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 property, the purchase of real property is a complex financial transaction that involves multiple parties.
The people involved are familiar to many, with the Realtor being the most common. The mortgage company provides the financial capital necessary to fund the transaction, while the title company ensures that all aspects of the transaction are completed and that a clear title passes from the seller to the buyer.
So who makes sure the value of the property is in line with the amount being paid? There are too many people 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. This is where the appraisal comes in. An appraisal offers 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 be an informed party, most people turn to a certified, professional Appraiser to provide them with an accurate estimate of market value for their property. The process typically beings with a property inspection.
An Appraiser inspects the subject property to ascertain the true status of that property. The inspection confirms numerous features via visual observation to readily accessible areas, such as the number of bedrooms, bathrooms, the location, and so on, to ensure that they exist and are in the condition a reasonable buyer would expect them to be. The inspection often includes taking notes on the various features of the property, taking photos, measuring/sketching the subject to determine square footage, and examining a parcel map to confirm the layout of the property. Most importantly, the Appraiser looks for any apparent or obvious features, or defects, that might affect the value of the house.
A variety of data sources are also utilized in this process (i.e. County Records, Preliminary Title Reports, Multiple Listing Service) to determine zoning, tax assessments, flood zones, recorded easements, and property use. An Appraiser then may use one, two or three approaches in determining the value of real property: the Sales Comparison Approach, a Cost Approach and, in the case of rental property, an Income Approach.
Sales Comparison Approach
Appraisers become familiar with the neighborhoods in which they work, understanding the value of certain features specific to each area. For example, external influences such as traffic patterns, school zones, and busy thoroughfares are noted, and such information helps to determine which attributes of a property will make a difference in the value. Recent sales in the vicinity are then researched to find properties which are "comparable" to the subject being appraised. Active indicators are also taken into consideration, which are often reflective of more current market conditions. The sales prices of the comparable properties are then used as a basis to begin the Sales Comparison Approach.
Using knowledge of the value of certain items such as square footage, bath count, quality of materials, fireplaces or view lots (to mention a few), adjustments are applied to the comparable properties to more accurately portray the subject property. For example, if the comparable property has a fireplace and the subject does not, the Appraiser may deduct the value of a fireplace from the sales price of the comparable home. 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. This comparative analysis reveals a range of value, which is then reconciled to arrive at a final value conclusion.
The Cost Approach is primarily useful when projecting costs for new or proposed construction, and is an essential method when land value is well supported. Sonoma, Napa and Marin County land sales are often quite minimal thus limiting the usefulness of the Cost Approach. The Cost Approach is no longer required by Fannie Mae if the Appraiser does not deem the Approach necessary. The Cost Approach derives the value of a property by using information on local building costs, labor rates and other factors to determine how much it would cost to construct a reproduction or replacement of the subject improvements, with consideration given to depreciation and land value. This value often sets the upper limit on what a property would sell for; i.e., why would you pay more for an existing property if you could instead spend less and build a brand new home? While there may be mitigating factors, such as location and amenities, these are usually not reflected in the Cost Approach, but often accounted for in the Sales Comparison Approach.
In the case of income producing properties ~ rental houses for example ~ the appraiser may use a third approach to value the property. The amount of income the property produces is used to arrive at the current value of those revenues over the foreseeable future.
Utilizing information from these approaches, the Appraiser then stipulates an estimated market value for the subject property. It is important to note that while this amount is probably the best indication of what a property is worth, it may not be the final sales price. This is due to mitigating factors such as seller motivation, urgency or "bidding wars" that may adjust the final sales price either way. Rather, the estimated market value is often used as a guideline for lenders who don't want to loan a buyer more money than the property is actually worth. In summary, an Appraiser can help you ascertain the most accurate property value, enabling you to make informed real estate decisions.