A home purchase is the largest, single investment most people will ever make. Whether it's a primary residence, a vacation home or an investment property, the purchase of real property is a complex financial transaction that requires multiple parties.
The Realtor is the most common face of the transaction. The mortgage company 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 and then there is the Appraiser. An appraisal is an unbiased estimate of what a buyer might expect to pay - or what a seller might expect to receive - for a parcel of real estate.
So what goes into a real estate appraisal? It all starts with the inspection. An appraiser's duty is to inspect the property being appraised to ascertain the true status of that property. The appraiser observes the subject’s features, such as the number of bedrooms, bathrooms, the location, and so on, to ensure that they are in the condition a reasonable buyer would expect. The appraisal report often includes a sketch of the property, showing the square footage and the layout of the property. Most importantly, the appraiser looks for any obvious features - or defects - that would affect the value of the house.
Once the subject site and property have been observed, the appraiser uses one, two or three approaches to determine the market value: a Cost Approach, a Sales Comparison and, in the case of a rental property, the Income Approach.
The cost approach is the easiest to understand. The appraiser uses information on building costs, labor rates and other factors to determine how much it would cost to reconstruct a property similar to the one being appraised. This value often sets the upper limit on what a property would sell for. Why would you pay more for an existing property if you could spend less and build a brand new one? Most often the Cost Approach is an applicable approach for new or “like new” properties.
The Sales Comparison is the most widely known approach, this approach considers similar properties and makes adjustments for market valued differences. Appraisers get to know the neighborhoods in which they work and must understand the value of certain features to the residents of that area. They know the traffic patterns, the school zones, the busy throughways; and they use this information to determine which attributes of a property will make a difference in the value. Then, the appraiser researches recent sales in the vicinity, or comparable neighborhoods and finds properties which are "comparable" to the subject being appraised. The sales prices of these properties are used as a basis to begin the sales comparison approach. Using knowledge of the value of certain items such as square footage, extra bathrooms, hardwood floors, fireplaces or views (just to name a few), the Appraiser adjusts the comparable properties to more accurately portray the subject property. For example, if the comparable property has a fireplace and the subject does not, the appraiser may deduct the value of a fireplace from the sales price of the comparable home. If the subject property has an extra half-bathroom and the comparable does not, the appraiser might add a certain amount to the comparable property.
In the case of income producing properties - rental houses for example - the appraiser may use a third approach to valuw the property. In this case, the amount of income the property produces is used to arrive at the current value of those revenues over the foreseeable future.
Combining information from the developed approach or approaches, the Appraiser is then ready to develop an estimated market value for the subject property. It is important to note that while this amount is probably the best indication of what a property is worth, it may not be the final sales price. There are always mitigating factors such as seller motivation, urgency or "bidding wars" that may adjust the final price up or down. decisions.