What is an appraisal

A home purchase is typically 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 often involves quite a few dollars and requires multiple parties working toward finalization.

Most of the people involved in a real estate transaction are familiar to us. The Realtor is the most common face of the transaction. The banks or mortgage company provides access to the financial capital necessary to fund the transaction. The closing attorney and the title company ensure that all aspects of the transaction are properly completed: the deed is filed, the mortgage is recorded and a clear title passes from the seller to the buyer.

In the loan process, who makes sure the value of the property is in line with the amount being paid? Considering that markets often change, who knows this information on a current basis. There are too many people financially 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. The lender needs to know the property value with a high degree of accuracy. But so does the buyer.

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 obtain an impartial professional opinion, both lenders and individuals can turn to a qualified state-certified real property appraiser to provide them with the most accurate and professional estimate of the market value of a given property. Bear in mind that all appraisals are only valid as of the date of appraisal, though they may prove useful for months and years.

The Inspection:
So what goes into a real estate appraisal? It all starts with an identification of the subject property and an  inspection. An appraiser will  inspect the property being appraised to ascertain the site, the home's size, construction, condition, amenities, features and overall status of that property. He or she 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 typically results in a computer sketch of the property, delineating the proper square footage and the floor plan of the property. Most importantly, the appraiser looks for any obvious features - positive amenities and features - or adverse deficiencies and defects - that would affect the value of the house.

Once the property has been inspected, an appraiser uses two or three approaches in determining the value of the subject real property: a cost approach, a sales comparison and, in the case of a rental property, an income approach.

Cost Approach:
The cost approach is a useful tool and is the easiest to understand. The appraiser uses information on local building costs, local profit margins and other factors to determine how much it would cost to construct an improvements package similar to the one being appraised. Together with the lot or site value, the resultant cost figures often set the upper limit on what a property would sell for. According to the "principle of substitution": Why would you pay more for an existing property if you could spend less and build a brand new home instead? It is a form of common sense and it regulates market behavior considerably.

Sales Comparison:
Under most conditions, appraisers rely heavily on the sales comparison approach to value real property. Appraisers cultivate a fundamental knowledge of the various cities, towns,  districts, neighborhoods and subdivisions where they work. They understand the value of land tracts, lots, homes, home elements and property features to the residents of a market area. They cultivate a knowledge base that relates to the demographics, housing trends, traffic patterns, school zones, parks, job centers in an area and they use this information to determine which variables of a property will make a difference in the value. A sale of a property forms a historical reality. Thus, the appraiser researches recent sales in the vicinity and finds properties which are similar and ''comparable'' to the subject being appraised. While they may not be identical properties, the sales prices of these properties are used as a basis to begin the sales comparison methodology.

Using knowledge of the contribution value of certain items such as lot values, home construction, square footage, bathrooms, flooring, garages, appliances, fireplaces and specialty equipment items (just to name a few), the appraiser adjusts each comparable property directly to the subject property. This will yield an inferior, superior or neutral comparison result. This adjustment process thus accounts for differences in the properties relative to the subject property. For example, if the comparable property has no fireplace and the subject does, the appraiser would add the contributory value of a fireplace to the sales price of the comparable home. If the subject property has a garage and the comparable does not, the appraiser would add a certain amount to the price of the comparable property to reflect this features contribution to value in the marketplace.

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. The relationship of a sale price to a monthly rent is called a GRM or Gross Rent Multiplier.

Reconciliation:
Combining information from all approaches, the appraiser is then ready to formulate first a range of value indications and then, typically, a stipulated estimate of market value for the subject property. It is important to note that while this amount reflects the appraise's professional opinion of what a property is worth, it may not be reflected in a particular sales price. Who knows more about the market and has access to more sales data: the buyer and seller or the appraiser? Yes, you know the answer.

In this vein, the appraiser recognizes three related but separate concepts: price, value, and cost. Sometimes they merge and sometimes they diverge.

They are different because market preferences, social forces and individual irrationalities affect prices and the perceptions of both the seller and the buyer. While many parties toa  tranaction are fairly well-informed, there is little chance that a buyer would have access to all extant market transations over a given time frame.  In reality, mitigating factors such as seller or buyer motivations, seller paid closing costs, and market conditions that impct sales prices substantially. 

The bottom line is: a competent and ethical appraiser will impartially provide a reliable and supportable value estimate, backed up with market data and sound reasoning. Experience, education, skill and training do matter. Accuracy is important. It's not always as easy as it looks. Choose your appraiser wisely.