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An appraisal is the act or process of developing an opinion of value. It is also defined as an opinion of value.
An appraisal begins with the determination of the intended use and intended users. From that point, a scope of work is established. The scope of work typically involves obtaining physical information regarding the property (usually from a physical inspection by the appraiser) and developing an opinion of value using one or more of the approaches to value.
There are three recognized approaches to value – sales comparison approach, cost approach and income approach.
In the sales comparison approach, the appraiser identifies recent sales of properties similar to the subject being appraised. These similar properties are often referred to as comparable properties. The comparable properties should be as similar as possible to the subject in location, size condition and use. Since there are seldom properties that are exactly similar, the appraiser makes “adjustments” for differences such as size, age, quality and (most important) location. These adjustments should be made in accordance with recognized appraisal practices and summarized within the appraisal report. After adjusting each comparable property for differences from the subject, each comparable will show an indicated value. The appraiser then reconciles the indicated values to come up with a single market value or value range for the subject.
The cost approach employs recognized sources of building costs to determine a replacement cost of the property as if it were new. Depreciation is then applied to the new cost and site value is added.
The income approach is used by determining what income would be from the property if rented or leased. This income is then converted to a value for the property. Typically, this is accomplished by determining a gross rent multiplier (GRM) which is the sale prices of income properties in the area divided by their monthly incomes. The GRM is then applied to the potential rental income from the subject property to determine a market value.
Real estate appraisals will show a value as defined within the appraisal report. Depending on the intended use and intended users of the report, the definition of value could be different. Most often, the value determined in the appraisal is “market value”.
The definition of “market value” as defined by entities such as the FDIC (Federal Deposit Insurance Corporation) and Fannie Mae (Federal National Mortgage Association) is widely used in real estate appraisal work. Under this definition — Market value is the most probable price that 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:
A certified appraisal is an unbiased estimate of market value. A Realtor’s CMA is a tool for the Realtor to obtain a listing and set an offering price to sell the property.
To become a state certified appraiser the applicant must first become a trainee by taking 81 hours of real estate appraisal education and begin work with a certified real estate appraiser supervisor. The trainee must then complete another 75 hours of real estate appraisal education, accumulate 1,000 hours of experience and pass the licensed appraiser exam to become a licensed appraiser. For the licensed appraiser to become a certified appraiser, he or she must take an additional 50 hours of appraisal classes, accumulate an additional 500 hours of experience and pass the certified appraiser exam. Additional education is also required – a bachelor’s degree from an accredited college or other alternatives specified by the state.
To become a real estate sales agent, a person must complete 120 hours of real estate education and pass the sales agent exam. Only a small portion of the total hours deals with real estate appraisal.
Whether you are selling your property yourself or using a Realtor, it is important to obtain an unbiased and accurate opinion of market value. Although a top real estate agent will likely provide good guidance and an asking price that will sell your property, only a licensed or certified real estate appraiser is required by law to be unbiased. They have no interest in the property other than to provide a credible estimate of value. A quality appraiser with years of experience can also provide insight into local trends in market value and what is driving these trends. As an additional benefit, the appraiser will measure your property and provide a documented square footage of your home.
An appraisal for divorce settlement needs to be prepared with a heightened degree of detail. An appraiser experienced in divorce work knows that the appraisal may end up in court with the appraiser being subject to examination and cross-examination. All data within the appraisal report must be verified by credible sources. Statements regarding the quality and condition of the property must be totally accurate. Work shown within the appraisal report such as choice of comparable properties, analysis, adjustments, and conclusions must all be totally explained and completed according to accepted appraisal practices. Any omissions, unverified assumptions or inaccuracies open the appraisal to be discredited by the opposing attorney. It is important to employ an appraiser who has court experience in divorce work.
Appraisal reports for estate planning typically fall into two categories – 1) transferring ownership of the property to an individual or a trust, or 2) determining a value to settle the estate of a deceased person.
Attorneys or accountants often request that an appraisal be performed on properties to place the properties into a trust. Since the appraisal may be subject to IRS review, it is important to employ an appraiser who is familiar with this type of work.
In settling the estate of a deceased person (often a parent or relative) it is especially important that the appraisal be accurate and well documented. If interest in the property is being bought by a relative, those involved expect the value to be unbiased and accurate. If the property is to be sold, the sellers expect a totally unbiased and accurate value for a listing and sale price. Often an attorney or accountant will suggest that an appraisal be completed showing the value as of the date of death for tax purposes. This is called a retrospective appraisal. An opinion of value can be developed for a date in the past, whether it is days, months or even years in the past.
PMI stands for Private Mortgage Insurance. Private Mortgage Insurance protects the lender, not the buyer/homeowner. If a buyer has less than 20% down payment, the lender typically requires private mortgage insurance be added to the mortgage. This insurance protects the lender against loss in the event of foreclosure. The PMI rate is based on several factors including your down payment amount, debt-to-income ratio and credit score. The annual average PMI premium as a percentage of original loan amount varies between 0.58% and 1.86%. On a $500,000, 30-year mortgage loan this adds between $188.94 and $622.39 to your monthly payment.
Most lenders allow you to cancel the PMI policy when you gain 20% equity in your home. This can happen either as your home gains in value over time due to appreciation or by paying down your mortgage loan. Typically, PMI does not automatically get cancelled once your equity reaches 20%.
An appraisal by a certified appraiser can be provided to the lender evidencing that you have at least 20% equity in your property. This could save you thousands of dollars over the life of the loan.
A home inspector does not develop an opinion of value. They are not appraisers. In a purchase transaction, the buyer is encouraged to order a home inspection. The home inspector looks at the structure and mechanical systems of the property from the roof to the foundation. The home inspector reports on items such as the condition of the roof (remaining life and does it meet building codes), condition of heating and air conditioning systems, structure of the property, electrical system, plumbing system, etc. He is looking for any defects and anything that is not in compliance with building codes.
Licensed and certified real estate appraisers are under legal obligation to develop and report appraisals in accordance with the Uniform Standards of Professional Appraisal Practice. One aspect of these standards requires the appraiser to maintain confidentiality for his client. In other words, the appraiser must not disclose confidential information or assignment results to anyone other than the client or parties specifically authorized by the client.
The client is the person or entity that engages the services of the appraiser. Clients could be banks, credit unions, mortgage companies, attorneys, accountants, or individuals. Even though someone pays for the appraisal, that does not necessarily imply that person is the client. Typically, a borrower pays for the appraisal through their lender. However, the lender who engaged the appraisal services is the client, not the borrower.
In developing and reporting an appraisal for residential income property, whether a single-family residence or a multi-family residence such as a fourplex, a competent appraiser will report what typical rental income is for similar properties in the same area. Based on rental income along with the condition of the property the appraiser will develop an opinion of value. The appraiser should also report on rental income and value trends, what is driving these trends and what is to be expected. With this information, the investor will be guided to make a wise investment decision.
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