Monday, January 11, 2016

Understanding the Appraisal

   For Realtors and several real estate professionals, the value of a property along with real estate financing, listing, investment analysis, property insurance and taxation is one of the most important endeavors to be undertaken. This number will certainly be one of the determining factors in the asking price or purchase price for buyers. For sellers it is often used as one of the factors to set the selling price. This could very well be one of the most useful tools for the application of real estate valuation. The following paragraphs will give an insight into the basic concepts and methods of real estate valuation in relation to real estate.
 The appraisal is the main tool used by realtors to appraise a property's value. These attributes that must be taken into account when estimating a property's value are economic and social trends along with government regulations and controls and  the environmental conditions that may influence the four elements of value.

  •    Demand - the desire and willingness to pay a price for a property while holding all other factors constant, the price increases as its demand increases and vice versa; 
  • Utility - the ability to satisfy future owners' desires and needs; 
  • Scarcity  the short supply of competing properties  
  • Transferability - the ease with which ownership rights are transferred.  

   What are the differences between the value versus the cost and price? Value is not necessarily the same as cost or price. Cost refers to the actual expense, for example the cost for materials and labor. Price is basically referring to what someone would pay for an item. While on the other hand price is what someone pays for something.while cost and price can affect the value of an item, they do not determine its value. Let's take for example if a house has a price of $200,000, the actual value may be significantly higher or lower. One of the mitigating factors that could affect value would be if the new owner found a serious flaw in the foundation, the value of the house could be much lower than the actual price.
   An appraisal would be an opinion or an estimate in regards to the value of a property at the time of the appraisal. Appraisal reports can be used by a multitude of organizations and individuals Realtors, businesses, government agencies, investors. and mortgage professionals when they make decisions regarding real estate transactions. The main purpose of the appraisal is to determine the market value which the property will likely bring in a competitive and open market. The market price is what the property actually sells for and doesn’t always represent the market value. Some mitigating circumstances that could influence value would be if the seller is under duress and is under the threat of foreclosure which doesn't expose the property to the open market and would probably sell below market value.
   There are several  appraisal methods and the most accurate approximation depends on the methodical collection of data to determine price. Very specific data which covers the details of a particular property and general data which pertains to national, regional and local data including the neighborhood location are collected and analyzed to determine the value. There are three specific methods  that are used to to determine the most accurate appraisal.
   The first method is the sales comparison approach, which is used mostly for homes and land. This method is sometimes called the market data approach and the value is derived by comparing a property with recently sold properties with similar characteristics within a certain location. These similar properties are often called comparables (comps) and are able to provide a true comparison but each must have the following characteristics:

  • Be as similar to the subject property as possible; 
  • Have been sold within the last year in an open and competitive market; 
  • Have been sold under typical market conditions;

   When comps are chosen, they must be as similar to the subject property as possible and at least three or four are used for the appraisal process.The size, number of bedrooms and baths and location of the subject property are the most important factors to consider when selecting comps. The location of these properties are the most important factors in determining a properties value and similar homes in the same neighborhood or adjacent localities will mostly be used.
   These comps should be two properties that are exactly alike unless they are found in a newer development where buyers pick from a choice of a few models.That is why adjustments must be made to compensate for the dissimilar features and other factors that could make a tremendous difference in the market value.

  • Age and condition of properties must be considered; 
  • The time between date of sale and date of the appraisal and which economic changes occurred between those dates if any; 
  • Location, since similar properties might differ in price from neighborhood to neighborhood; 
  • The Physical features, which includes lot size, landscaping, type and quality of construction, number and type of rooms, square feet of living space including amenities and upgrades with  floors, garages (size), kitchens, bathrooms (number), bedrooms (number),  fireplaces, pools, central air, etc. 
  • Terms and conditions of sale, such as if a property's seller was under duress or if a property was sold between relatives (at a discounted price).  

   The estimate of the market value of the appraised property should fall within the range formed by the adjusted sales prices of the comps.
  Another method used for appraisal is called the cost approach. This method can be used to estimate the value of properties that have been improved by one or more buildings.This approach uses separate estimates of value for the buildings and the land and taking into consideration the depreciation of the buildings. These estimates are usually added together to calculate the value of the entire property. In the cost approach the assumption is that the buyer will not pay more for an existing improved property than he would for a comparable lot and constructing a comparable building. This approached is often used when the property is one of a kind and not sold frequently and is not an income producing property. Examples for these types of properties are schools, churches. hospitals and government buildings.
The cost approach for real estate valuation involves five basic steps:

  • Estimate the value of the land as if it were vacant and available to be put to its highest and best use, using the sales comparison approach since land cannot be depreciated. 
  • Estimate the current cost of constructing the building(s) and site improvements. 
  • Estimate the amount of depreciation of the improvements resulting from deterioration, functional obsolescence or economic obsolescence. 
  • Deduct the depreciation from the estimated construction costs. 
  • Add the estimated value of the land to the depreciated cost of the building(s) and site improvements to determine the total property value.  

   The final method that's used for appraisal is called the Income Capitalization Approach. This third method of real estate valuation is based on the relationship between the rate of return of an investment and the net income that it produces. This method is mainly used for income producing properties like apartment complexes, office buildings and shopping centers. This method is straightforward when the property being evaluated can expect to have future income and expenses are steady and predictable.
   Appraisers will use these steps which helps with the direct  capitalization appraisal method:

  • The annual potential gross income must be evaluated; 
  • The effective gross income has to be taken into  into consideration as do vacancy and rent collection losses; 
  • The calculation of the annual operating expense deduction must be made to find the annual net operating income; 
  • The capitalization rate or rate of return is accomplished by estimating the price that a typical investor would pay for the income produced by that particular type and class of property;  
  • The property's value is found by applying the capitalization rate to the property's annual net operating income;  

   The GIM or Gross Income multiplier can be used to appraise some properties that are not purchased as income properties but could be rented out like one or two family homes. The GRM (Gross Rate Multiplier) method relates to the sales price of the property to the expected rental income. This method used for residential properties is the gross monthly income and for commercial and industrial properties, the gross annual income is used. Recent sales and rental figures can be used on three similar properties to establish a more accurate GIM.
   The importance of accurate real estate valuation is important to mortgage lenders, investors, insurers and buyers and sellers of real property. Appraisals are usually performed by Appraisers who are skilled professionals, Realtors especially should have a  basic understanding of the different methods of real estate valuation and will help them when  they are asked for a home market analysis which is very important in setting the value of a property. Although Realtors are not professional licensed Appraisers they need to know the basics to establish the home value for prospective sellers.

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