What is an appraisal?
Simply stated, an appraisal is an opinion of an item's economic value; what you might expect a typical buyer to pay for something in a typical market. Many items are appraised every day: Diamond rings, vehicles, works of art, and of course real estate.
Of course, just as you wouldn't trust an appraisal of a diamond ring to anyone other than a qualified jeweller, it's important to be sure that a qualified real estate appraiser is consulted when you need a value for real estate: Land and homes, condominiums, and other properties where you hold an interest in "real" property.
The average homeowner will come into contact with a real estate appraiser at one of two times: When purchasing a home or when refinancing an existing mortgage. It is the appraiser's job to provide an unbiased estimate of what a buyer may pay (or a seller receive) for a particular parcel of real estate where both the buyer and seller are informed parties. In order to become an informed party, most people will find a licensed, certified, professional appraiser to provide an accurate estimate of the value of the property to be bought or sold.
So what constitutes a typical real estate appraisal? For an average residential property, the appraiser will first inspect the property to determine the physical characteristics of both the parcel and the improvements (structures). The appraiser will typically walk throughout the interior of the dwelling and note features, including the number of bedrooms and bathrooms, type and condition of appliances, and other features or defects that may have a substantive impact on the value of the property. This process will be repeated for the exterior, where the appraiser will also usually measure the exterior of the property to determine the actual square footage of the dwelling.
Once this data has been collected from the inspection, the appraiser will return to the office in order to compile the information into an appraisal report.
The typical residential appraisal report is compiled into a form known as the FNMA 1004 form. This form was promulgated by the Federal National Mortgage Association ("Fannie Mae") and the Appraisal Foundation as the general format for residential appraisals. It is by no means the only available means to deliver an appraisal, but is certainly the most common. Within this report, the appraiser will apply one or more "approaches" to determining the value of the subject property in the market.
The cost approach is usually the easiest to understand. The appraiser will use local data for materials costs and labor rates to determine what it might cost to construct a property similar to the subject property as new. This is then combined with an estimate of the subject parcel value to arrive at an estimate of value for the subject. Generally, this figure represents the "ceiling" of the subject value, since the figure derived represents the "cost to construct" (why pay more for an existing property when one could be built new for less?). A shortfall of the cost approach is the general inability to account for "intangible" aspects of a property; things like location, external amenities, and the desirability of a particular view or similar feature.
The sales comparison approach is generally considered the most reliable approach to value for residential properties. Part of an appraiser's expertise is knowledge of the impact of the aforementioned "intangible" features of a property on market appeal and value. Appraisers use their accumulated knowledge of local schools, traffic & roadways, waterways & lakes, and other features to determine which factors have a significant impact on the value of a property in a given area. This knowledge allows the appraiser to select similar properties in the subject market to utilize as comparable sales.
The appraiser then accounts for fixed features (things like square footage, bathrooms, floor coverings and finish, appliances), parcel size, views, and determines a "value" for those features in the subject market. Using that data, the selected comparable sales are adjusted so that they more closely reflect the subject property. As an example: If the subject property has 2 baths, but a comparable sale has 3 baths, the appraiser will use market data to determine what value the market assigns to an additional bathroom and then deduct that number from the sales price of the comparable sale. Conversely, features present in the subject but missing from a comparable may warrant a positive adjustment.
In certain circumstances there is a third approach to value that may be utilized by the appraiser. If the subject property is an investment property (a rental property), and is likely to be resold as such, then the appraiser considers the income potential of similar rental properties and uses that data to derive an estimated value for the subject.
Finally, the appraiser combines data from all applied approaches, determines which approaches will receive the greatest consideration, and produces a final opinion of the market value of the property. While this opinion is a good indicator of the worth of the property, it may not indicate the final sale price, as there are additionaly factors (including seller motivation, a very recent glut or lack of buyers, etc.) that may effect the sales price of a particular property. The appraised value is, however, often used to determine financing arrangements by a lender that doesn't want to lend more than a property is worth.
What is an appraisal?