Anyone who buys the house will get an appraisal which will show the same information so trashing the contract and looking for a different buyer isn't going to solve the problem.

If the seller is getting more than it's worth, good for them.  If this deal doesn't go through then put in confidential remarks "nothing less than 20% down".

Education is important, even before the appraisal comes in.

Explain the process, the options, and the likely outcome.

I try to get both the seller and buyer to work it out.  The problem in our California community, and I'm not sure if it's the same around the country, is that a FHA Appraisal sticks with the home for a certain length of time.

You should flick that switch on the moment a contract is acknowledged which has a mortgage contingency. Better yet when the decision is made to accept cash, financing or other at the signing of the listing agreement. At each step there is opportunity to soften the blow, an informed owner can take this in stride if you've done your part. 

It's best to discuss with the sellers upfront all potential appraisal issues as well as strategies so expectations are managed.  It doesn't become a panic moment, rather it is something we've discussed and will address. 

Home sellers should be advised in advance what will need to be done if the appraisal comes in too low. 

Kim Johnson Educate the seller ahead of time and it won't be a big surprise should the appraisal come in low. Education is key.

A lot of listening, explaining and hand holding.  

Education of the facts

I've been here and it depends on the Asking price vs. Market Analysis I originally did and whether we're in multiple offers or not. You have left out the circumstances so here's my top 3 solutions:

If the seller went against my price advice, based on the market numbers & trends, I let the numbers do the talking which I rerun and now I have the support of an appraisal to reduce the asking price.

If we have multiple offers on a fair market price and they drove the price up in a bidding war, I put it on the buyer. (I've countered out the appraisal as a contingency at this point though. They need to prove they have cash to cover my projected difference in value; I've seen the appraisal issue coming in this scenario).

If it's not too far apart, it was priced well but at top dollar and time is of the essence, I discuss the wisdom of compromise and not losing time starting over and see if there's an equitable solution for both parties.

Was the negotiation between the buyer and seller or the seller and bank?

It is the listing agents job to remove the bank and appraisal from the equation. 

90% of every house I sell is meaningfully above appraised value.

Perhaps the listing agent needs to see the light if the local real estate market is biased in favor of the seller. The buyer and the seller SEE the value.

PROTECT YOUR SELLER!

that's out of your hands and what one appraiser sees, they'll all see, within a few dollars.... adjust or don't sell....