"Under the Hood" > Theory & Process
What is an Appraisal?
A home purchase is the largest, single investment most people will ever make. Whether it's a primary residence, a vacation home or an investment, the purchase of real property is a complex financial transaction requiring multiple parties to make it work successfully.
The Realtor is a common face in the transaction. Another is the mortgage company that provides the financial capital necessary to fund the transaction. The title company establishes that all aspects of the transaction are complete and that a clear title passes from the seller to the buyer.
But who establishes the market value of the property? The risks are too high and there are too many parties in the real estate process to let such a weighty transaction proceed without knowing that the value of the property is commensurate with the amount being paid and/or financed .This is the role of the professional real estate appraiser.
The "bible" for appraisers is the Uniform Standards of Professional Appraisal Practices (USPAP). All appraisers are required to conform to USPAP which identifies market value (in part) as "the most reasonable price which a property should bring in a competitive and open market."
An appraisal usually defines market value as an unbiased estimate of what a buyer might expect to pay, and a seller receive, for a parcel of real estate when both parties are informed. To become an "informed party," most people turn to a certified appraiser to provide them with the most accurate estimate of the value of the property.
So what's involved in an appraisal of residential real estate?Let's briefly walk through the process.
Data gathering and the inspection
It all starts by obtaining data on the property and its surrounding neighborhood. This is followed by an inspection of the property and its improvements (house, garage, deck, etc.). An appraiser's duty is to inspect the property in order to ascertain its current status. The appraiser looks for features (the number of bedrooms, bathrooms, the location, etc.) and assesses their condition relative to what a reasonable buyer would expect. The inspection often includes a sketch of the property which depicts the square footage and room layout. The appraiser also looks for any obvious features (or defects) that would affect the property's value.
After the inspection, sound professional appraisal practice (and USPAP) require that an appraiser consider three approaches in estimating the value of a property. These three approaches to value are the cost, sales comparison and income approaches. Each provides a different perspective and serves as guidance in estimating the market value of a specific property.An appraiser must also analyze the appropriateness, accuracy, and amount of market data available in order to choose the optimal approach to value.
The appraiser uses information on local land value, building costs, labor rates and other factors to determine how much it would cost to construct a dwelling similar to the one being appraised. This value often sets the upper value limit for a property because why would someone pay more for an existing property if they could spend less and build a brand new home instead?
Sales Comparison Approach
For most single family residential properties, appraisers rely on the sales comparison approach to value. Appraisers know the neighborhoods in which they work and understand the value of certain features to the residents of that area. They know the traffic patterns, the school districts, the busy throughways and they use this information to determine which property attributes will make a difference in value. Then the appraiser researches recent sales in the vicinity and finds properties which are ''comparable'' to the subject property. The sales prices of these properties are used as the basis for the sales comparison approach.
Using knowledge of the value of certain items such as square footage, extra bathrooms, hardwood floors, fireplaces, etc., the appraiser adjusts the comparable properties to accurately portray the subject property. For example, if the comparable property has a fireplace and the subject does not, the appraiser might deduct the value of a fireplace from the sales price of the comparable property. If the subject property has an extra half-bath and the comparable does not, the appraiser might add a certain amount to the comparable property to compensate for this difference.
In the case of income producing properties (apartments, flats and rental houses for example), the appraiser uses a financial approach to valuing the property. In this case, the present value of the income stream produced by the property is used to determine its likely market value to an investor.
Utilizing data from all three approaches to value (if deemed necessary for an accurate and credible determination of market value), the appraiser is ready to stipulate an estimated market value for the property. It's important to note that while this amount is probably the best indication of a property's value, it could be different than the final sales price.This is because there are always mitigating factors such as seller motivation, buyer urgency or bidding wars that could influence the final sales price upward or downward.
Regardless of the process and approach to value, the bottom line is that we establish the most accurate property value.With that critical piece of data in place, all involved parties can make the most informed real estate decisions.