When a home is exposed to the market under normal conditions, it will most often sell within a reasonably tight range. This range is the most probable price and is a fundamental part of the definition of market value. So how is it that market participants (buyers, sellers, and agents) usually agree on a price that is close to market value, even when they are not making adjustments, verifying data, and analyzing statistics like an appraiser does? There are three key factors why the market usually gets the price right.
When someone decides to buy or sell a home, they usually start by contacting an experienced agent who provides expert advice. Agents help to educate buyers and sellers on factors that may not be readily apparent to the layperson. An agent may or may not know the value of a property, although most agents have experience in setting price based on comparable sales or other approaches. (Even so, I still recommend ordering an appraisal before you sell). In addition to helping with setting strategic list prices or offer prices, an agent will be able to point out local trends, help guide decisions, and provide buyers or sellers with a foundation to start searching.
Buyers will usually determine where they want to purchase and start looking at homes in their price range to see what is available. When a buyer is focused on one area, one price range, and one set of key features, it is not long before they can accurately determine what a good deal is. Buyers will not necessarily know what market value is, just that some homes are priced better than others given the buyers’ individual need and budget. This process usually leads a buyer to the right price.
Sellers will set a price, but once the home is exposed to the market, they will usually know quickly if the price is close to market value. A home that is priced very high will typically not receive many showings. A home that receives showings, but no offers, might only be slightly high. A home that is priced too low will often receive multiple offers and still sell for close to or even more than market value (depending on many factors but there are different opinions on this).
This begs the question, if buyers usually get the value right, then why do banks require an appraisal in a purchase? The answer is that buyers usually get it right, but sometimes do not. Some properties are unique, and buyers will just fall in love without sound justification for the price. Other times there are non-market factors that influence the price. Whatever the case, banks use appraisers as one way (of many) to verify and protect their interest in the loan. The typical appraisal cost is very low in relation to the cost of making a bad loan. An independent opinion of value from an experienced local certified appraiser just makes good financial sense.
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An appraisal of a home includes a definition of value. Typically, that definition of value is for “market value” or something similar. There are many official appraisal definitions of market value. Often such definitions begin with the phrase “The most probable price,” as shown in the example below. Do you know what the most probable price is?
The above market value definition, from the 1004 Uniform Residential Appraisal Report form, starts with, “The most probable price….” What does that mean?
The concept of most probable price suggests that if a single property were hypothetically exposed to the market many times over the same period, it would not always sell for the same price. If the property sold enough times, the resulting sale prices would likely be distributed along a range and resemble a bell curve when graphed.
In the above illustration of a bell curve, the sale price range would be from left to right of the graph or on the x-axis. The number of times that the property sold at a particular price would be graphed bottom to top or on the y-axis.
The bell curve shows that most of the sales are likely clustered in the center with fewer and fewer sales moving up or down on the price scale (away from the center of the curve). This means that an accurate appraisal should conclude a value close to the peak of the bell curve. Appraisers can also provide a value opinion in the form of a range, but a single point is often requested and value opinions will vary among appraisers.
If more than one appraisal is ordered for the same property, most appraisers should conclude a value that is close to the peak of the bell curve. The larger the quantity of comparable sales data, the closer one would expect appraisers to be able to find the peak of the bell curve accurately and the closer the value opinions would be among different appraisers. Since small differences between appraiser opinions of value can significantly affect the lives of people who use appraisals, it is important to select your appraiser carefully.
If you find this information interesting or useful, please subscribe to my blog. Also, please support us by making Portland real estate appraisal related comments on our blogs and YouTube videos. If you need Portland, Oregon area residential real estate appraisal services for any reason, please contact us. We will do everything possible to assist you.
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