Appraisals are a key component of the home buying and selling process. A residential real estate appraisal is a security tool used by lenders to establish the market value of a property.

Appraisals may sound strikingly similar to other home buying and selling processes, such as the Home Inspection and the Comparative Market Analysis. While the three share some of the same tools of analysis, each is different and serves a separate purpose.

When a home is sold, the buyer’s mortgage lender will order an appraisal of the ‘subject’ property. This is done to make sure the home is worth the amount being mortgaged (the principal amount owed to the bank). Lenders need accurate appraisals to ensure that they could reasonably recoup their loss through resale of the property if the buyer defaults on the loan. Real estate appraisals compare home size, general condition, location and amenities against similar properties in the area to arrive at a market value for the subject property.

Home inspectors are far more thorough than home appraisers in regards to the condition of the home. Home inspectors test and inspect every aspect of a home, its structure, its wiring and safety features. A home appraiser might note glaring disrepair, but is more concerned  with the size and appearance of the property. An appraisal is not a replacement for a home inspection and makes no guarantees to the condition of the home.

A Comparative Market Analysis (CMA) is the tool used to determine a listing price for the subject property. It, too, compares the subject to several other recent sales and listings to arrive at an asking price for the home. The difference is that a CMA is a tool of the seller or the seller’s agent, not the lender, and it is less detailed. Well-researched CMAs net list prices very close to appraised values, but they are not accepted by lenders as proof of the property’s worth.

Appraisal Overview

·         Appraisers are licensed by the states they work in. Targeted courses and hours interning with experienced appraisers are required.

·         The appraiser should be an objective party; he or she should have no financial or personal connection to the buyer or seller.

·         Lenders may retain appraisers on staff or contract with an independent appraisal company.

·         Lenders sometimes allow buyers to hire the appraisal firm, but the report may be subject to review if it is a company the lender is not familiar with.

·         The cost of an appraisal is assumed by the buyer seeking the loan. It is either an upfront cost to the buyer or a fee the lender pays in addition to closing costs.

·         Appraisals are generally considered null by lenders after six months.

·         Appraisals are somewhat subjective; four different appraisers may arrive at four different property values.

Appraisal Report

Appraisal reports are quite detailed. A few of the major components of the report include the following:

·      A detailed description of the subject property and comparison to three local comparable properties.

·      Evaluation of the local real estate market.

·      Appraiser statements noting factors which contributed to diminished value (poor access, obvious disrepair, etc.).

·      Serious disrepair or structural damage notations.

·      Community environment (development, condominium complex, stand-alone, rural, etc.).

Appraisal Methods

One of two methods are generally used to appraise residential properties.

·      The Sales Comparison Approach: This estimates value by comparing the subject property to "comps" in the area (recently sold comparable properties, similar in size, location and characteristics). Three properties are usually evaluated, and adjustments are made to their selling prices to accommodate for property differences. Square footage is multiplied by the value per square foot; value is added for additional subject home features. Additional amenity values are subtracted from comps. The resulting price is one the comp would have sold for if it were the same as the subject home.

·      The Cost Approach: This is most accurately used to appraise new constructions. Building costs (present and known) are calculated to arrive at a replacement value for the subject home.

Impact of Appraisals

Although real estate appraisals are primarily lender’s tools, the resulting appraised value impacts both buyers and sellers.

Seller’s Impact

If the resulting appraised value is higher than expected, sellers may feel they have shortchanged themselves; however, with an accepted Purchase and Sales Agreement, there is little that can be done to break the contract to net a higher profit. In this case, prevention is the only cure. Sellers may opt to have a property appraised themselves before marketing. The appraisal will not be accepted by lenders and will increase cost to sellers, but an accurate report can help prevent problems later on. Note, however, that there will likely be some difference in reports between appraisers.

Low appraisals can be forewarned with a pre-market appraisal, but are not necessarily deal-breakers after the fact. Work methodically through negotiations to reach a solution. Sellers have the option of reducing the sale price; improving the property or escrowing a portion of the sale profits may also be an option.

Buyer’s Impact

Buyers should have preliminary loan approval before the appraisal, but final commitment will not come until the property value is confirmed.

Low appraisals might result in loan denial or concessions with the seller. In addition to the seller lowering the purchase price, the buyer may choose to put more cash down on the property. The solution may be met halfway between the buyer’s deposit and the seller’s reduced price.

Notations made by the appraiser, regardless of whether the appraisal is high or low, may result in the lender requiring further documentation. For example, long life on the market may require explanation, or shared property access may require signed agreements from abutters.

Residential real estate appraisals are a necessary part of transacting real estate where property loans are involved. Appraisals need not be a source of stress to buyers and sellers that have researched a property’s worth. When unexpected hurdles do arise, a systematic, solution-oriented approach on the part of both parties will ensure completion of the sale. A good understanding of the function of appraisals can help to eliminate appraisal complications before they become an issue.