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Appraisals

Everybody wants to know what a house is worth, the buyer, the seller, the lender, and even the tax man.

• The buyer wants to feel assured he is getting value for his money and not paying too much.
• The seller wants to know she is receiving fair compensation for the house she is losing.
• The lenders want to know if things go bad for the buyer (who is borrowing the money) that the lender can get their money back by foreclosing and selling the property, if all else fails.
• The tax collector wants to know that the tax assessor put the right value on the house so taxes are proper for the house and not too small or so large the owner can protest the value.

Appraisal Defined

By definition the market value is what a willing and able buyer will pay to a willing and able seller to get the property.  Any concept of distress or undue pressure on either party must be absent.  But if you take any two buyers and sellers with exactly the same property, the "market value" will be different.  Some buyers will pay more than others and some sellers will sell for less than others.  It's all a matter of perception and desires.

In real estate the appraised value is a third party's opinion of what the property is worth – it's not necessarily what the buyer or the seller think.  For many years USPAP dictated that the appraised value should be the one that yields the highest value for the best use.  Since the mortgage meltdown around 2005-2007 (with its continuing effects for several years), USPAP has mellowed on this approach to say it should be the expected sale price, not necessarily the highest, for the best use, and certainly without any distress in the sale.

For the mathematicians, statistically we can measure, if we have long enough, what every possible pair of buyers and sellers would willingly pay and accept for a property.  If we could do that, we would see a curve much like the 'bell' curve, peaking in the middle around an average value, with lower numbers of people who would buy or accept a lower or higher price.  There would not be a single answer – it would just depend on who is buying and who is selling.

This may not seem satisfactory to a seller to know that the value is a number but a range of values, and the buyer equally would feel that there must be a single number that represents the "true" value of a property.  Everybody wants 'the answer' but there really isn't one.  So, the pressure is on the appraiser to find a single value, usually the median or middle value if she could predict that over the course of hundreds of hypothetical sales to different buyers from different sellers.

Market Sales Approach to Appraisal

The appraiser does this first by comparing previous sales in the nearby geographic area of properties similar in size, age and so on.  Of course, this doesn't always work, especially if the nearby homes are all custom-built houses, or if the subject property is one of a kind either in size, construction, age and so on.  So, the appraisal institute gives appraisers guidelines to follow to adjust the values of nearby properties to make them match all the characteristics.

So, now a 3-bedroom home can be valued based on a 4-bedroom home by subtracting the value of the extra bedroom.  Really?  It is a theory.  Nevertheless, this market sales approach is used to get a number (which is actually an average or median value).

Cost Approach to Appraisal

Second, the appraiser gets to calculate a hypothetical value if the property were constructed today using today's material and labor costs, and then depreciated that cost by the age of the subject property.  The land assumed to be the land value of similar sized lots nearby.  Of course, this cost-up approach has its own flaws, like the value of the land being similar between an interior lot and a corner lot.  So, adjustments can be made for the land value, too.

Investment Approach to Appraisal

If the property is an investment property with income, the appraiser can also use a third approach, based on ROI (return on investment).  The rental income is used to calculate a market value by dividing income with market rate.  A $10,000 income and a rate of 10% would value a property at $100,000.  But, we all know the rental price is dependent on the landlord and the tenant and could be higher or lower going forward.  Also, the fixtures and condition of the property could be renovated to bring in a disproportionately higher income compared to the additional cost.

On a residential property the lender will send an appraiser to establish a market value.  The value is based on entering the house, seeing the condition, comparing it to other sales and figuring a cost approach value.  This is more comprehensive than what the tax assessor does.

Tax Assessed Value

Similar principles to the lender's appraisal are used by the tax man, but typically he never leaves his desk.  He may receive copies of the blueprints from the county or city building department so the construction value can be evaluated, but after the first sale (from a builder), the tax assessor uses the sales approach method without visiting the property to inspect it.

In the industry we refer to the method used by assessors as a "mass appraisal" because commonly houses in a single subdivision might be re-valued by the same proportion en masse if the tax appraisal deems the neighborhood as increasing or decreasing in value.

A building department official might discover that the owner added more living space or something of value to the real property and then notify the tax assessor of the situation.  He would probably also contact the owner to discuss having it inspected or torn down.

Broker Price Opinion

BPO is a common method of valuation used by banks about to foreclose or considering an offer on a house in a short sale situation.  A short sale, as discussed previously, is where the house is sold for less than the mortgage loan balance, leaving the bank short of money.  It also could be the house is sold for more than the loan balance, but after closing expenses and so on, the money left is short of the balance.

A licensed Realtor or broker visits the house, much like the appraiser does and evaluates the condition of the property.  Using data readily available in the database of the multiple listing service (MLS), the licensed person calculates a market sales approach value, and renders that opinion to the bank or other interested party.  BPOs are generally lower cost than a full appraisal, but don't carry the word "appraisal" anywhere on them – it's just an opinion.