Whether you’re a residential homebuyer, a seller, or an aspiring real estate investor, learn the basics of an appraisal, why an appraisal is useful, how it’s conducted, and what various appraisal terms mean.
What Is a Real Estate Appraisal?
A real estate appraisal is an objective, qualified expert’s analysis of a property to help determine its value. Lenders commonly use appraisals before financing property purchases. The lender wants to ensure the amount of money being loaned isn’t more than the property is worth. The appraisal also reassures the buyer that the price paid isn’t higher than the home’s market value. Lenders and potential buyers are not the only ones ordering appraisals. There are many reasons to get an appraisal. For example, a seller may want an appraisal to help decide on a competitive listing price before selling. Appraisals can even be used for dispute resolution (e.g., divorce settlements) or estate planning purposes.
Appraisal vs. Inspection: What’s the Difference?
A real estate appraisal and an inspection may seem similar at first. An expert examines a property and ultimately issues a report about it. While both involve analyzing the condition of a property for real estate transactions, the methods and purposes differ. An appraisal is an analysis of a property by an expert to determine what the Appraisal Institute calls an “opinion of value,” or how much money the property is worth. An inspection is an analysis of a property’s physical condition and material defects, or how much repair it needs. While an appraisal is generally required by lenders before financing a home sale, an inspection is something an individual buyer or property owner chooses to have completed.
Single-Family vs. Multi-Unit Appraisals
For a single-family home, an appraiser typically relies primarily on data about similar properties that have sold or are pending sale to help determine the market value of the property in question. All appraisal types include some analysis of comparable properties nearby that have sold recently, also known as “comps.” Multi-unit properties or multifamily homes are usually purchased for investment purposes, so appraisers also rely on calculations about the property’s possible production of income and expenses. The appraisers then typically calculate values per unit and a total value for each multifamily property. Since this process is more complex, multi-unit appraisals are more expensive.
Common Real Estate Appraisal Methods
Typically, every appraisal involves research and analysis of local property values in the market, current supply and demand, and other economic factors that could raise or lower those values, along with evaluation of the property’s specific characteristics and analysis of comparative home sales. However, depending on the type of real estate, the reason for the appraisal, and what relevant data is available, an appraiser will determine the property’s value through the sales comparison method, the cost method, and/or the income capitalization method.
Sales Comparison Method
The sales comparison method relies primarily on data about the sale of comparative properties. By looking at properties most similar to the subject property, the appraiser identifies a range for the property’s value. The appraiser will consider a number of factors when determining how similar the comps are to the property in question, including:
LocationPhysical characteristicsEconomic characteristicsMarket conditions at the time of saleConditions of the sale itselfUse and zoning
When calculating a useful value range from a comp, the appraiser may make dollar or percentage “adjustments.” These adjustments add to or subtract from its sale price based on advantages or deficiencies in the subject property. For example, if one comp has an outdated kitchen, but the subject property has a recently upgraded kitchen, the appraiser may raise the value range derived from that comp.
Cost Method
If a property doesn’t really have any true comps, the cost method of appraisal may be most appropriate. This could be because the property contains new or specialized improvements, is unique, or isn’t commonly on the market. In this method, the appraiser determines the value of the land (not counting any buildings). The appraiser then calculates what it would cost to build the same or similar type of improvements, and adds that cost to the land value. Finally, the appraiser subtracts an amount for how much any structures have depreciated over time; in other words, how much value a property has lost due to aging, wear and tear, changes in the surrounding area, and more.
Income Capitalization Method
Whereas the previous two appraisal methods discussed deal more with residential real estate, this method is used specifically to determine the present value of an investment property such as multifamily properties. With this method, the appraiser looks at a variety of factors to form an opinion of a property’s future investment benefits, such as:
Intended useEstimated profitsEstimated lossesEstimated expensesHow long and how consistently is the property likely to provide incomeEstimated value of the property if and when it is eventually sold againRates of return for similar properties
What Does an Appraisal Cost?
Appraisal costs vary widely depending on the local market. The Organization of Real Estate Professionals’ 2021 Appraiser Fee Survey of professional appraisers across the U.S. revealed a range of pricing in most markets. For example, appraisers in the San Francisco area indicated charging anywhere between $301 to more than $751 to appraise a single-family home. More than half of appraisers charged $550 or more. In Oklahoma, statewide, most appraisers surveyed reported charging $550 or less. The homebuyer typically pays the appraisal fee—sometimes upfront and sometimes as part of the closing costs at the official time of closing. If you’re a homeowner or buyer wanting an appraisal for your purposes, such as determining a list price, settling a divorce, or purchasing with cash, you’ll both order and pay for the appraisal yourself.
After the Appraisal
After viewing a property in person, compiling and analyzing data, completing calculations, and applying one of the three valuation methods discussed, the appraiser is ready to determine a “final opinion of value.” This is the number that lenders, hopeful homeowners, and potential investors await.
What’s in an Appraisal Report?
The final opinion of value arrives in an appraisal report that supports the appraiser’s estimate of the home’s value. Any credible appraisal report should include:
The appraiser’s methods for defining and determining value, including how the property was inspected, and any lender-specific requirementsClear identification of the subject property and its relevant characteristics and featuresThe client and intended use of the propertyThe report’s purpose, such as financing or investingMarket area and comps used for analysis
What if the Appraisal Comes in Lower Than the Contracted Price?
Sometimes the opinion of value on an appraisal can come in lower than the sale price a buyer and seller have agreed upon. Possible reasons for this could be that the property was overpriced, prices are artificially inflated in the market, or the appraiser was inexperienced or made an error. Since lenders won’t loan more money than a property is worth, a low appraisal presents a problem for both buyers and sellers. For buyers, possible solutions to a low appraisal include asking the seller to lower the sale price, making up the difference in cash, or consulting with an attorney about canceling the sale. Depending on contract conditions, the buyer may be forfeiting earnest money. You can also contact your lender. The lender can request that the appraiser consider additional information, correct errors, or explain the value. For sellers, possible solutions might include lowering the price or disputing the appraisal with the lender in hopes they will order a second appraisal. It’s best to dispute the appraisal in writing if you feel the appraiser missed critical details about the property or available comparable properties. The appraiser may ask a second appraiser to review the appraisal, or conduct a second appraisal—but isn’t required to do so.
