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A for sale sign outside a home indicates that it has sold for over the asking price, in Ottawa, on March 1, 2021.Justin Tang/The Canadian Press

Home prices are running up so fast in some parts of Canada that valuations set by appraisers are not keeping pace, putting some buyers and mortgage lenders in a bind.

An appraisal is a key factor when a bank or credit union decides how much it can lend against a particular home. It is a snapshot of what that home is worth at a moment in time – and a check on exuberance, based on data of recent sales that have closed.

But with one record sale price after another in many communities, especially in smaller cities outside the largest urban centres, valuations are increasingly falling short of the prices paid. That can leave a financing gap for buyers who are relying on mortgages to fund a large share of the purchase, forcing them to come up with extra cash quickly to close a deal.

“We are, on a very regular basis, not able to meet the expectations of some of these successful buyers,” said Rick Sieb, owner of Intercity Appraisals Ltd. in Port Coquitlam, B.C. “Before COVID, I would say we would have one in 50 [not match up]. I would say right now we’re not hitting numbers maybe one in 10.”

The challenge for an appraiser evaluating a home with a high sale price is determining whether it is part of a trend in the market or an outlier, then anchoring that judgment with hard data. But it can take weeks before conditions placed on a sale are waived, then 30 to 90 days before many transactions close. In the early days of the pandemic, there were fewer sales to use as comparisons. And when prices are climbing quickly, it’s more likely that the best comparable sales were at prices that have already gone stale.

“We’re seeing more of that now,” said Mary Ellen Brown, senior vice-president of personal financing products at Royal Bank of Canada, in an interview. The bank doesn’t track how often valuations fall short of purchase prices, but based on the number of loan applications escalated to higher levels of adjudication, there are “more occurrences of that happening right now in the marketplace.”

Some appraisals are done solely using data run through automated models. But most involve an appraiser visiting or entering the home. In the current market, both the automated and human approaches are “struggling a little bit,” Ms. Brown said. And with prices soaring, “we’re relying less on the [automated] model.”

One aspect of the housing frenzy works in appraisers’ favour: an increasing proportion of successful bids with no conditions attached. Those sales are deemed final more quickly, “so we do get some pretty fresh market data,” Mr. Sieb said.

But that same trend is what puts some buyers at risk when the valuation of a home falls far short of its lofty sale price. Competition for many homes is so fierce in some cities that conditions that would normally allow a buyer to back out are seen as anachronisms. “We haven’t had clients do offers with conditions for years,” said Davelle Morrison, a broker at Bosley Real Estate Ltd. who works with first-time homebuyers and investors in the Greater Toronto Area.

When appraisals and prices don’t match, banks and mortgage lenders tailor their loans using valuations and other risk factors, rather than prices, which means a buyer may not be able to borrow as much as they expected. “As the potential purchaser, I then have a situation where I have to come up with the shortfall,” Keith Lancastle, chief executive officer of the Appraisal Institute of Canada, said in an interview. “You could find yourself in a very difficult situation financially.”

No mortgage loans at RBC have fallen through because the borrower couldn’t come up with a down payment, Ms. Brown said. “Maybe they’re calling up family to figure that out. Maybe they’re dipping into savings to figure that out.”

Or, in some cases, buyers may turn to private lenders that charge higher interest rates to close the gap.

When appraisals come in lower, real estate agents and mortgage brokers sometimes urge appraisers to look at additional data or push lenders to seek a second opinion. “There’s a lot of pressure on us,” Mr. Sieb said, especially with the volume of requests coming in. “On a daily basis, we’re turning down twice as many as we take because we can’t get them done in time.”

In typical market conditions, mismatches between sale prices and valuations are most common in major cities such as Vancouver and Toronto. But with buyers desperate for more elbow room because of the pandemic, and remote work gaining in popularity, some of the hottest markets are in smaller communities such as Gatineau in Quebec, Barrie and Kingston in Ontario, as well as Mission and Abbotsford in B.C.

Regions such as Prince Edward County, east of Toronto, are seeing “irrational exuberance,” said Treat Hull, owner and broker at Treat Hull & Associates Ltd. But appraisal gaps are less common there because fewer buyers need significant financing – often they are affluent professionals buying second homes or tapping equity built up in homes in larger cities.

Even in those markets, the gulf between current and past prices can be wide. Bob Clarke, a broker at Clarke Muskoka Realty who deals in luxury homes and cottages north of Toronto, recently estimated one property would fetch more than $2-million. Another agent suggested a $3.5-million price tag. The home sold for $3.3-million, Mr. Clarke said.

When he called his appraiser and asked, “Am I crazy?” he learned that the appraiser had declined to evaluate the property, telling the seller the valuation and selling price “won’t even start with the same first number. It won’t be close.”

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