Editor’s note: This is the third in a four-part series. Read Part 1, Part 2, and Part 3.

Last year at this time, we were still worried about the 2 million homes in the shadow inventory and perhaps another round of price decreases. While a fair number of areas are still saddled with a buyer’s market, California and other parts of the country are in a flaming hot seller’s market.

As the market shifts, what types of upheaval can you expect?

For those of you who haven’t experienced a flaming hot seller’s market, they’re tough. There’s no inventory, buyers are so desperate to buy that they will pay almost anything, and accept almost any terms that the seller may propose.

These are risky times for almost everyone involved.

Lenders don’t throw out the comps

Suppose your buyers have just become the winning offer in a situation where there were eight other offers. The property was listed at $350,000 and your buyers agreed to pay $402,000. Fortunately, they had $85,000 to put down, so they still could obtain an 80 percent loan with a full 20 percent down.

Because this house is the first home to shatter the glass ceiling on the down market prices, it’s a safe bet that the appraisal will come in substantially lower than the current purchase price. Here’s the way this scenario generally plays out.

1. The buyers are excited to have the winning offer, and the sellers are over-the-moon they got so much more than their asking price.

2. The next day, the buyers begin asking themselves whether it was smart to pay that much over the asking price. The sellers may start to wonder whether they priced the property too low.

3. Because the buyers paid a premium for the property, they expect the sellers to do all the repairs on the physical inspection report. If the sellers don’t agree, in many cases the buyers walk away.

4. The next round of challenges is more serious. The appraisal comes in based upon the previous sales rather than the current market conditions.

5. The buyers, who were already feeling somewhat insecure about paying so much over asking price, decide to walk away from the transaction. The lender won’t provide them with a loan that is large enough to close the gap between the appraisal and the amount agreed to in the purchase contract.

Appraisal strategies

The best way to avoid being ambushed by a low appraisal is to be proactive. Here’s what to do.

1. Advise the buyers

When your buyers decide they want to engage in a bidding war, advise them about what may happen with respect to the appraisal. Warn them that the current comparable sales will probably result in the appraisal coming in at the old prices, not the current contract price. Be direct by asking, "Are you prepared to stay in the transaction if the appraisal comes in at close to the original asking price, not at the extra $52,000 you are now planning on paying?"

Next, before they write their counteroffer, ask them if they can cover the increase in the down payment the new offering price will require. If the buyers are comfortable with both of these shifts in the transaction, continue. If not, withdraw from the negotiation.

2. Cut the appraiser off at the pass

If you are the listing agent, immediately remove the lockbox from the property. If you represent the buyers, ask the listing agent to remove the lockbox. This forces the appraiser to go through the listing agent to access the property for an appraisal.

Ideally, the listing agent will meet the appraiser at the property and supply not only the latest comparable sales, but copies of the multiple offers to show there were multiple "ready and willing buyers" who were ready to pay a much higher price than the older comparable sales suggest. Also, gather as many interior photos of the comps as possible to help the appraiser determine the price more accurately.

You can also show the appraiser the list of properties in the area that sold for substantially more than the current comparable sales would suggest.

3. If the appraisal comes in low

A primary challenge when the appraisal comes in low is that you may have to find secondary financing. In other words, you may have to ask the seller to carry a second for the difference between the current down payment and the loan amount. Credit unions or local business banks can sometimes bridge the gap, provided the buyer has an account (or is willing to open) an account with that lender.

"Hard money loans" are a third source for bridging this gap. These are much more expensive than traditional financing and are usually provided by a third party that has nothing to do with the transaction.

If the inventory is declining in your area and multiple offers are occurring more often, it’s time to shift gears, obtain as many new listings as possible, and hunker down for battle in the next red hot seller’s market.

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