable selection and eventually impact their valuation direction.
Perhaps it would be better if appraisers developed their opinion of value first before looking at the real estate sales contract. They could avoid unintentionally being influenced by the sales price and deliver an unbiased appraisal report that way.
What is in the sales contract that an appraiser actually needs to see?
For a typical “as-is” Market Value assignment with a straightforward contract with no contingencies or conditions, there is probably nothing that an appraiser actually needs to see. If a property appraises for $200,000 for a refinance, then it is still a $200,000 property for a sale transaction.
Of course, if the sale transaction has a “subject to” provision such as adding, replacing, or repairing something that would impact value, then the appraiser could properly account for that in the appraisal. However, that information could also have been provided to the appraiser without seeing the contract, by the lender (or client) stating in their engagement letter to “Appraise the property subject to replacing the roof or HVAC, etc.”
The appraiser might also analyze the contract to comment or explain in the report prior to delivery, rather than afterward, why the value opinion differs from the sales price; for instance, when a condo is sold with non-real property items, such as expensive furnishings and artwork included in the sales price.
What is an appraiser expected to analyze and give an opinion on?
Attorneys are the professionals who are licensed to analyze and give opinions on the accuracy, appropriateness, adequacy, abnormalities, and legality of contracts. Appraisers should be careful not to perform analysis and/or provide opinions and conclusions that would fall under “practicing law without a license.”
That said, there is no clear guidance in USPAP, Secondary Market Guidelines, HUD or VA handbooks, etc. that states exactly what the appraiser is supposed to be looking for when performing the contract analysis. That lack of guidance creates two questions without answers:
- Without specific standards or guidelines, how does the appraiser know what to do?
- How does a state appraisal board or a court determine what was an appropriate analysis given the lack of any authoritative guidance?
Should the contract price have any impact on the value conclusion?
The pre-printed Certification item #18 on the URAR form which states:
“My employment and/or compensation for performing this appraisal or any future or anticipated appraisals was not conditioned on any agreement or understanding, written or otherwise, that I would report (or present analysis supporting) a predetermined specific value, a predetermined minimum value, a range or direction in value, a value that favors the cause of any party, or the attainment of a specific result or occurrence of a specific subsequent event (such as approval of a pending mortgage loan application).”
When contract prices and value often differ
Contracts provide a “price”, which may or may not have anything to do with “market value.” A key element in classic fraudulent transactions is getting an appraisal that overvalues the property. Without a gap between actual value and the inflated contract price there are often no illicit proceeds for the perpetrators. Of course, the number one tool to achieve that is a phony contract showing an inflated price.
These phony contracts typically give no obvious signs of their falsehood. Fraudsters with experience know how to select targets in high-end properties areas. The perpetrators are hoping that having seen the contract, the unsuspecting appraiser will search for comparables by price range. And find those higher priced sales and use them as comparables to support the stated contract price. Even some of the most experienced appraisers can fall victim to this scam. A reliable way to avoid falling into this trap is to complete a proper market analysis. Searching based on relevant characteristics for the subject’s market rather than search by sale price.
Considering the investor segment of the market can make real estate sales contracts complicated. I have encountered instances where I paid more than market value for a property that I really desired or needed. However, I have also taken advantage of desperate sellers and obtained less than market value. It’s worth noting that the contract prices on the properties I’ve purchased seldom reflect their true market value.
