Property Appraisal for Buying a Home
An Unbiased Estimate
A Residential Real Estate Appraisal is an unbiased estimate of what a buyer might expect to pay – or a seller to receive – for a parcel of real estate, where both buyer and seller are informed parties.
An informed party is someone who has gained comprehensive information about the parcel of real estate in the transaction. An Appraisal is an opinion of value, based on a significant amount of research as well as the specific expertise of the Appraiser.
Steps of a Simple Transaction Requiring a Real Estate Appraisal
Let’s walk through a sample transaction, for a residential property that is being passed from the current owners (Mr. and Mrs. Seller) the the anticipated new owners (Mr. and Mrs. Buyer).
For the purposes for this transaction, we have these facts:
- This is a re-sale transaction, i.e. the home is currently owned by Mr. and Mrs. Seller, and is not new construction.
- The home is in an area that has regular turnover of properties, such as a subdivision of several hundred homes that share similar characteristics such as size, quality and amenities.
Mr. and Mrs. Buyer have visited a dozen homes in the past month with their REALTOR®, a Real Estate Agent licensed in Texas to engage in the practice of Real Estate Sales. Ms. Agent is licensed by TREC, the Texas Real Estate Commission. They have selected a home they want to purchase, have written an offer, negotiated the details and are in the process of completing the financing for their purchase.
Before this transaction can close, the Lender for the mortgage must determine the value of the property. The market value of a parcel of real estate is determined by an appraisal. For the Buyers, however, the market value as indicated by the appraisal is only one piece of the informational puzzle they need to obtain prior to purchase. In most cases, before an appraisal is ordered, the Buyers will have gathered detailed, relevant information about the property they have placed under contract:
Sources of Real Estate Parcel Information
Information about a parcel of real estate can be obtained from a variety of sources, including but not limited to:
- A visual examination of the property by the person interested in purchasing it.
- A comprehensive property inspection by a Licensed Real Estate Inspector (licensed by TREC, The Texas Real Estate Commission).
- A pest inspection performed by a Licensed Pest Control Inspector (licensed by The Texas Department of Agriculture Structural Pest Control Service)
- A foundation inspection, if warranted due to the location, or condition of the property.
- Calling a home insurance company to determine of the property is insurable. Insurance companies have access to a huge database that tracks claims to property. If a property has had too many claims, or too many claims relating to major problems, it may be uninsurable.
In this case, Mr. and Mrs. Buyer visited the home twice before decided to make an offer to purchase. They like the style, floorplan and location of the property.
Mr. and Mrs. Buyer had the home inspected to determine if the structure and the systems are sound (i.e. in working order) and have reviewed the report. They have negotiated for repairs, and the repairs have been completed by Mr. Seller or experienced (preferably licensed) tradespeople.
The “Termite Inspection” as it is frequently called, revealed no evidence of pest infestation.
This re-sale home is on a slab (concrete) foundation that has been in place for 30 years. There is no evidence of settling or cracking discovered in the regular home inspection, and the Buyers have decided not to have the foundation inspected by a structural engineer. If the home had any suggestion whatsoever of foundation problems, a foundation inspection is imperative.
In this case, the home is insurable, at a rate the Buyers can afford, and the transaction has moved forward towards closing – the process for transferring ownership from Mr. and Mrs. Seller to Mr. and Mrs. Buyer.
Mr. and Mrs. Buyer have done their research, have thoroughly reviewed the home’s inspection report(s) and have decided to proceed with the purchase of this property.
Why Market Value of Property Must be Determined
Before this transaction can close, however, the Lender for the mortgage must determine the value of the property.
The Lender must ensure that the amount of money the Lender is lending Mr. and Mrs. Buyer is consistent with the actual market value of the property. If the property “appraises low”, the Buyers may not be able to obtain their desired financing. If the property “appraises high”, then the Buyers may be acquiring property that is worth more than the agreed-upon selling price, which would please them greatly. The price agreed upon between the Sellers and the Buyers is not necessarily the same as the actual market value of the property – it is simply the value the two parties to the transaction have negotiated.
To determine Actual Market Value, the Lender orders an Appraisal.
Appraisals in Texas must be performed by an Appraiser licensed to perform appraisals. As a home buyer, your appraisal should be performed by a Certified Appraiser (Certified Residential Property Appraiser). Although the cost of the appraisal is paid by the Buyers, the appraisal will be ordered by the Lender. In many cases the realty appraisal must be ordered by the Lender. The appraisal MUST be performed by someone who can provide an unbiased opinion of the value of the property.
An appraisal may not be performed by someone with an interest in the property, including someone related to either the Buyers or the Sellers, or someone who may benefit from the value being within a certain range. The appraiser may not be required or expected to “come in at a value”, i.e. the appraisal may not be based on an expected result. Appraisers are subject to stringent ethical, professional, legal and regulatory requirements. To be of any value to a transaction, the Appraiser must be unbiased, and the resulting appraisal must provably be an unbiased opinion of value.
FHA Appraisals Must be Performed by an FHA Approved Appraiser
FHA loans require an appraisal to be performed by an appraiser on the FHA approved appraisers roster. This type of appraisal has additional FHA Appraisal guidelines that must be followed before the loan can be approved.
The Appraisal Process
The appraisal process has many steps, each of which must be performed conscientiously and methodically before an opinion of value can be rendered:
- Analysis (The Cost Approach and the Sales Comparison Approach)
- Determination of Value (Reconciliation)
Inspection and Research
An appraiser’s responsibility is to inspect, or examine the property being appraised to ascertain the true status of the property. This is not the same as the property inspection that was performed to determine the soundness of the property (i.e., if the systems, windows, plumbing, HVAC, etc. work). He or she will visit the property, measure the exterior dimensions (first floor) and will measure interior dimensions (second and higher floors) to determine the actual square footage of the property. The appraiser should not rely on other sources for this measurement data, such as the original builder plans (frequently wrong), or the tax records (also frequently wrong).
He or she must actually see features, such as the number of bedrooms, bathrooms, the location, and so on, to ensure that they really exist and are in the condition a reasonable buyer would expect them to be. In addition, the appraiser looks for features – or defects – that would affect the value of the home or property. This includes examining proximity to busy roads, commercial property or amenities. Location and amenities affect value, and the appraiser must determine if, and to what extent, elements external to the property impact the market value of the property.
Analysis (The Cost Approach and the Sales Comparison Approach)
Once the site has been inspected, and extensive information about the property has been gathered, the appraiser uses two or three approaches to determine the value of real property: the cost approach, the sales comparison and, in the case of a rental property, an income approach. Because this transaction is for a home that the Buyers intend to live in, we will only review the cost approach and the sales comparison approach.
The Cost Approach
The cost approach is usually the easiest of the three approaches to value to understand. The appraiser uses information on local building costs, labor rates and other factors to determine how much it would cost to construct a property similar to the existing one that is being appraised. This data is readily available from sources that specialize in providing highly detailed, accurate and comprehensive information for new construction in different areas of the country.
The value obtained via the cost approach value frequently sets the upper limit on the potential selling price of a property: Why pay more for an existing property if you could spend less and build a new home, to your exact requirements, instead? Although there may be additional factors that would influence the Buyers to buy an existing home rather than build a new one, including location and amenities available in the area, these are usually not reflected in the cost approach.
The Sales Comparison Approach
The sales comparison approach uses detailed information about other properties for sale, or that have recently sold, to ascertain the indicated value of the property being appraised. A full-time certified appraiser may appraise 600 or more properties each year, and in the process of performing these appraisals, will review detailed information on several thousand additional properties. The best appraisers, like the best REALTORS®, are thoroughly versed in the areas in which they specialize: they understand the value of certain area features and amenities to the residents of the neighborhood or the specific market area.
Traffic patterns, school zones and busy roads may impact the value of a parcel of real estate. Experienced appraisers use this information to determine which attributes of a property will make a difference in the value and which ones won’t. With data on comparable properties in hand, and in-depth knowledge of the market area available for reference, the appraiser can weigh the relevant attributes of the property to determine market value.
Determination of Value (Reconciliation) and Reporting
With the resulting information from both the cost approach and the sales comparison approach, the appraiser can then determine an estimated market value for the property being appraised. The market value is not an average of these two approaches, it is a determination, based on the results of the two approaches to value, combined with the appraiser’s expertise in the market. Please note that the price agreed upon between the Sellers and the Buyers is not necessarily the same as the actual market value of the property – it is simply the value the two parties to the transaction have negotiated.
For the lender to make the loan on the property, this value, the appraised value, must be within the lender’s required limits vs. the amount of the proposed loan. If the value “comes in low”, the borrowers (i.e. Mr. and Mrs. Buyer) may have the option of coming up with more money towards the down payment, re-negotiating the contract, or canceling the transaction. The lender must make the resulting appraisal report available to the borrower and the borrower then has the ability to use this information to make a more informed decision regarding their transactional options.