A home appraisal is an impartial written estimate of the fair market value of a home or other property (condominium, commercial property, vacant land). Appraisals are based on the real estate appraiser’s analysis of recent sales prices of similar properties in the area (called comps), as well as the property’s location, size, and physical condition.
Interested in becoming a real estate appraiser yourself? Click here to read our article on how to get licensed.
What Is A Home Appraisal Used For?
Here are two common uses of an appraisal:
1. Purchase or Sale Transactions
The most common time an appraisal is used is for the purchase or sale of a property.
2. Mortgage Loan Process or Refinancing
All lenders order a home appraisal during the mortgage loan process so that there is an objective and unbiased way to assess the home’s market value. This helps ensure that the amount of money requested by the borrower to purchase the home is appropriate.
Generally speaking, a lender will not lend more than the appraised value of the home since the property serves as collateral for the loan. The appraised value is used to determine common loan ratios that factor into the loan approval process, such as loan-to-value (LTV).
How Do Real Estate Appraisers Come up With a Value for a Property?
There are many different ways that real estate appraisers come up with values for properties. The approach chosen by the real estate appraiser will generally differ depending on the type of property they’re appraising.
Here are the three most common methods appraisers use to value a property.
1. The Cost Approach
The cost approach to appraising real estate uses the cost to replace or rebuild the home, minus the physical deterioration of the property to come up with a value for a home. The cost approach is used for insurance reasons, commercial property, or new construction properties.
Since the cost approach relies on the value of vacant land to value a home, it is rarely used for residential real estate. After all, there are generally few vacant lots available in most neighborhoods to compare to come up with a value for the land. It also ignores the fact that many residential homes have historic value which is hard to quantify.
2. The Sales Comparison Approach
The sales comparison approach looks at properties of similar size, quality, and location that have recently sold in the area. Variations in the property are factored into the valuation by adding or subtracting amounts based on such factors as number of bathrooms, lot size, and more.
Since it values homes based on the pricing of similar, recently sold homes in the same neighborhood, the sales comparison approach is used most frequently for residential real estate. When your lender orders an appraisal for a home you’re trying to purchase, chances are the real estate appraiser will use the sales comparison approach to value the home.
3. The Income Approach
The income approach estimates the value of a property based on the net operating income it produces, divided by the capitalization rate, or cap rate for short. The cap rate is used to help real estate investors evaluate rental properties for sale. It tells them what percentage of the sales price they will get as a return from the investment every year.
For example, if a building has a 10% cap rate, that means an investor will essentially get back 10% of the building’s value every year. That they will have recouped their entire investment in 10 years. If the cap rate is 5%, it means they will only get back 5% of the value and can expect to recoup their investment in 20 years.
How Real Estate Appraisers Use the Income Approach to Value Commercial Properties
Once a real estate appraiser has come up with the net income for a commercial property, they then divide the net income by the capitalization rate. The capitalization rate is the ratio of the net operating income of a commercial property divided by the property’s current market value. For example, let’s say you purchase a commercial property for $500,000. After deducting operating expenses, let’s say this building will bring you an net income of $50,000 per year.
If we divide the next income by the sales price we get 0.1. Since the cap rate is expressed in a percentage, we move the decimal over and end up with a cap rate of 10%.
Is an Appraisal an Accurate Value of a Home?
An appraisal is not the definitive fair market value of a home. The fair market value of a property is the price that a willing and knowledgeable buyer would pay to a willing and knowledgeable seller. This also assumes both parties are acting voluntarily and in their own best interests. Appraisals can be very accurate or downright faulty, depending on the competence and experience of the real estate appraiser.
According to the Appraisal Institute, an association of professional real estate real estate appraisers, a qualified real estate appraiser must be licensed or certified as required in all 50 states through the Department of Commerce. Also, according to Federal regulations, all real estate appraisers must be impartial and have no direct or indirect interest in the transaction.
What Do Real Estate Appraisers Look for to Determine Home Values?
The important factors in determining a property’s value are your home’s physical characteristics (location, lot size, square footage, number of bedrooms and baths, age, view, etc.) as well as its observable condition. Real estate appraisers focus on the condition of what’s permanently part of (or attached to) the house, not the furniture, decor, or anything that’s not permanently affixed to the property.
Usually, during an inspection for an appraisal, real estate appraisers will measure the property to find out the true square footage. They will also take notes concerning features such as number of bedrooms, baths, and room layout. They will also try to determine the general condition, appeal, and functional layout of the house. These items are all taken into consideration in the appraisal report. Here are the important items that will be noted:
- Location of the home
- Size of the home and property
- General condition and age of the home
- Features of the home (i.e., 4 bedrooms, 3 baths, etc.)
- Remodeled rooms, additions, and other major structural improvements
- Architectural features, such as skylights and fireplaces
If you’d like to get a sense of what a home appraisal looks like, check out this uniform residential appraisal report from Freddie Mac.
How Much Does a Home Appraisal Cost?
The average cost for a home appraisal in the United States is around $300—$400. This price can vary based on the size of the home, the region.
Who Pays for the Home Appraisal?
Generally speaking the home appraisal is paid for by the buyer. The fee for the home appraisal is added to the closing costs which are paid at the closing. However, just because the buyer is paying for the real estate appraiser does not mean they represent their interests. Quite the contrary. Real estate appraisers are generally hired by and represent the interests of the lender.
How Long Does an Appraisal Take?
A home appraisal takes anywhere from two to seven days. It usually includes these three steps:
- Visiting the house to measure it and check its overall condition
- Checking the neighborhood and the MLS for previous sales of comparable homes (known as comps)
- Creating a report, justifying the home’s value based on the research of previously sold comparable homes, their in-person assessment, and other market conditions.
The physical inspection of a property doesn’t take that long. The home visit usually take between 15-20 minutes unless the property is difficult to measure or there are unique features that warrant more investigation. The real estate appraiser will usually take photos to document the condition of the home or unique features of the property.
Finally, the home appraisal report is made, incorporating all the findings from the actual home visit and the research from recent sales of comparable homes in and around the neighborhood.
The Bottom Line
A real estate appraisal is ideally an objective, unbiased written estimate of a property’s fair market value. This estimate comes from an in person inspection by a licensed real estate appraiser, as well as research of comparable homes that have sold recently.
It’s a helpful decision-making tool used to inform buyers on how much to pay; sellers on how much to charge; lenders on how much to lend; and tax authorities on how much to collect. A real estate appraisal is a way to quantify the quality and value of real property.