Real estate appraisals are used for a variety of reasons including the selling or purchasing of a home. You may have wondered before how the price of a house is known beyond the cost of the materials and after the house has aged or been built around. This is where appraisers come in. Much in the same way as a jeweler determines the value of a precious gem based on its condition and shine, an appraiser has specific methods to help determine the value of a home.
The Appraisal Process
First, it is essential to know that an appraisal is done by a third-party, independent and unaffiliated. This is one of several ways an appraisal can be justified as a legal and outstanding document for financial purposes. It is also worth mentioning that appraisal value can be calculated in several ways and differ over the years. Therefore, it is imperative that an appraisal be up-to-date for any financial, real estate transactions including remodeling.
To put it simply, an appraisal is used by lenders and other financial establishments to ensure that a home’s value and financial assistance are correct. They don’t want to lend out a much more substantial amount than the house, or property is worth in the event that they, the lender, ends up with the home due to non-payment or other unforeseen issues. Appraisals can also set a realistic tone to the buying and selling process as far as what may need to be done to the house.
Each appraiser will have different steps they do to get to the final report. This usually includes a basic walk-through of the home or property, picture taking, measurements, finding usable comparable sales, property condition and any relevant notes or assessments. Together this information will be put into a final report that the lender will then use for their loan procedures.
The Cost Valuation Calculations
Broadly speaking, the value can be determined by location, size, condition, type of property, features, neighborhood, region, etc. However, there is much more detail that goes into the reports. For this, there are three specific ways to get an accurate cost valuation: Sales Comparison, Cost Approach & Income Approach.
Sales comparison is one of the most widely used methods to determine value for single-family homes. In this case, comparably sold homes or units (such as a condo) are used to help determine the value. Properties will see adjustments based on how comparable they are to one another and can be reflected upward or downward in such cases. For example, if one property has all the features of another recently sold one except one thing, it will be adjusted downward to reflect the lacking feature.
Cost Approach is a more expansive way to determine value and is often used for properties that cannot be accurately valued with the sales comparison or income approach. The cost approach usually starts with the value of the land the building will be placed, such as for a school or hospital. Then, the cost of the building is added. Any other factors are then taken into account and added or subtracted to the total amount like for expected depreciation. The cost approach can also be used for complete reproduction or replacement valuation as well.
Unlike sales comparison and cost approach, the income approach takes into account any amount the property will generate. While this is most often used for office and other buildings, it can apply to homes that receive applicable income. The income is calculated by determining the following numbers – annual gross income, effective gross income, net operating income, gross rent multiplier and capitalization rate. These numbers may vary greatly and often the one with the heaviest “weight” will be used.
As mentioned before, one of the valuation measures includes comparably sold properties. Any comparables used for an appraisal can greatly influence the overall valuation number of the property in question. For example, a comparable property that has only two bedrooms to another’s three bedrooms may not help the appraisal property. While there are cases where the best possible comparisons are all that can be used, rest assured that there are ways to make up for any discrepancies in comparison.
The Final Report
When all of the information has been gathered, the appraiser will then refine and explain as needed in the report. Most appraisers use a unified report, but there is currently no standard form so reports may fluctuate in look. They are, however, all required to have the same necessary information of date, purpose, and use, estimate, and methods. The final report is the only legal document that can be used for financial purposes. Real estate estimates, home inspections, and other similar reports are great during the scoping process but will not replace an appraisal for home tax assessments or selling.