Are Homes Undervalued? A Deep Dive into Appraisal Practices and Market Trends
In the realm of real estate, the appraisal process is a critical step, particularly in mortgage origination. Appraisers have the responsibility of evaluating a property's value, an assessment crucial for lenders and buyers. This valuation is not merely about determining a number; it's a comprehensive analysis that takes into account various factors, including market trends, property condition, and neighborhood growth prospects.
A common occurrence in purchase transactions is appraisers valuing properties at or above the contract price. Studies indicate that almost 90% of appraisals in the US end up with an appraised value that is either equal to or above the agreed price between the seller and the buyer. This trend is not accidental but a reflection of the need to align the appraisal with the agreed-upon price. Literature extensively investigates this prevalence of "appraisal above contract," examining factors like the dynamics between appraisers and stakeholders benefiting from successful loan applications. Prior to the 2009 Home Valuation Code of Conduct (HVCC), appraisers, potentially influenced by lender selection, might have been inclined to support inflated contract prices. Post-HVCC, appraiser independence surged, granting them greater discretion in determining values. However, when the appraised value falls below the contract price, it necessitates a thorough justification from the appraiser. This scenario, while less common, demands an in-depth explanation and multiple reasons outlined in the appraisal report.
From the Federal Housing Finance Agency (FHFA) Uniform Appraisal Dataset (UAD) Aggregate Statistics dataset, there is a surprising trend: an unexpected increase in the ratio of appraised values falling below contract prices. Figure 1 below illustrates this trend, with coastal states like Florida and Texas displaying pronounced discrepancies. Delving into Florida, counties such as Miami-Dade and Palm Beach witnessed over 30% of properties appraised below contract price in recent years. This deviation signals significant market dynamics that merit deeper investigation. This deviation from the norm is not only significant but also indicative of underlying market dynamics that requires a closer examination.

Figure 1. The ratio of appraisal value below contract price in 2019
Data Source: Uniform Appraisal Dataset (UAD) Aggregate Statistics
Several factors may contribute to this phenomenon. Firstly, the rapid escalation of market prices might be outpacing the appreciation reflected in appraisal values. This lag creates a disparity between the current market price and the appraised figure. When appraisers select comparables from the past six months, justifying the soaring market values becomes challenging. Another possible explanation is that appraisers, especially in cases of substantial down payments, are likely to provide a valuation that reflects the property's true worth, irrespective of the contract price. The loan amount could be approved despite a marginally lower appraisal value.
Additionally, appraisers may have access to information or market insights not yet fully integrated into the broader market pricing. Climate risks, such as higher probability of being inundated in case of flooding, might be one of them. Appraisers, as arguably the most informed individuals in the real estate sector, are acutely aware of local market risks impacting property values. If these risks are factored into appraisals, resulting in lower valuations for high-risk properties, it's possible that appraisal values might trail behind contract prices, which may not yet reflect these risks due to buyer and seller unawareness. This hypothesis is partially corroborated by data from Figure 1(b) and Figure 2, showing areas with higher hurricane frequencies (based on FEMA climate risk index) exhibiting a greater proportion of appraisals below contract prices. However, a more robust analysis is needed to establish causality.

Figure 2. Appraisal value, contract price, and hurricane frequency (2021 value)
Notes: The circle size indicates the population size of the county. Data Source: Uniform Appraisal Dataset (UAD) Aggregate Statistics and FEMA National Risk Index.
The issue of homes being “undervalued” through the appraisal process is deeply intertwined with market dynamics, appraisal practices, and evolving trends in real estate. This intriguing trend of appraised values falling below contract prices invites a deeper exploration. Our team at the MIT Center for Real Estate and MCRE is actively investigating the multifaceted reasons behind this trend. This research is not just about understanding a discrepancy in value numbers but delving into the complex interplay of market forces, appraisal methodologies, and real estate dynamics. As we continue our analysis, we aim to uncover insights that could significantly impact both the appraisal industry and the broader real estate market.