Ask the Expert - The Effect of Short Sales on Home Appraisals

Question: I’ve recently noticed some places for sale listed as a “short sale”. My understanding is that they are trying to get an offer to present to the lender in hopes they will accept the offer instead of the seller defaulting on the loan and forcing the lender to foreclose. My question is this. If a lender accepts a very low offer because it is more than they would get in a foreclosure sale, does that sale price negatively impact the property value of the surrounding homes? Or is there something that distinguishes a short sale price from a regular sale price when looking at comps? Thanks

Answer: The simple answer to your question is yes - the sale price does negatively impact the value of surrounding homes, and no - there is nothing to distinguish a short sale from any other sale. Now for the details....

You are correct in your understanding of the mechanics of a short sale. Typically, the homeowner lists the property with a Realtor. On the multiple listing service, the agent is required to show that this is a short sale and that the sale is contingent on being accepted by the lender.

However, it is not always the case that a short sale will yield a higher price than a foreclosure. The lender will weigh the costs involved in a foreclosure: months that the borrower lives in the home without paying the mortgage; attorneys fees; repairs and upkeep; etc. In comparison, short sales can be less of a drain on the lender. The borrower remains in the property until it sells, which usually means the home stays in good condition. Because the borrower initiates the short sale, they are much more likely to cooperate with the lender, and this can greatly reduce any legal fees. Therefore, in many instances, the lender will agree to a short sale price that is significantly lower than what the home would sell for had it gone into foreclosure. So this addresses the first part of your question - short sales absolutely will negatively impact the value of surrounding homes, often more so than foreclosures.

Now to your second question. When a home sells, it is recorded into the public records. There is nothing in these records that differentiates a "regular" sale from a short sale or a foreclosure. If an appraiser is looking for comparables, they may be able to find this information on the multiple listing service, or by talking to the local Realtor.

If the appraiser learns that the sale of record is a short sale, they will try not to include it as a comparable. Why? The definition of "fair market value" is the price a willing buyer will pay and a willing seller will accept. This definition assumes that there are no mitigating forces pushing either party. Such forces include divorce, death, and job layoff. Certainly, the inability to pay the mortgage fits this category. So, from an appraiser's point of view, a short sale price does not reflect fair market value. However, if you live in an area where the majority of sales are from foreclosures or short sales, the appraiser may not have an option. In that case, these sales will be used.