What is an appraisal

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Real estate appraisals may be used for many things. For the sake of the next few paragraphs, lets assume that an appraisal is to be used as part of a sale transaction.  A real estate purchase is one of the largest, single investments that most people will ever make. Whether it's a primary residence, a second home, or an investment, the purchase of real estate is often complex, requiring several different parties to consummate the transaction.

Most of the people involved are very familiar. The Realtor is often the most common face in the transaction. A financial institution typically provides the financial capital necessary to fund the transaction. The title company ensures that all aspects of the transaction are completed and that a clear title passes from the seller to the buyer.

So who tries to ascertain whether the value of the property is in line with the amount being paid? There are too many people exposed in the real estate process to let such a transaction proceed without getting a professional's opinion about the value of the property as it relates to the agreed upon purchase price.

This is where the appraisal comes in.  An appraisal is an unbiased estimate of what a buyer might expect to pay - or a seller receive - for a parcel of real estate, where both buyer and seller are informed parties.

The Property Observation (Inspection)
So what constitutes a real estate appraisal? The process begins in earnest with the appraiser's observations at the property.  An appraiser observes the property being appraised in order to form an unbiased opinion about its nature, condition, and features. Of interest are things such as the number of bedrooms, bathrooms, the property's location, and et cetera. The property observation often includes a sketch of the property and/or the improvements thereupon.  Measurements are generally taken of the improvements for the purposes of calculating square footage or size.  The sketch may also used in order to create a floor plan layout that is placed in the final appraisal report, which conveys the layout of the property to the client.  

The appraiser's observations at the property being appraised also try to ascertain the nature of any obvious defects that may affect it.  It is important to note that an appraiser is not a professional home, environmental, or structural inspector and should not be viewed as such.  The appraiser typically has a layman's level of sophistication regarding structural and system components of a house or other structure.  Likewise, he or she typically does not have any advanced training or expertise in the field of environmental affairs.  Therefore, the appraiser's capability along these lines is limited to that of a layman.  As such, the appraiser will report only those defects or adverse conditions that are obvious in nature and that would be readily apparent to the typical person.  At Monroe/Owen Appraisal, Inc., we recommend that every client of ours obtain a professional home or structural inspection for the property that is being appraised.  We also recommend that all of our clients obtain a professional environmental assessment of the property that we are appraising.  In our appraisals, we assume, but do not warrant, that there are no hidden or unknown property defects or adverse environmental issues with respect to the property being appraised that would adversely affect its market value.  If such conditions are discovered to exist, our analysis and valuation opinion(s) are to be considered null and void.

Once the site observation is complete, an appraiser typically uses one or more of three different approaches to determine the market value (or other type of value) of the property being appraised.  The approaches to value that may be used include the cost approach, the sales comparison approach, and the income approach.

Cost Approach
The cost approach is the easiest to understand.  The appraiser uses information on local building costs, labor rates, land values, and other factors to determine how much it would cost to construct a property similar to the one being appraised.  This value often sets the upper limit on what a property would sell for.  Why would somebody pay more for an existing improved property if he/she could spend less and build a similar, brand new one?  While there may be mitigating factors, such as location and amenities, these are usually not reflected in the cost approach.

Sales Comparison Approach
When trying to estimate a property's market value, an appraiser commonly relies on the sales comparison approach.  Appraisers get to know the neighborhoods in which they work. They try to understand the value of certain features to the residents of that area.  They then try to gain an understanding of the traffic patterns, the school zones, the busy throughways, and et cetera.  Thereafter, they use that information to estimate which attributes of a property likely will make a difference in the property's value.  Then the appraiser researches recent sales in the vicinity in order to find properties that are ''comparable'' to the property being appraised.  The sale prices of the comparable properties "comps" are used as a basis to begin the sales comparison approach.

Bearing in mind the contributory value of certain features such as square footage, extra bathrooms, hardwood floors, fireplaces, and et cetera, the appraiser adjusts the sale prices of the comparable properties to reflect the features of the subject property.  For example, if a residential comparable property has a fireplace and the subject does not, the appraiser may deduct the estimated contribution of a fireplace from the sale price of the comparable property.

After the analysis has been undertaken and the appropriate adjustments have been made to the comparable sales, the appraiser typically correlates the various adjusted sale prices into either a single point value estimate or a range of value estimate depending on the client's needs.  The correlation constitutes the value indication via the sales comparison approach.

Income Approach
The income approach to value can be a complex method of estimating the subject property's market value (or other type of value).  In a nutshell, it is a method of using the subject property's actual or estimated income stream to forecast its likely market value to the typical property owner (usually and investor-owner).  There are various methods and techniques to do this, which are beyond the scope of this discussion.  If you would like to learn more about the income approach to value, call and talk to us here at Monroe/Owen Appraisal, Inc.  We will be happy to discuss it with you or point you to various texts with good discussions about it.

The reconciliation process is a technique by which the appraiser looks at the various valuation approaches that were developed with respect to the property being appraised.  The merits and weaknesses of each approach are weighted and the appraiser then reconciles the subject property's market value (or other value) estimate either as a point value estimate or as a value in range estimate.