How falling home prices are leading to growing appraisal gaps



With national home prices on the decline, some homebuyers are seeing appraisals come in lower than their purchase price, and that’s leaving many scrambling to come up with ways to close the gap.

Jim Tourloukis, president of Verico Advent Mortgage Services, knows at least one of them. A client came to him after buying a home through another broker in February for $1.02 million. The original broker didn’t do the appraisal quickly, and the close is set for mid-July. Their recent appraisal came back at just $830,000.

“They’re short $190,000,” Tourloukis said. “Now they’re having a challenge. They can’t close. We’re going to the Bank of Mom and Dad to make up the difference because the bank will only lend up to 80%.”

In a recent CMT post, mortgage broker Ross Taylor outlined the issue that arises when an appraisal comes back lower than the purchase offer.

“Suppose you agree to buy firm for $1,100,000. You are willing to put up 20%, or $220,000. But, the property appraises at only $1,000,000,” Taylor wrote.

“Your lender will offer you a mortgage of $800,000, which is 80% of the appraised value. You will have to come up with $300,000 to fulfill the purchase price of $1.1 million,” or $80,000 more than the approved mortgage amount.

Where are home values falling?

The latest data from the Canadian Real Estate Association (CREA) shows average prices at the national level trending down over the past few months. In May, the average home price was $711,316 – a 4.6% drop from April and a nearly 13% drop from February.

But outside of the national headline figures, there are regional and local dynamics at play. Keith Lancastle, CEO of the Appraisal Institute of Canada, said it is difficult to point to any high-level trends around appraisal values. “Markets are inherently local,” he told CMT. “For that matter, every transaction is a unique transaction.”

Tourloukis said he’s seen house prices drop 20% from their peak in cities around Toronto, particularly Oshawa and Hamilton. Over the last eight months to a year, he said, people looking for more space left Toronto for the suburbs and beyond. That drove up prices in smaller cities, including Lancastle’s home city of Ottawa.

“We saw, during the pandemic, a 20% plus increase in the value of residential real estate in the Ottawa market year-over-year,” Lancastle said. “I’ve lived here for 30 years and that’s unprecedented during that time.”

But prices are now falling. According to a June report from Desjardins Economic Studies, the Maritime region is expected to see a 20% decline in home prices between February 2022 and December 2023. Ontario home prices could drop by 18%, British Columbia by 15%, and Quebec by 12%.

Meanwhile, the city of Toronto itself didn’t grow at the same rate as the Greater Toronto Area at large. Tourloukis recently used the Automated Valuation Model, a real-time estimate of Canadian market value, to assess a condo bought by a client at $1.35 million. “It came back spot-on,” he said.

A similar situation is playing out in Metro Vancouver, one of the hottest housing markets in the country. According to May data from the Real Estate Board of Greater Vancouver (REBGV), the benchmark price for a detached home was just over $2 million – a 0.4% decrease from April.

How can appraisal values drop?

Appraisers consider several factors when calculating the value of a home. One is how similar homes are selling in the marketplace within a set period of time. But they also consider a home’s construction cost, size, features and previous selling price. All of these are affected by a complex variety of forces beyond any single buyer’s control.

The pandemic-driven exodus from major urban markets to smaller cities and towns – and a slackening of demand – is one of them. Another are the effects higher interest rates from the Bank of Canada are having on monthly carrying costs for variable-rate mortgages and lines of credit.

An area’s local economy can also have a tremendous impact, Lancastle says. He recalls a story about a town in Atlantic Canada years ago that depended on a manufacturing facility for much of its employment. When it shut down, home values plummeted. “No one’s moving to that small town. Value prices immediately dropped significantly in that small town,” he said.

Immigration levels, interest rates, and the sheer availability of affordable housing can also play a role. As Daniel John, chair of REBGV, wrote on the Board’s website: “Homebuyers have been operating in a frenzied environment for much of the past two years. This spring is providing a calmer environment, with fewer multiple-offer situations, which is allowing buyers to explore their housing options, understand the changing mortgage market, and do their due diligence.”

Overall, Lancastle said he isn’t surprised to see appraisals dropping to reflect the housing market’s current moderation. “That is their function,” he said, “to be the sober second thought on the market that talks about what the value of a property is today – not what it was three months ago, and certainly not what it’ll be three months from now.”

What happens if your appraisal comes back lower than expected?

Having an appraisal come up short can be a huge financial headache. In such a situation, Lancastle says homebuyers have two choices. They can come up with additional cash, or they can walk away from the deal.

The latter could be problematic if a homebuyer makes an unconditional purchase offer. Because of the intense competition to buy homes during the pandemic, it wasn’t uncommon for some homebuyers to make purchase offers that weren’t conditional on financing – meaning they had to either pay up or default on the deal. Tourloukis advises against going this route.

“As a buyer, you should always have conditional financing because life happens,” he said.

Renegotiating might be an option, Tourloukis says, as some sellers might be willing to accept a lower price from a buyer if it means actually closing a deal. After all, he said, nobody wants to be dragged into court for the next two years and have to pay tens of thousands of dollars in legal fees.

Above all, Tourloukis said brokers shouldn’t be waiting weeks or months to order an appraisal in the housing market’s current conditions.

“In a dropping environment, you must order the appraisal immediately,” he advises. “A deal comes across your desk – do not order it the next day. You order it immediately. You get it done.”