Considering Financing and Sales Concessions: A Practical Guide for Appraisers
![Scott Reuter](/sites/g/files/ynjofi176/files/styles/avatar_circle/public/scott_reuter.png?itok=P4fFavJ4)
With mortgage rates continuing to hover around 7%, many sellers and homebuilders in the current market are offering additional concessions and rate buydowns to attract interest in their properties. It’s important that appraisers are aware of that and consider its impact on market value. If not properly considered, there’s potential for it to negatively impact Freddie Mac from a risk perspective. Below, I’ll discuss some of the most common questions I’ve received from appraisers on this topic.
Most Common Questions
While addressing sales concessions is a topic often discussed, and even debated, among appraisers, there’s still confusion on how to appropriately consider it in an appraisal assignment. Some of the most common questions I get on the topic are:
- Do I really have to consider sales concessions in the appraisal?
- How much should one adjust?
- Why not just adjust concessions dollar for dollar?
- What if the subject’s transaction has concessions?
- What if concessions are very common in the area?
Do I really have to consider sales concessions in the appraisal?
The short answer is, yes. The definition of market value used for government sponsored enterprise (GSE)-related appraisal assignments says that the opinion of most probable price must represent the normal consideration for the property sold unaffected by special or creative financing or sales concessions.
If an appraiser fails to confirm concessions in a comparable transaction and/or fails to adjust for the effect of the concession on the price, then the result doesn’t reflect the definition of market value.
How much should one adjust?
As noted on the Uniform Residential Appraisal Report (Form 70/1004), “Any adjustment should not be calculated on a mechanical dollar for dollar cost of the financing or concession but the dollar amount of any adjustment should approximate the market’s reaction to the financing or concessions…”
How much would the comparable have sold for without the concessions? That’s the adjustment rate that the appraiser should apply to that comparable.
Why not just adjust concessions dollar for dollar?
The effect that concessions have on the net amount of cash received by the seller is a simple calculation. However, an appraiser’s adjustment is based on sale price, not the net cash to the seller. The effect of concessions on the sale price may be something equal to, less than or greater than the amount of the concessions.
What if the subject property’s transaction has concessions?
While adjustments aren’t made to the subject property for any financing terms or concessions, they may be indications of the prevalence of concession activity in the subject property’s market area. This is especially common in new subdivisions where builders often offer concessions or buydowns to drive interest and support higher prices.
An appraiser should never apply adjustments due to concessions in the subject property’s contract. Adjustments are only made to reflect the effects of concessions on the sale prices of the comparable properties. The terms of sale negotiated for the subject do not affect the sale prices of the comparable properties.
What if concessions are very common in the area?
Some appraisers don’t adjust for concessions if they’re common in an area. Others only adjust if the concession exceeds what is “typical in the area.” In all cases, adjustments should be made when the sale price of a comparable property was affected by concessions, regardless of what is common practice in a market area.
Get the Information, Make the Adjustment
We’ve established why it’s so important to make adjustments, but what information can the appraiser use to do it and how can they get it? The seller is required to provide the appraiser with the sales contract. This is important so that the appraiser can identify the financing terms, note concessions, non-arm’s length transactions, etc. This information can help the appraiser identify whether the price is potentially impacted by the existence of these conditions leading to an inflated or understated sales price.
In terms of getting the information, the appraiser typically doesn’t have access to the sales contract for the comparable sales. This is where verification of the sales data is so critical. The appraiser may be able to identify certain terms of sale in the MLS (multiple listing service) and should be confirming all of the details and terms (usually with an agent).
Buydowns and Concessions - Impact on Risk
While the ability to identify and verify transaction terms for comparable sales data can be challenging and inconsistent at times, appraisers are still responsible for adjusting the comparable sale(s) for special or creative financing concessions. Concessions and buydown activity that are not appropriately considered and adjusted can raise credibility concerns for the appraiser and introduce potential risk to Freddie Mac.
Determining whether prices are inflated by concession or buydown activity is part of an appraiser’s core responsibilities when analyzing market conditions and developing and supporting necessary adjustments. While certain mitigants are structured into Freddie Mac policy to help limit risk exposure (e.g., limiting number of sales from same builder), it relies on appraisers to verify sales and determine the extent of stimulus evident in the subject market.