What is an Appraisal Gap and Appraisal Gap Contingency?

In many real estate markets across the country, sellers are receiving multiple offers above the listing price of the home.

While a home appraisal is meant to estimate fair market value, sometimes there is a time lag between what buyers and sellers agree a property is worth, and what an appraiser says a home is worth.

Until there’s a meeting of the minds between buyer, seller, and appraiser, an appraisal gap can occur. In this article, we’ll discuss how and why an appraisal gap happens, and some strategies for buying a home that doesn’t appraise for the purchase price.

Key Takeaways

  • Appraisal gap is the difference between the offer price and the appraised value of a home.
  • Gaps in the appraisal can occur when market conditions quickly change and bidding wars occur.
  • An appraisal gap contingency clause is used by buyers to make a stronger offer in a seller’s market.


What is an Appraisal Gap?

An appraisal gap is the difference between the offer price on the purchase contract and the appraised amount of the home that the bank will finance.

For example, if the price offered by a buyer is $150,000 and the home appraises for $140,000, the gap between the offer price and the appraised value is $10,000. That means that in addition to the down payment, a buyer needs to come up with an additional $10,000 to close on the transaction unless the purchase contract can be renegotiated.

According to a recent article on RealTrends, appraisal gaps are becoming increasingly common due to competition for homes in today’s low inventory, high-demand real estate markets. It’s not uncommon to find houses selling for thousands of dollars above the asking price, with buyers who need to finance a home purchase competing with all-cash real estate investors.

One might think that if home prices keep rising, appraisal valuations should keep going up as well. But sometimes that isn’t always the case, at least over the short term.

In order to know how an appraisal gap can happen, it’s useful to understand the process for appraising a home.



How a Home Appraisal Works

A home appraiser is a professional trained in the valuation of real estate and licensed by the state. Certified Residential Appraisers may appraise one to four residential units, and must complete 200 hours of qualifying education and also have 1,500 hours of experience over the past 12 months or less.

When a buyer purchases a property using a mortgage, the lender will hire an appraiser as an independent third-party to estimate the home’s value. The bank wants to make sure that it is not lending more than the home’s appraised market value.

Buyers paying all cash for a property may also order their own appraisal as part of the normal due diligence process. A home appraisal typically costs around $400 but will vary based on the size and price of the home, and the property type such as a single-family rental versus a small multifamily building.

There are four general steps to the home appraisal process:

1. Order appraisal

The appraisal is ordered immediately after the purchase agreement is accepted and escrow is opened. Most home purchase agreements have a contingency clause stating that the property must appraise for at least the purchase price.

The quicker a buyer learns whether or not the home will appraise, the more time they have to attempt to renegotiate the offer, back out of the deal, or find additional funds to fill any appraisal gap.

2. Run comparables

The appraiser will inspect the inside and outside of the home and run comparables showing recent sales transactions and active listings of similar homes in the same area.

Because no two homes are exactly the same, the appraiser will make adjustments to the comps to help determine the fair market value of the property being purchased. For example, if the home being appraised has a brand new roof, adjustments will be made to the comparables to factor in the added value of a new roof.

Other factors affecting appraised value include the square footage of the property, number of bathrooms and bedrooms, lot size, recent improvements, or signs of potential maintenance issues, such as a foundation crack or signs of a water leak.

3. Review the appraisal

Once the appraisal is complete, the buyer can contact the lender to learn if the home has appraised for at least the purchase price. While some banks or credit unions used to refuse to provide the buyer with a copy of the appraisal report, under the Dodd-Frank Wallstreet Reform and Consumer Protection Act, lenders are required to provide to applicants free copies of all appraisals and other written valuations developed in connection with an application for a mortgage on a dwelling. Lenders must notify applicants in writing that they may obtain copies of appraisals.

When shopping for a rental property loan, it’s important to obtain a copy of the appraisal. That way, an investor will be able to review the appraisal report for accuracy and use it as part of the negotiating process.

4. Decide on the next move

If the home appraises for at least the purchase price, a buyer may remove the appraisal contingency in the purchase agreement and move forward on the transaction.

On the other hand, if the home appraises for less than the purchase price, a buyer may:

  • Attempt to renegotiate the price with the seller.
  • Walk away from the transaction if the seller won’t budge on the price.
  • Fill the appraisal gap by paying the difference between the purchase price and the appraised value, in addition to making a down payment.
  • Include an appraisal gap coverage clause in the offer to the seller.


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Why Appraisal Gaps Happen

There are a number of reasons why an appraisal gap may occur, and sometimes gaps in the appraisal happen for more than one reason.

Savvy real estate investors will take the time to understand the reasons why there is a gap between the sales price and the appraised value, to help better understand the risks and potential rewards:

  • Market values rising faster than the recent sales comparables.
  • More demand for homes than there is supply creating a seller’s market and bidding wars.
  • Property values in the area are beginning to decline.
  • Overpricing or underpricing by the seller.
  • Property not well maintained with a lot of deferred maintenance.
  • Rent roll indicates declining rents and rising vacancy in a small multifamily building.
  • Large percentage of short sales or foreclosures in the area driving home prices artificially low.
  • Errors made by the appraiser, such as overlooking significant recent improvements made to the home.


How to Compete in a Bidding War

According to research from Realtor.com (June 2021), the national inventory of active listings declined by 43.1% last year, while the median price for active listings increased by 12.7% during that same period.

The typical home is on the market for just 37 days versus 72 days during the same month in 2020. As Redfin notes, a record high of 50% of homes sold for more than their list price, nearly double compared to the same period last year.

Of course, whether the strong demand for homes will continue is anyone’s guess. But for investors purchasing rental property today, there are some things to do to help compete in a bidding war:

1. Include an Appraisal Gap Coverage Guarantee in the Offer

A buyer who uses an appraisal gap coverage guarantee clause when making an offer to the seller agrees in advance to pay a fixed amount over the appraised value.

For example, assume a home has a listing price of $125,000.

Based on recent sales activity and activity in the marketplace, the buyer thinks the home has a market value higher than the listing price and makes an offer for $130,000. In addition to making an offer above the listing price, the buyer also writes an appraisal gap guarantee clause into the offer agreeing to pay up to $5,000 over the appraised value to help make the offer even stronger.

If the home appraises for $127,500, then the buyer needs to bring an additional $2,500 on the day of closing. The purchase contract does not need to be renegotiated, because the buyer already agreed to pay up to $5,000 more above the appraisal in the appraisal gap contingency clause.

On the other hand, if the appraisal comes in at the offer price of $130,000, the buyer can keep the additional $5,000 because the bank will lend based upon the higher appraisal value.

2. Fill the Appraisal Gap by Paying the Difference

One of the potential drawbacks to writing an appraisal gap contingency clause into the purchase contract is that the buyer may accidentally end up under bidding.

In the above example, by writing an offer for $130,000 and including a $5,000 appraisal gap contingency clause, the buyer is effectively saying that the maximum price to be paid is $135,000.

Now imagine the seller receives multiple offers ranging from the asking price of $125,000 up to $140,000.

While the seller could submit multiple counteroffers, the seller may decide to accept the highest offer, assuming all offers are from qualified buyers and the contingencies in the purchase contract are more or less the same.

In a situation like this, the buyer writing the contingency clause of $5,000 would have the offer rejected, even if he was willing to match the highest offer. Although the buyer intended to make a strong offer by using an appraisal gap contingency clause, in hindsight, it may have been better to not address a potential appraisal gap.

3. Minimize Other Contingencies in the Offer

Another good way for a buyer to compete in a seller’s market is by minimizing the contingencies in the purchase offer. A contingency is something that must be met before the contract becomes legally binding.

Sometimes buyers will remove one or more contingencies to make the offer appear stronger. However, there could be potential risks in taking contingencies out of the purchase offer. It’s a good idea to consult with your attorney or real estate agent to understand the pros and cons of removing a contingency.

Common contingencies in a residential purchase agreement include:

  • Inspection
  • Appraisal
  • Financing
  • Homeowners insurance availability
  • HOA document review
  • Title
  • Sale of an existing home

When buying a rental property, a common contingency is to review documents such as the rent roll, existing lease agreement, and the property’s profit and loss statement (P&L). If the property isn’t generating the NOI the seller claimed, the buyer may choose to walk away from the transaction and have the earnest money returned.

One way to find good rental property that has had up-front due diligence performed is on the Roofstock Marketplace. In many instances, the rental homes on Roofstock already have key documents gathered to give buyers the confidence to purchase an investment property sight unseen.



Where to Find Appraisal Gap Funds

Agreeing to pay an appraisal gap in addition to the down payment means a buyer will need to bring extra cash to the closing table. For example, if a buyer offers to pay $130,000 for a rental property and the home appraises for $127,500, the buyer will need to pay $34,375 in cash at closing:

  • Down payment of $31,875 based on 25% of the appraised amount
  • Appraisal gap of $2,500 based on the appraisal gap contingency clause written into the purchase offer
  • Total cash due at closing is $34,375

There are several ways a motivated buyer can potentially find money to pay for an appraisal gap.

Loans or gifts from family members may be one option. When gift money is used to help close on a loan, the mortgage lender will normally ask for a gift letter so that the source of funds is disclosed.

Real estate investors may also tap into a retirement fund, or convert a current retirement account into a self-directed IRA (SIDRA).

Another option for finding appraisal gap funds is to form a joint venture with a fellow real estate investor. Any potential recurring monthly income and profits would need to be shared, but some investors choose to partner with somebody else rather than losing out on a good investment.


Appraisal Gap vs. Appraisal Contingency

An appraisal contingency in the purchase contract allows the buyer to have the earnest money refunded and walk away from the deal if the home does not appraise for at least the purchase price.

On the other hand, an appraisal gap contingency clause is written into the contract by the buyer to agree ahead of time to make up the difference between the offer price and the appraised value if the home does not appraise for at least the purchase price.


Final Thoughts

There are potential risks and rewards to buying a home with an appraisal gap. Although the housing market has been performing exceptionally well for several years, there’s always a chance the market will enter a downward trend due to factors such as rising mortgage interest rates.

Rental property investors who believe the time is right to buy should consult with their real estate team and create pro forma income statements to help decide whether paying an appraisal gap makes good business sense.


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This article, and the Roofstock Blog in general, is intended for informational and educational purposes only, and is not investment, tax, financial planning, legal, or real estate advice. Roofstock is not your advisor or agent. Please consult your own experts for advice in these areas. Although Roofstock provides information it believes to be accurate, Roofstock makes no representations or warranties about the accuracy or completeness of the information contained on this blog.
Jeff Rohde


Jeff Rohde

Jeff has over 25 years of experience in all segments of the real estate industry including investing, brokerage, residential, commercial, and property management. While his real estate business runs on autopilot, he writes articles to help other investors grow and manage their real estate portfolios.

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