Resources to help you better understand appraisal. You might think, “That’s what I am hiring HomeLab for!”. Some people like to ask questions and understand things even if they hire someone else to do the work. For those curious people, enter the lab and seek knowledge.
Approaches to Value: There are most commonly three approaches to value. All three can be used for the most improved properties. Here is a brief overview of each.
1. Sales Comparison Approach: This is the most common approach. It involves selecting the most comparable properties, developing adjustments, and reconciling the adjusted values into a final indication. This approach extracts data from the market, i.e., actual completed sales explicitly.
2. Cost Approach: This approach seeks to set a value for the land and buildings separately. For new construction, this is the actual cost to build. This is the actual cost to build less accrued depreciation for existing properties. The depreciated improvements value (including any site improvements) is added to the site value to give the cost value. Site value can be its separate appraisal, as there are several methods to determine that, including extraction, allocation, and, you guessed it, Sales Comparison.
3. Income Approach: This typically does not apply to most single-family residential, but as with most appraisals, it depends. If an area is hefty in investment properties, even single-family homes can potentially be valued this way. It just depends on how the market is reacting. This approach is usually used for specific investment properties 2+ units and commercial properties. With commercial, there are even more methods related to income that can vary by property type.
Cost v. Value
There is a common misconception that cost should always be close to value. This is not always the case; most people understand this when given examples. The most common example is a swimming pool. In areas of the country where collections can be used year-round, they likely add more value, possibly even giving you a total return on your investment. However, in areas like Colorado, with limited use, they rarely will bring anywhere near that return. In some areas, they will add no value, as buyers consider them a hazard they would instead not want to deal with. But the cost is what it is; if it costs $50,000, that is the value it adds to the cost approach. The value it adds to the sales comparison approach depends entirely on how the market reacts to a pool, and this can vary neighborhood by neighborhood. This can be applied to almost any item, but there is more disparity the more unique the item is, as buyers’ expectations for such things are lower.
Quality v. Condition
Some appraisers often misunderstand these terms, so it’s no wonder most people do not know the difference. The actual difference as it relates to appraisal is as follows:
Quality – Relates to overall build quality, closely tied to RCN (Replacement Cost New). This essentially establishes the price per square foot to build a similar improvement. For residential, the Q scale is used, Q1 being the highest (Excellent Quality) and Q6 being the lowest (Subpar Quality). Class (A, B, C, D) is usually indicated for commercial purposes. The higher the quality, the higher the cost per square foot. Again, this typically correlates closely to value, but not always. Suppose someone chooses to build a high-quality building in an area of average-quality buildings. In that case, the value will likely be significantly less than the quality would typically bring. Again, this relates to the expectations of the buyers.
Condition – This is tied to depreciation on the cost approach and represents more of the effective age rather than actual age. Effective age is how old the building appears based on how well it has been taken care of, updated, etc. So this determines what percentage of the RCN (new value) the subject still has. This is typically represented with a C scale where C1=new and C6=should be demolished.
Generally speaking, quality does not change throughout a structure’s life unless significant structural changes exist. If a building is remodeled, this speaks to condition, not quality. You can have a high-quality facility in poor condition and a subpar quality building in good condition. They are two separate things.
Intended Use, Intended User, and Client
The Intended Use- How the engaged users expect to employ the information in a report.
Intended User – the client and any other party as identified, by name or type, as users of the appraisal or appraisal review report by the appraiser, based on communication with the client at the time of the assignment.
Client – the party or parties (i.e., individual, group, or entity) who engage an appraiser by employment or contract in a specific assignment, whether directly or through an agent.
The client is always an intended user, but not all our clients. The appraiser can only discuss the report’s details, including assignment results, with the client.
For property owners obtaining a loan on their property, this means the lender is the client, and the appraiser cannot discuss the appraisal details with them. This can be confusing, as they are often charged a fee by the lender and assume that they are paying the appraiser and therefore entitled to information regarding the appraisal from the appraiser. However, regardless of whether or not the borrower is charged a fee, the appraiser is never paid directly by the borrower. This is not allowed per Appraiser Independence Requirements. The appraiser is produced by the client or AMC (appraisal management company) but not by the borrower. The appraiser is paid regardless of whether the borrower is charged a fee, and these fees do not necessarily match what the appraiser is paid (often do not). Some states require that the appraiser disclose the price paid to them in the report.
Scope of Work – The scope of work is the amount and type of information researched and the analyses applied in an assignment.
Other Appraiser jargon:
Adjustment – When comparable properties have been identified, the appraiser makes adjustments to each comparable’s Sales Price to bring them into equivalency with the subject property, accounting for differences in location, construction quality, living area, acreage, frontage, amenities, and the like. This is where the professional expertise of an appraiser is most valuable.
Chattel – Personal property may be on the subject property but does not figure into the opinion of value in the appraisal report.
Comparable or “comp.” – Properties like the subject property nearby, which have sold recently, are used as a basis to determine the fair market value of the subject property.
Drive – by. An appraisal that is limited to an exterior-only examination of the Subject to determine that the property is there and has no apparent defects or damage visible from the outside. Fannie Mae’s form for this type of appraisal is 2055, so you may hear a drive-by referred to as a “2055.”
Fair market value – The appraiser’s opinion of value as written in their appraisal report should reflect the property’s fair market value — what a willing buyer would pay a willing seller in an arms-length transaction.
GLA – “Gross Living Area,” the sum of all above-grade floor space, including stairways and closet space. GLA is often determined using exterior wall measurements.
Latent defects – A defect on the property is not readily apparent but impacts the fair market value. Structural damage or termite infestation might be examples.
MLS – A Multiple Listing Service is a proprietary listing of all properties on the market in a given area and their listing prices and a record of all recent closed sales and their prices. Created by and used primarily by real estate agents, many appraisers pay for access to these databases to aid comparable selection and adjustment research.
Obsolescence – The value of assets diminishes as their capabilities degrade or more desirable alternatives are developed. Functional obsolescence is the presence or absence of a feature that renders the property undesirable. Obsolescence can also occur because the surrounding area changes, making a part of the property less desirable.
Subject – Short for the property being appraised — the “subject property.”
Useful life – The time during which a property can provide benefits to its owner.
URAR – Short for Uniform Residential Appraisal Report, Fannie Mae form 1004 is the form most lenders require if they need a full appraisal (that is, with walk-through inspection).
USPAP – Short for Uniform Standards of Professional Appraisal Practice, USPAP promotes standards and professionalism in appraisal practice and is often enacted into law in a state. It is promulgated by the Appraisal Foundation, a non-governmental entity chartered by Congress to, among other things, maintain appraisal standards.
Walk-through – An inspection that includes a visit to each part of the house’s interior is used in estimating value.