A home purchase is the largest single investment most people will ever make. Whether it's a primary residence, a second vacation home, or an investment, the purchase of real property is a complex financial transaction that requires multiple parties to pull it all off.
Most of the people involved are very familiar. The Realtor is the most common face of the transaction. The mortgage company provides the financial capital necessary to fund the transaction. The title company ensures that all aspects of the transaction are completed and that a clear title passes from the seller to the buyer.
So who makes sure the value of the property is in line with the amount being paid? There are too many people exposed in the real estate process to let such a transaction proceed without ensuring that the value of the property is commensurate with the amount being paid.
This is where the appraisal comes in. An appraisal is an unbiased estimate of what a buyer might expect to pay - or a seller receive - for a parcel of real estate, where both buyer and seller are informed parties. To be an informed party, most people turn to a licensed, certified, professional appraiser to provide them with the most accurate estimate of the true value of their property.
The Inspection
So what goes into a real estate appraisal? It all starts with the inspection. An appraiser's duty is to inspect the property being appraised to ascertain the true status of that property. The appraiser must actually see features, such as the number of bedrooms, bathrooms, the location, and so on, to ensure that they really exist and are in the condition a reasonable buyer would expect them to be. The inspection often includes a sketch of the property, ensuring the proper square footage and conveying the layout of the property. Most importantly, the appraiser looks for any obvious features - or defects - that would affect the value of the house.
Once the site has been inspected, an appraiser uses two or three approaches to determine the value of the property: a cost approach, a sales comparison and, in the case of a rental property, an income approach.
Cost Approach
The cost approach is the easiest to understand. The appraiser uses information on local building costs, labor rates and other factors to determine how much it would cost to construct a property similar to the one being appraised. This value often sets the upper limit on what a property would sell for. Why would you pay more for an existing property if you could spend less and build a brand new home instead? While there may be mitigating factors, such as location and amenities, these are usually not reflected in the cost approach.
Sales Comparison
Instead, appraisers rely on the sales comparison approach to value these types of items. Appraisers get to know the neighborhoods in which they work. They understand the value of certain features to the residents of that area, and they use this information to determine which attributes of a property will make a difference in the value. Then, the appraiser researches recent sales in the vicinity and finds properties which are "comparable" to the subject being appraised. The sales prices of these properties are used as a basis to begin the sales comparison approach.
Using knowledge of the value of certain items such as square footage, additional bathrooms, hardwood floors, fireplaces or view lots (just to name a few), the appraiser adjusts the comparable properties to more accurately portray the subject property. For example, if the comparable property has a fireplace and the subject does not, the appraiser may deduct the value of a fireplace from the sales price of the comparable home. If the subject property has an extra half-bathroom and the comparable does not, the appraiser might add a certain amount to the comparable property.
Income Approach
In the case of income producing properties - rental houses for example - the appraiser may use a third approach to valuing the property. In this case, the amount of income the property produces is used to arrive at the current value of those revenues over the foreseeable future.
Reconciliation
Combining information from all approaches, the appraiser is then ready to stipulate an estimated market value for the subject property. It is important to note that while this amount is probably the best indication of what a property is worth, it may not be the final sales price. There are always mitigating factors such as seller motivation, urgency or "bidding wars" that may adjust the final price up or down. But the appraised value is often used as a guideline for lenders who don't want to loan a buyer more money that the property is actually worth. The bottom line is: an appraiser will help you get the most accurate property value, so you can make the most informed real estate decisions.
Appraisal Myths
Myth: Assessed value should equate to market value.
Reality: While most states support the concept
that assessed value approximate estimated market value,
this often is not the case. Examples include when
interior remodeling has occurred and the assessor is
unaware of the improvements, or when properties in the
vicinity have not been re-assessed for an extended
period.
Myth: The appraised value of a property will
vary, depending upon whether the appraisal is conducted
for the buyer or the seller.
Reality: The appraiser has no vested interest in
the outcome of the appraisal and should render services
with independence, objectivity and impartiality - no
matter for whom the appraisal is conducted.
Myth: Market value should approximate
replacement cost.
Reality: Market value is based on what a willing
buyer likely would pay a willing seller for a particular
property, with neither being under pressure to buy or
sell. Replacement cost is the dollar amount required to
reconstruct a property in-kind.
Myth: Appraisers use a formula, such as a
specific price per square foot, to figure out the value
of a home.
Reality: Appraisers make a detailed analysis of
all factors pertaining to the value of a home including
its location, condition, size, proximity to facilities
and recent sale prices of comparable properties.
Myth: In a robust economy - when the sales
prices of homes in a given area are reported to be
rising by a particular percentage - the value of
individual properties in the area can be expected to
appreciate by that same percentage.
Reality: Value appreciation of a specific
property must be determined on an individualized basis,
factoring in data on comparable properties and other
relevant considerations. This is true in good times as
well as bad.
Myth: You generally can tell what a property
is worth simply by looking at the outside.
Reality: Property value is determined by a number
of factors, including location, condition, improvements,
amenities, and market trends.
Myth: Because consumers pay for appraisals
when applying for loans to purchase or refinance real
estate, they own their appraisal.
Reality: The appraisal is, in fact, legally owned
by the lender - unless the lender "releases its
interest" in the document. However, consumers must
be given a copy of the appraisal report, upon written
request, under the Equal Credit Opportunity Act.
Myth: Consumers need not be concerned with
what is in the appraisal document so long as it
satisfies the needs of their lending institution.
Reality: Only if consumers read a copy of their
appraisal can they double-check its accuracy and
question the result. Also, it makes a valuable record
for future reference, containing useful and
often-revealing information - including the legal and
physical description of the property, square footage
measurements, list of comparable properties in the
neighborhood, neighborhood description and a narrative
of current real-estate activity and/or market trends in
the vicinity.
Myth: Appraisers are hired only to estimate
real estate property values in property sales involving
mortgage-lending transactions.
Reality: Depending upon their qualifications and
designations, appraisers can and do provide a variety of
services, including advice for estate planning, dispute
resolution, zoning and tax assessment review and
cost/benefit analysis.
Myth: An Appraisal is the same as a home
inspection.
Reality: An Appraisal does not serve the same
purpose as an inspection. The Appraiser forms an opinion
of value in the Appraisal process and resulting report.
A home inspector determines the condition of the home
and its major components and reports these findings.
