Why do real estate appraisals nearly always equal offer price?. A theoretical justification
| DOI | https://doi.org/10.1108/14635780210433481 |
| Pages | 242-253 |
| Published date | 01 June 2002 |
| Date | 01 June 2002 |
| Author | Carl R. Gwin,Clark L. Maxam |
| Subject Matter | Property management & built environment |
JPIF
20,3
242
Journal of Property Investment &
Finance, Vol. 20 No. 3, 2002,
pp. 242-253. #MCB UP Limited,
1463-578X
DOI 10.1108/14635780210433481
ACADEMIC PAPERS
Why do real estate appraisals
nearly always equal offer
price?
A theoretical justification
Carl R. Gwin
Department of Economics, Baylor University, Waco, Texas, USA, and
Clark L. Maxam
College of Business, Montana State University, Bozeman,
Montana, USA
Keywords Real estate, Valuations, Theory, Appraisal
Abstract Are real estate appraisals based on fundamentals that determine the value of the real
estate or on offer price? Does this question really matter? In a game of moral hazard with hidden
information, we examinean appraiser's incentives in conducting an appraisal. We find thata moral
hazard problem can arise if themortgagee rewards the appraiser withfuture business for successful
appraisals. An appraiser may be willing to overstate the value of a property if the lender wants him to
do so. Additionally, we define the conditions under which the moral hazard problem actually makes
all of the players better or no worse off. We argue that the subjective judgment of an appraiser may
be Pareto improving. Thus,excessive regulationof the appraisal industry or finer tunedquantitative
models that constrain subjective judgment may actually reduce the gains of real estate trade.
Introduction
Mortgagees require appraisals before mortgages are approved. The purpose is
to insure the value of the real estate meets or exceeds a minimum loan to value.
Offer prices are the product of negotiation between sellers, real estate brokers,
and buyers who may have interests inconsistent with those of a mortgagee. For
example, property buyers/mortgagors have a strong incentive to see appraisals
at their maximum value in order to qualify for as large a loan as possible and as
independent verification of a fair price. Sellers and brokers happily accept high
appraisals to close the sale and avoid the costs of further marketing the
property. These incentives contribute to the possibility that offer price can be
significantly greater than value. Unfortunately, a mortgagee may face losses if
the mortgagor defaults on the mortgage and there is insufficient collateral to
recover the face value of the loan. Mortgagees rely on independent professional
appraisers to verify the true value of the real estate.
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The authors wish to thank the discussant, Stellan LundstoÈrm, and participants at an American
Real Estate and Urban Economics session at the European Network for Housing Research
Conference, Uppsala University, in GaÈvle, Sweden, 26-30 June 2000, for their invaluable
comments. Any errors are the sole responsibility of the authors.
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