If you have obtained a mortgage or other real estate loan in the past several years, chances are that you had to get an appraisal of your property. You may have wondered how the appraiser came up with the value. It can be helpful to understand a little about the appraisal process and how appraisers determine a value so you know what to expect when you get an appraisal in conjunction with a loan.
Appraisals must be performed by a state licensed appraiser with the appropriate certification for the job being performed and using certain standards regulated by the appraisal industry and by U. S. laws such as the “Uniform Standards of Professional Appraisal Practice” (USPAP), the Financial Institutions Reforms, Recovery and Enforcement Act of 1989 (FIRREA) and the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act).
Appraisers generally use up to three methods of estimating the value of a property to arrive at a final estimate of value. They are:
- Cost Approach – This approach is based on the proposition that the informed purchaser would pay no more than the cost of producing a substitute property with the same utility as the subject property. It is particularly applicable when the property being appraised involves relatively new improvements and for which there exists no comparable properties on the market. The older the improvements (buildings, etc.) to a property, the less value this approach is because the appraiser must use a subjective figure, known as depreciation, to compare the current costs to build a house to the age (wear and tear) of the existing house.
- Sales Comparison Approach – This is an appraisal procedure in which the market value estimate is predicated upon prices paid in actual market transactions. It is a process of analyzing sales of similar recently sold properties in order to derive an indication of the most probable sales price of the property being appraised. The reliability of this technique is dependent upon: (a) the availability of comparable sales data, (b) the verification of sales data, (c) the degree of comparability or extent of adjustment necessary for time differences, and (d) the absence of non-typical conditions affecting the sales price. This is sometimes called “substitution” or what did comparable houses sell for in the current market.
- Income Capitalization Approach – This procedure is an analysis, which converts anticipated benefits (dollar income or amenities) to be derived from the ownership of property into a value estimate. The income approach is widely applied in appraising income-producing properties. The appraiser uses actual income vs. expense figures and standard USPAP formulas to arrive at an estimated value. If actual income/expense figures are not available for a property, the appraiser will use actual cost/expense figures from similar properties to make his estimates. This approach is not typically used for an owner-occupied residential property.
In essence, all approaches to value (particularly when the purpose of the appraisal is to establish market value) are market data approaches since the data inputs are presumed to be market derived. All three approaches may be used to determine the final estimated value of the subject.
In the current real estate market, the sales comparison approach usually carries the most weight for residential real estate properties. The other two approaches may be used to support the final estimated value.
An appraisal is an estimate or opinion of value as of a specified date based on analysis of factual data. Appraising is not an exact science. It is sometimes referred to as an art, but you will do well to remember that it is an opinion of value that is good for that day only and any two appraisers are likely to derive different values – similar, but possibly different – due to the criteria they used. The true value of a property is an unemotional, objective price at which a seller would sell and a willing buyer would purchase, with neither party under abnormal pressure to act.
Appraisals continue to be the best tool available to support the borrower (purchaser), seller and lender in estimating a market value of real property.
As with all government regulations, there are many more issues involved that cannot be enumerated in this article. If you are dealing with a qualified lending professional, they will be able to explain current appraisal regulations and how they affect you. QCBN
By Tim Naylor
Country Bank is a full service community bank serving Yavapai County with offices in Prescott, Prescott Valley and Cottonwood. Tim Naylor, NMLS #478313, is a vice president of Country Bank specializing in commercial lending and residential construction lending. Please visit www.countrybankaz.com or call 928-759-8600 for more information.
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