How Appraisers Determine Value
An appraisal is an essential and vital part of the process in the purchase of a home when the purchaser is securing a home loan because, in essence, it "proves" or assures the lender/bank that the property is worth the purchase price of the property to justify the purchasers loan amount. Lenders simply do not or won't take the risk with lending a purchaser money for a property if the property isn't worth in from an appraisers perspective.
If an appraisal comes in short of the purchase price, the loan is not likely to get loan approval from the lender. To put simply, a lender may not be willing to take the risk of loaning money to a buyer if the house isn't worth what they have agreed to pay.
So, how does an appraiser determine the value of a home?
An appraiser has several different approaches when it comes to determining the value of a home, but in order to complete these approaches, they will first need to do the following:
1. Get the order from the lender or AMC (appraisal management company...IE- 3rd party management company to basically be the "go between" with the lender and appraiser to ensure that the appraisal is not unbiased. Lenders can no longer order the appraisals on their own)
2. Physical inspection- The appraiser will visit the property onsite (Sometimes just a driveby if the purchaser's financial capability is extremely strong). They will measure the property and visually inspect the condition.
3. CMA- Much of the time an appraiser may complete a Comparative Market Analysis (CMA) to dig in to recent sales of comparable/similar homes in the area to get a data point or feel for the market before they even arrive for their physical inspection. Appraisers have access to their local MLS, so with all of the videos, pictures and marketing remarks that Realtors put online/MLS, an appraiser can probably get most of what they need from the MLS alone.
Once an appraiser completes the steps above, they will then determine what approach they need/want to use. It will really depend on the property. The various approaches are as follows:
-Cost approach- Basically what it would cost to reproduce the property, taking into consideration physical depreciation and adding value of land.
-Income approach- This is used for income producing investment/rental properties. This approach helps calculate the value based on the revenue it produces.
-Sales Comparison Approach- This is probably the most used approach, at least in our market of Southern Indiana and KY. Essentially this is a Comparative Market Analysis (CMA) as mentioned above, but the appraiser will make dollar amount adjustments based on features/condition that the subject property has/doesn't have. Once they have completed all of their adjustments and comparing the subject to other similar homes (typically the 3 most comparable), they will come to an end value.
Lastly, the appraiser will create a comprehensive report including the comparables used, any adjustments, map, floor plan with measurements, pictures of the subject property, signature, license number, and then submits it to the Appraisal Management Company (AMC) where they will review for quality compliance. Once reviewed and satisfactory, they will then submit the the lender.
As a Realtor in Southern Indiana and Kentucky, I use the Sales comparison approach the most. After being in the business for almost 20 years and provided a vast amount of training and relationships with appraisers, my methodology is pretty much identical, OTHER THAN there are some unspoken factors that can affect value that are sometimes overlooked by data......such as- Steep driveways and how they can affect property value in the end. I will save that for another blog though. :)
Thanks for reading.