This article was published in several periodicals over the past couple of years. The blog will not allow me to show you the actual diagram labeld Fig. 1, but as with any of my articles or books if you email me I'll forward a copy to you in a Word document (.doc).....Enjoy!
Understanding Appraising
A vital part of the success of any investment is making sure that you know the value of the investment. It is an appraiser’s job to help you to understand the value of the property and how he arrived at his conclusions. Many investors do not understand the appraisal or the appraisal process. Once you have a clear understanding of how appraisals are performed, how to read and use the conclusions and what the appraiser’s purpose is, you will become a more informed buyer and a savvy investor.
Let’s begin with the appraiser himself. Appraisers are actually chartered by the federal government to be a disinterested third party whose job is to assess the market value of the property without regard to influences exerted by buyers, sellers or lenders. They are to be the true arbiters of equality and fairness when assessing the value of a particular property. They are to ignore factors such as the predominant race or religion in an area. They are also to ignore other non market force factors which relate to the population make up of a market. Their main focus is on the property to be assessed and the economic forces which affect the value of that property.
To understand the appraiser’s job you must first understand the appraiser’s charter. Real Estate Appraisers are held to the same moral and ethical standards that are applied to police officers, firemen and elected officials. Their integrity and honesty must be undeniable for the appraising community to be trusted. The appraiser does not work for the buyer or the seller or even for the lender, even though one or all of those parties may request and pay for the appraisal service. Many times people who order appraisals when purchasing a property are put off when the value conclusion of an appraisal turns out to be exactly the same as the contract price. This happens often and many people think that the appraiser has just taken their money without providing any valuable service. However one must understand the main tenant by which an appraiser is guided in order to see the value in what they have been provided.
The main focus of the appraiser’s duties is to reach a value conclusion as defined by the ‘market value’ of the property. Simply stated, the market value of a property is that price for which a willing seller and a willing buyer, neither under duress or undue influence, both educated in the market place will agree to transact the property in terms of cash or it’s equivalent. Now that’s a mouthful, but what it essentially says is that if you agree with another individual to buy a particular piece of real estate and neither of you is forced to enter into the contract and both people are educated in the market place, then the price you have agreed upon is the market value of the property. Hence, you will in many cases be presented with an appraised value conclusion that matches your contracted price.
When appraising a home, appraisers break down their value assessment into three main categories to determine what adds measurable value to the home and what items are not measurable. There are actually three types of value that appraisers see when they begin to assess a home. There are amenities that add value in the traditional since and these items fall into the category of measurable value added items. There are other amenities that have use value and may or may not add value to the home. As a matter of fact, some use value amenities will actually detract from a homes value in some markets. A Use value item in some markets would be a swimming pool. The owner received value from the amenity because they did not have to pay an association or membership fee to go and use a pool somewhere else. The pool does not offer any monetary value because the majority of people in the market don’t want to take care of the pool and because they would rather pay for a membership to use a pool somewhere else.
The third type of value an appraiser considers is also a non-measurable item and it refers to the time-value of money and how inflation eats away at the dollar over time. A Time-Value of Money item might be thousands of dollars of landscaping added to a property. The landscaping gives the property curb appeal and helps it to sell faster which reduces the damaging affects of inflation on the dollars as they remain tied up in the property during the marketing period. These three types of value are all considered during the appraisal process helping the appraiser to plus and minus items and allowing him to focus on the things that buyers react to when considering whether to purchase a property and what to pay for the property.
It is very important to understand the value of real estate in terms of being a value range. Even though an appraisal has a specific number assigned to its value, it would probably be more appropriate to express the conclusion as a range. The value range for a property can be found on page two of the URAR (Uniform Residential Appraisal Report). The overall value range for property being appraised is usually expressed by looking at the actual sales prices of the recent comparable homes found in the subjects neighborhood. These are the first numbers just below the address of the comparables used to determine the subject properties value. The specific value range for the property can be found at the bottom of each column after all measurable adjustments have been made. The appraiser picks a value for the property from the adjusted range by applying his feeling about how non-measurable items might affect the value of the property. For instance; if the overall value of the property were non-adjusted sales that ranged from $100,000 to $120,000 and the adjusted range was from $105,000 to $115,000 and the property had beautiful curb appeal that made it much more desirable than many homes in the market, the appraiser might choose to render an appraised value of $115,000 placing the property at the top of the adjusted value range. Realistically, the value of the property is between $105,000 and $115,000. The exact value can only be established by a contract for the purchase of the property that meets all the tenants of fair market value.
When reading an appraisal there are some very important things to consider. You should always begin on page one. Read the neighborhood section of the report. Has the appraiser given specific information about the market or is the information general? Has he/she explained all economic forces that might affect the value, like a plant closing that may be causing people to sell rapidly and move quickly? Has he/she talked about new technology companies moving to the area causing a large population influx that has pushed builders to the brink and the demand for housing is so strong that values are rising rapidly? The neighborhood section of the report is your first sign that an appraiser has taken their task seriously. Too little information may signal a poor value conclusion or may be the sign of an appraiser who has not fully investigated the market.
Next you should read about the details of the property. Does the appraiser’s description sound like the house you are buying? Has he described the condition accurately, the rooms, the style and the amenities. If this section seems correct, you are ready to move on. Go to page two and look at the actual sale prices of the comparables. Write down the lowest number and the highest number. Now scan down the report and look at the adjusted sales prices, the highest adjusted sale price should be equal to or less than the highest actual sale prices at the top of the page. Conversely, the lowest adjusted sale price should be equal to or less than the lowest actual sale prices at the top of the page. Think of the adjustment process as a funnel. The top is wide and open giving you a nice target when you want to poor something in it. But the bottom is narrow and when the liquid comes out the bottom it creates a nice tight stream. An appraisal should be the same way. The top spread of values is wide and is a nice target. As information is poured in the funnel it comes out the bottom in a nice tight stream giving direction to a tighter value range and more accurate conclusion.
The Appraisal Funnel - Fig. 1
Actual Sale Prices
$100,000 $125,000
Information
(Adjustments)
$105,000 $115,000
Adjusted Sale Price
$110,000
Value
If the adjusted sale prices of the comparables is bracketed by the actual sale prices of the comparables and all of the homes are similar to the property being appraised (also referred to as the ‘Subject’) and are from the same direct competitive market, then the value conclusion is most likely valid. Common sense will tell you the most about the validity of a real estate appraisal. For instance, even if the appraisal funnel requirements have been met and it has been 6 months or less since the sale of the comparables, the appraisal may not be valid if the subject property is a two story English-Tudor and the comparables are all traditional one story ranch style homes.
The following is a list of general questions that will help to create guidelines to check when determining if an appraisal is valid.
Who ordered the appraisal? If it was the seller of the property you should be weary of the value conclusion.
Does the neighborhood section on page one of the URAR tell you something about the surrounding market? If the comments seem canned and it appears that no thought has gone into explaining the neighborhood and the market forces that affect values in the area then you may have an appraisal that has been washed over and may not be thoroughly researched.
Does the property description on page one of the URAR describe the home being appraised and does the information match on page two? This sounds very simple, however some appraisers don’t check to make sure that the information about the property being appraised matches from the first page to the second page of the appraisal. If you see a report that has this problem the value conclusion may be completely incorrect.
Are the adjusted sale prices of the comparables bracketed by the actual sale prices with the range of adjusted prices being equal to or less than the range of unadjusted prices? See the figure titled ‘Appraisal Funnel’ for an example.
Is the value conclusion within the range of the adjusted sale prices? The value conclusion should always be stated as a number within the adjusted sale price range. Remember, the number on the report is just a number placed by the appraiser out of necessity. The real value of the property is more accurately expressed as the range reflected in the adjusted sale prices.
The appraisal can be a very important tool in your real estate investment tool box and a qualified appraiser as part of your team of trusted advisors is a very valuable asset. So think about these rules and questions the next time you read an appraisal and you should be able to make a confident and informed decision about the validity of the value conclusion.
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