We had this exact experience w/ a short sale we put in an offer for 4 months ago. We just entered escrow this week. First we offered $25K above asking after carefully researchiung comps in the area, and looking at many properties. We were quite confident it was worth that plus we really wanted to ensure we got the home.  The sellers agent came to us and said our offer was much higher than we needed and our agent said it likely wouldn't appraise at our offer. So we ended up lowering our offer by $20K to only $5K above asking. When we got the news that they were ready to move on the deal, the short sale negotiator for the seller's bank did the BPO and it came in at $35K HIGHER than what the listing price was ($30K higher than our offer). After going back and forth for a few weeks, we ended up settling w/ $30K above listing price, which was only $5K more than what we originally wanted to offer. Our agent told us if it didn't appraise we would just come back to the bank and they'd likely take close to the price it appraised for. The appraisel ended up exactly at $30K above listing so that's where we stayed!  I wondered if we had gone w/ our original offer of $25K above listing if negotiator for the bank would have just stuck w/ that price as it was obviously real close to the value based on the comps. Of course it's the comps that mostly determine market value in the end and w/ a short sale that could change a lot between the time you make your offer and the time they finally start to move on the deal.

In your situation, if you go w/ the lower offer, are you sure the listing agent won't continue to accept more offers? The house will be listed "contingent show" and you may not want to risk more offers coming in higher than yours if you really want the house. Most of all I'd reasearch what the comps are in the area now, and if prices in the neighborhood are in a pattern of rising, stability, or decreasing. Then consider the amount of time you estimate it will take before the bank is going to be ready to make the deal, remembering that if values are going up the home could go up in value between now and then and the negotiator will be looking at the value of the home at the time the deal is done, not the time you made the offer.  If you offer too high and it appraises lower you can try and negotiate. But if you offer too low and the BPO comes in higher then you may have to go through days or weeks of negotiations, slowing down the process. It really depends on how quickly you want the process to move, how badly you want the house, and what the true market value is on the home.

Good luck! 

This is becoming more and more the norm.

If you are concerned that you might lose the property, cut your offer by 1/2 of the suggested amount. The appraisal may still come in lower. Most, but not all, SS and REO offers that have low appraisals will lower the price to market. This way you still get the house with the highest offer with a possible additional reduction in price depending on the appraisal.

Thanks for reading,

LoansbyJW

Thank you everyone for the responses.  

We also asked around and was told that this is normal.  My fear was that the listing agent was still going to accept other offers and ours would be outbid, but was told that new offers will be backup offers and since we were the highest during the first round, we would have priority.  Now, we don't know if it will matter or if this is true or not.  I guess we'll find out soon.  Hopefully sooner then later...