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Appraisal Basics
An appraisal of real estate is the valuation of
the rights of ownership. The appraiser must define the rights
he intends to appraise.
The appraiser does not create value; the
appraiser interprets the market to arrive at a value estimate.
As the appraiser compiles data pertinent to a report,
consideration must be given to the site and amenities as well
as the physical condition of the property. An appraiser may
spend only a short time inspecting the property, however, this
is only the beginning.
Considerable research and collection of general
and specific data must be accomplished before the appraiser
can arrive at a final opinion of value.
Due to the many types of value, such as Fair
Market Value, Insurance Value, Tax Value and Value In Use, the
need to precisely define the purpose of the appraisal is
essential.
Appraisal Methods
An appraisal is an opinion of value or the act
or process of estimating value. This opinion or estimate is
derived by using three common approaches, all derived from the
market. They are:
1.
Cost Approach
to value is what it would cost to replace or reproduce the
improvements as of the date of the appraisal, less the
Physical Deterioration, the Functional Obsolescence and the
Economic Obsolescence. The remainder is added to the Land
Value.
2.
Comparison Approach
to value makes use of other "bench mark" properties of similar
size, quality and location that have been recently sold. A
comparison is made to the subject property.
3.
Income Approach
to value is of primary importance in ascertaining the value of
income producing properties and has little weight in
residential type properties. This approach provides an
objective estimate of what a prudent investor would pay based
upon the net income the property produces.
Then, after thorough analysis of all general
and specific data gathered from the market, a final estimate
or opinion of value is correlated.
When to Order an Appraisal
There are many reasons to obtain an appraisal.
The most common reason is for Real Estate and Mortgage
Transactions, but we have compiled a list of other reasons you
may need to order an appraisal:
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To obtain
a loan.
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To lower
your tax burden.
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To
establish the replacement cost of insurance.
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To contest
high property taxes.
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To settle
an estate.
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To help
you make one of the largest financial decisions in your
life.
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To provide
a negotiating tool when purchasing real estate.
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To
determine a reasonable price when selling real estate.
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To protect
your rights in a condemnation case.
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To allow
you to obtain a qualified appraisal report.
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Because a
government agency such as the IRS requires it.
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You are
involved in a lawsuit.
Home's Market Value
In the real world, very few individuals order
appraisal reports to establish an offering price or to
substantiate a purchase price. At the point that an offer to
purchase (in a typical residential transaction) is made, the
price has been set by other parties, not the purchaser. The
price has been determined by the seller, who wishes to obtain
the highest price possible, or the agent, who receives a
percentage of the price as compensation and often represents
the seller in the transaction.
The real estate agent will typically perform a
comparative market analysis (CMA). The appraisal laws in most
states allow real estate agents to perform CMAs without an
appraiser's license or certification. A CMA is a necessary
part of the agent's preparation for a listing and consists of
examining sales of properties in the area to arrive at a
listing price. The reliability of the CMA depends upon the
agent's experience and the characteristics of the property.
The agent will suggest a selling price to the seller based
upon the analysis. However, neither the seller nor the agent
is bound by the results of the analysis, and the agent is not
required to follow any formal procedure in completing the CMA.
If a seller wishes to list the property at a price higher than
the price suggested by the agent, then the agent may be forced
to accept the listing at that price or risk losing a
commission.
Purchasers believe that they are getting a good
deal if they make an offer lower than the listed price. But
how far above the market value was the property listed? 10%,
15%, maybe even 20% above the fair market value? A negotiated
price of 10% less than the listed price on a property that was
listed at 20% above its value is not a bargain. The agent
cannot tell the purchaser that the offered price is higher
than the value, or even higher than their own CMA. In most
states, they must submit the offer to the seller.
The seller of a property may want to order an
appraisal before listing the property. Of course, the cost of
the appraisal is always a deterrent, especially if the seller
knows that a buyer will pay for it when applying for a loan.
But the appraisal is often justified. The seller could lose a
sale if the property appraised for less than the sale price
when appraised by the appraiser.
Appraisal To Obtain Loan
Usually, individuals applying for a loan are
only interested in obtaining the loan and unfortunately are
not worried about the prudence of buying the property at the
agreed price. In fact, many purchasers will try to encourage
appraisers to increase the appraised value so that they can
purchase the home regardless of its value.
The majority of real estate appraisals are
requested by mortgage companies to validate the property's
purchase price for loan purposes. Except for periods of very
low interest rates when everyone is refinancing, most loans
are for the purchase of real estate and ordered after a sale
price is negotiated. Purchasers mistakenly assume that
mortgage companies are looking after their interests in the
purchase transaction.
The law states that if the mortgage company
orders the appraisal, the appraiser is responsible only to the
mortgage company. We expect mortgage companies to be prudent
and they should be, but being prudent is protecting their
interest, not necessarily the purchaser's. The mortgage
company's position:
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It has two
sources of repayment: the purchaser's income and the
property.
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The
responsibility to repay the loan is not based upon the
property's value, so the purchaser is obligated to pay the
note even if the property value declines to zero.
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The loan
may be insured or guaranteed by a government agency.
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The
government does not promise to pay the purchaser's debt if
the property value is wrong.
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If the
loan is greater than 80% of the value, a portion of the loan
may be insured by a private mortgage insurer.
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There is
no decrease in risk for the purchaser regardless of the
loan-to-value ratio. The investment by the purchaser is the
same, a mixture of personal cash and a loan that must be
repaid.
Helping the Appraiser
Once you have selected an appraiser, be
prepared to answer questions and provide requested
information.
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What is
the purpose of the appraisal?
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When is
the required completion date of the appraisal?
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Is
property listed for sale and if so, for how much and with
whom?
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Is there a
mortgage? If so, with whom, when placed, for how much, type
of mortgage [FHA, VA etc.], interest rate, and any other
types of financing.
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What
personal property, such as appliances, is included?
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If it is
an income producing property, provide a breakdown of income
and expenses for the last year or two and a copy of leases.
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Provide a
copy of deed, survey, purchase agreement or other pertinent
papers pertaining to the property.
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Provide a
copy of current real estate tax bill, statement of special
assessments, balance owing and on what [sewer, water, etc.].
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