A home purchase is the largest, single investment most people will ever make. Whether it is a primary residence, a second home, or an investment property, the purchase of real property is a complex financial transaction with particpation of multiple parties to pull it all off.
Most of the professionals are very familiar with the transaction process. The Realtor, assisting buyers and sellers in the sale of a property, 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.
There are too many people working on commission in the real estate process to let such a transaction proceed without ensuring that the value of the property is on par with the amount being paid. Who makes sure the value of the value of the property is comparable 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 professional appraiser to provide them with the most accurate estimate of the true value of the property.
Appraisers DO NOT set market value, they interpret market value and report the results of the market.
Appraisers have extensive experience researching market data and understanding the nuances of the local market so they can properly gauge value. This experience takes years to obtain and becoming a state licensed appraiser take years as well. The average appraiser has a 4 year degree and has mentored under another licensed appraiser for 2-3 years before they can even obtain their license. It then takes more time to really be familiar with markets that we service. According to our founding principles and mandated by Congress, appraisers must be geographically competent to appraise in the market they cover.
What goes into a real estate appraisal?
It all starts with the inspection. An appraiser’s duty is to inspect the subject property to determine 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 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 one, two, or three approaches to determining the value of real property: a cost approach, a sales comparison, or in the case of a investment / rental property, an income 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 subject property. In a healthy market, 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. This is the method that the majority of lenders will not accept yet insurance companies rely on to insure the home.
In the current market appraisers rely on the sales comparison approach to value the subject property. Appraisers get to know the neighborhoods and markets in which they work. They understand the value of certain features to the residents of that area. They know the traffic patterns, the school zones, the busy throughways; 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, extra 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. This is the method that the majority of the lenders will accept.
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. This approach is only used for income generating investment properties.
Combining information from all approaches developed, the appraiser is then ready to determine 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 do not want to loan a buyer more money than 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.