APPRAISALS - WHO, WHAT, WHY, HOW - AND SO WHAT?
Who - Appraisals are most commonly ordered by banks when approving mortgages, rarely by cash buyers, and often by trustees upon the death of a trustor. They are done by trained, licensed, appraisers who often belong and can be located with professional organizations such as The American Society of Appraisers.
What - Appraisers use a standardized appraisal report form such as this that explains the justifies their opinion of value with their signature and date. It documents characteristics such as lot and living area sizes, neighborhood, condition, etc.
Why - The bank's goal is to ensure the value of the property that secures the loan is greater than the loan, so in the unlikely event they must seize and sell the property they can get their money back. Cash buyers invest in an independent appraisal to reassure themselves their purchase price is reasonable (and that they could resell the property later if needed). Trustees order appraisals to value an estate that usually results in (and documents) a tax-free stepup of basis for the beneficiaries.
How - This is the interesting and useful part! Appraisers start with prices of comparable properties (similar, nearby, recently sold and on the market), then calculate how large the adjustments are needed to rationalize the contract price. Their goal is to appraise at contract without large adjustments from comps and not surprisingly, appraisals for mortgages usually end up at contract price. That's because an arm's-length transaction in an efficient market is the best indication of current market value.
The adjustments from comparable prices are made based on living area (based on depreciated construction cost $/sqft), house upgrade quality and age/condition, room count, lot size, location, views, and other subjective factors. Appraisers weigh recent sales (less than 6 months) more heavily than active listings.
In addition to the market-based approach, appraisers usually cross-check their valuation with a replacement cost approach, starting with estimated lot value then adding replacement cost of the house (less depreciation) and hope to come up with about the same answer. For income properties, they can also take a rental income-based approach in addition to market and cost comparisons.
So What - If the adjustments needed get too large, however, such as 20%, the appraiser may conclude a different value, which can complicate an escrow. Most escrows that have a loan contingency also have an appraisal contingency. If the appraised value comes in above contract price, everyone usually smiles on their way to closing. But if it's lower, there's a new negotiation that could result in delays, a lower purchase price and/or less loan with more down payment.
Appraisers usually make their own measurements of living area, which can often be a useful double-check of the size listed on public records or MLS listings.
So - if you're buying a property with a loan that requires an appraisal, ask for a copy (otherwise you may not get one). Then take a minute to read through it - they can be interesting and useful!
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Whether you’re exploring a move, comparing neighborhoods, or simply curious what your home might be worth, Debbie is always happy to talk through options and share insight.
Debbie Carpenter
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