Understanding the Appraisal Process INTRODUCTION This paper explains and describes the appraisal process and how an appraiser arrives at the market value of the property being appraised. Appraiser’s “look” at a house differently than Realtors, sellers and buyers look at the same house.   The appraiser views/inspects the property with emphasis on the items that add value and the items that have a negative effect on value. WHAT DOES AN APPRAISER DO & NOT DO? 1.   APPRAISER DOES         Neighborhood analysis             View/inspect the site for value related items.         Measure & draw the house to determine the square footage.         Cost & depreciation analysis of the house.         Analysis of listings, sales & rentals in the neighborhood (plus land sales).         Compile this data to estimate market value. 2.   APPRAISER DOES NOT Make mechanical / electrical / plumbing / roof / termite or structural inspections. Appraise a house for a predetermined target value set by someone as a condition of receiving more assignments or as a favor. Measure the site. (Done by the surveyor) Reveal confidential information about the transaction. The appraiser is not involved in the transaction in any way, except to establish the market value for the mortgage company, or whoever ordered the appraisal. THE APPRAISAL OF YOUR HOUSE 1.    The Appraiser Measures and Draws the House. The exterior of the house is measured and drawn to determine the size in square feet. Photographs are taken of the house.  A visual inspection of the house is made to determine what items would have a negative effect on value - or a positive effect on value. Only the living area of the house is included in the square footage.  Garages, porches, patios, sun rooms, balconies, separate quarters are not included. If there is a room addition that has been finished similar to the house and has heat & air conditioning, it will be included in the size.   Enclosed patios with direct access from the house that also have heat & air conditioning may be included in the size.    (A judgement call by the appraiser.) Any enclosed patio or room addition that is not included in the size will be given a value separately.   The interior is drawn and measured to show the floor plan and relationship of the rooms.  A home with an unusual floor plan may exhibit some Functional Obsolescence.   While measuring and drawing the house the appraiser observes the overall condition, notes any obvious defects, and notes the features of the house.  These observations are with respect to value.  Some items will add value, some will have no additional value, and some will have a "negative" value. The appraiser then re-draws the house from the rough sketch to determine the square footage and to provide a floor plan for the report.  The size is one of the major criteria in selecting what recent sales to use in the report. The size, features, condition, location, age, and lot size are evaluated.  These items are noted on the appraisal form, and used to compare with sales of other properties to determine the value of your house.     2.   The Appraiser Analyzes the Neighborhood In addition to evaluating the house, the neighborhood is also evaluated.  Factors noted on the neighborhood include: distance to employment centers, freeway access, number of rent properties, marketing times, stability of the neighborhood, is there new home construction, and any other items that may affect value. The analysis of the neighborhood is important because it will have a major effect on the value of the house.    You can improve the condition of the house, but it would be very difficult to improve the condition of the neighborhood.  The three most important factors in real estate are typically listed as    1) Location, 2) Location, and 3) Location. It is important for the appraiser to use recent sales from the same neighborhood in the report. If not the same neighborhood, then a competing neighborhood. 3.   What Determines the "Neighborhood"? Uniformity is one criteria.  Two adjacent subdivisions that are quite similar would be considered the same neighborhood.  While two adjoining subdivisions that are quite different would be considered two different neighborhoods. Physical boundaries may or may not define a neighborhood.  Quite often freeways, rivers, railroads or county lines may distinguish one neighborhood from another.   A new freeway going through a subdivision may affect only the houses in close proximity, the two "halves" of the original subdivision may still be considered one neighborhood. If the appraiser needs to use sales from another subdivision due to a lack of sales, it is important to select a similar subdivision.  If it is necessary to use sales from a subdivision that is not similar, an adjustment for location would be made on the report. Any time the appraiser uses sales from another neighborhood an explanation is required as to why, and an analysis is done to determine the value difference between the two subdivisions.      4.    Cost and Depreciation Analysis The appraiser estimates the cost to build a new house exactly like the original, known as Reproduction Cost. The Reproduction Cost is based on the cost to build the original house (an exact duplicate). The Replacement Cost is the cost to replace the house (similar size, room count, and features).  You could probably build it for more or less than shown on the appraisal.  The appraiser's estimate is based on file data on builder's costs. The cost analysis includes the house, garage, driveway, fences, landscaping, pool or any other site improvements. This reproduction cost new is then depreciated based on the age, condition, functional utility and location of the property. 5.    Income Analysis An analysis of rental properties is done if enough data is available.  A neighborhood with only a few rental houses would not have enough data required for the report. The rental analysis is done even if the house being appraised is not rented.   The income analysis determines the Gross Rent Multiplier, which is the sales price divided by the rent.  A house that sold for $100,000, then rented for $1,000 would have a GRM of 100.  If it sold for $110,000 and rented fro $950/month, the GRM would be $110,000 divided by $950, or 115.79 (rounded to 116).  If a GRM of 116 appeared to represent most rents of similar rental properties, then 116 would be multiplied by the rent of another house to determine its value.  So, if the Market Rent for the subject is $975/month, a GRM of 116 would indicated a value of $113,100 (116 X 975 = $113,100) - based on the Income Analysis. 6.     Compiling the Data to Determine Market Value         Three sets of data have been collected and analyzed.  Sales data  Cost data  Income data These three sets of data give three indicated values for the property being appraised. (Usually slightly different values) While the sales comparison data is usually given the most emphasis in the report, the other two indicated values are also considered when estimating market value. MARKET VALUE OF YOUR HOME Definition of Market Value The most probable price which a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller, each acting prudently, knowledgeably and assuming the price is not affected by undue stimulus.  Implicit in this definition is the consummation of a sale as of a specified date and the passing of title from seller to buyer under conditions whereby: 1.   Buyer & seller are typically motivated. 2.   Both parties are well informed/well advised, and each acting in what he considers his own best interest. 3.    A reasonable time is allowed for exposure in the open market. 4.   Payment is made in terms of cash in U.S. dollars, or in terms of financial arrangements comparable thereto. 5.    The price represents the normal consideration for the property sold unaffected by special or creative financing or sales concessions granted by anyone associated with the sale.                   This definition is part of each residential appraisal. My Definition of This Textbook Definition Market value could be defined as a consensus of prices that a group of different people would pay for a house. If several people were interested in buying the same house, and they had already seen several homes that are for sale, after any negotiations, what would be the consensus of what they would pay for the house. The appraiser analyzes recent sales of properties as similar as possible to the property being appraised to estimate market value.     What Affects Market Value?     Location of the property.     Condition of the property.     Features or lack of features. Location of the property. Location of the property is the most important factor affecting value because it can not be changed. Is the property on the golf course, or next to rail road tracks, or in the flood plain? 1. Location on the golf course is a positive feature, usually reflected in a higher land value. A. The golf course location does not add value to the house itself; it adds value to the total property (higher land value). 2. Location next to rail road tracks is a negative factor,  reflected in a lower land value. A. Again, the rail road tracks do not lower the value of the house itself; it lowers the value of the total property. A negative location influence is known as External Obsolescence. 1. External obsolescence refers to any outside influence on the value of a property.  This negative factor is not on the property, it is "external" to the property. A. Negative factors include: junk yard across the street, toxic waste site within one mile, busy through street, too close to airport, several homes on your street are in very poor condition, etc.      The Condition of the House The overall condition of the house is probably the second most important factor affecting value. 1. The difference in average and good condition can affect the value of a home by 5% to 10%. However, the difference between fair and average would be more in the range of 20% to 30%, depending upon the degree of difference.  A house in fair condition would be livable, but would need a lot of work (not just cosmetic).   2.  The overall condition refers to the whole property, not just the house, or "cosmetic" items. 3.   One upstairs bedroom that needs some touch-up paint would not lower the overall condition from good to average. 4.   A new roof on a house in average overall condition would not raise the condition from average to good.  A new roof would be taken into consideration in the appraisal though. The Floor Plan of the House The room arrangement is known as Functional Utility.  A house with an unusual floor plan can be difficult to sell and often sells for less. An actual example of a poor floor plan is a house I appraised that had only one bathroom.  One bathroom isn't so unusual, but this bathroom was upstairs in a bedroom.  Not only did you have to go upstairs, but you had to go through a bedroom. Any negative feature about a property (does not have to be the house itself) is known as Functional Obsolescence. Another example would be a swimming pool behind the detached garage.  (Another house I appraised.)  In this example, any value usually attributed to a pool would be lost by its location behind the garage (out of sight). Functional obsolescence refers to negative features of the property itself; whereas, external obsolescence refers to negative factors outside the property. HOW VALUE (OR LOSS OF VALUE) IS DETERMINED The process is known as Paired Sales Analysis.  All that means is that two sales (a pair) are compared to each other.  These two homes are as similar to each other as possible except one has a pool (in this example), and the other one doesn't. Since one pair of sales is not enough to establish a value for a pool, this "paired sales analysis" is done several times.   The concept is that when comparing two homes that are identical, except for the pool, the difference in the sales prices is attributed to the pool.  The more comparisons made, the better; with 10 to 12 a good minimum number.  Each of these 12 comparisons will indicate a different value for the pool.  Hopefully, they are close in value.  The appraiser then uses this information and makes a judgement call as to what value to place on a pool. A Paired Sales Analysis is used to determine the value added (or value lost) due to any factor that affects the value of a property. WHAT'S THE DIFFERENCE BETWEEN SALES PRICE AND MARKET VALUE? SALES PRICE is the price that a property sold for; that is, a specific property sold for a specific price. MARKET VALUE is an estimate in round numbers that most buyers would pay for a property.   Here we have a group of buyers providing a consensus of what a property would sell for; not what just one of them would pay for a property. TO EXPLAIN FURTHER: Suppose you just bought a house for $80,000.  This house is located next door to a relative or friend, and you have long wanted to move to this street.  So that you don't miss the chance to buy this house, you pay the asking price of $80,000 since the price is right for you (to move to this street). The market value is not determined by this contract price of $80,000.  The $80,000 is "your" value.  The appraiser is going to determine market value.  Again, this is what "other" buyers would pay for the property. When reviewing sales, it is found that similar properties sold for $76,000 to $79,000.  Therefore, the market value is between $76,000 and $79,000.  If the $79,000 sale was the same floor plan and in the same condition, then the appraised value (market value) would be $79,000 (all other factors being equal). ANOTHER EXAMPLE WOULD BE: Suppose the situation was reversed; that is, you buy a house for $80,000 that was priced low so that it would sell quickly so the owner could move.  Other, similar properties have sold for $81,000 to $85,000.  Now the market value is higher than the sales price.  The appraised value is not adjusted or "manipulated" down to $80,000 because that is the sales price.   A FINAL COMMENT:  If you have an appraisal for your house before you sell, say for $80,000; that market value is based on sales that have closed recently.  That appraisal does not mean that your house will definitely sell for $80,000.  What your house sells for depends upon which buyer makes an offer and what their particular needs are and what they can afford.   MARKET ANALYSIS BY AN APPRAISER:  If you have a unique property that is difficult to price correctly, an in-depth market analysis by an appraiser would probably be more meaningful to you than an appraisal, which is prepared in a format for the underwriter of the loan to use in making financial decisions concerning the property.  This market analysis may be similar to a Comparative Market Analysis (CMA) provided by Realtors.