Real estate appraisal is an integral part of the home buying and selling process. Appraisals are required for any home sale that requires a mortgage and is more common than you may think.
What Is a Real Estate Appraisal?
Definition: A real estate appraisal is an estimation of the market value of a home by a licensed appraiser that is hired by the mortgage lender.
Example: After deciding they wanted to buy the house, Mr. and Mrs. Smith went to the bank to get a loan. The bank is making an investment and therefore pays for an appraiser to ensure the value of the home. The appraiser does an evaluation of the outside and inside of the home in order to fully estimate the value.
What Is the Purpose of a Real Estate Appraisal?
There are a lot of reasons for a real estate appraisal, but they are all doing it for one reason: to determine the market value of the home.
Appraisers provide insight into the value of the home for buyers, sellers, lenders, lawyers, accountants, etc. Many people rely on these reports to make good business decisions.
Appraisals for a Mortgage
This is the most conventional type of appraisal and is generally used by banks to ensure that the home you are getting is a good deal. The bank is investing in your home and therefore wants its investment to be secure.
If not done properly, the bank could end up losing a lot of money if you were to foreclose. Basically, they don’t want you to be the only one determining if you are getting a good deal.
Here are some examples:
Mr. Smith has decided that he wants to move into a specific house valued at $250,000 and makes a down payment of $50,000. He goes to a mortgage lender who sends an appraiser out to the property. He values the house at $250,000; therefore, so they are willing to issue the mortgage. Mr. Smith stops making his payments, so the mortgage lender acquires the house. They sell the house for $250,000 and don’t lose any money.
Alternatively, if they had not sent the appraiser out to the property, the house could be worth anything. After Mr. Smith stops making payments, the mortgage lender acquires the house. Uh oh, it turns out that Mr. Smith overpaid on the house, and now the lender can only sell the house for $150,000 and loses money.
Lenders of any kind are always really careful with where they spend their money. An appraiser is a way for them to mitigate risk.
Appraisals for Estate Valuation
Sometimes home buyers seek an appraisal to evaluate the value of an estate for the purposes of inheritance or divorce. In order to properly split up assets, the value of those assets must first be valued.
Here is an example:
Rachel and Ian had their father pass away recently. He owned two homes, one in California and one in Ohio. Rachel and Ian’s father stated in his will that he wanted his property split 50/50. Rachel likes the house in California, and Ian likes the home in Ohio, so their initial thought was just to each take a house. Ian’s wife asked him to get an appraisal on both of the houses and found out that the home in California was worth three times as much as the house in Ohio. Now that they have an appraisal, they know that each of them taking a house would not be respecting their father’s wishes.
These types of appraisals are fairly common and are recommended by many lawyers during the process of fulfilling a will or completing a divorce.
Appraisals for Business Purposes
This is a pretty broad category. Businesses rely on real estate appraisals to conduct all sorts of business activities. Appraisals are required when businesses are negotiating mergers, leases, and acquisitions. They also use appraisals to determine the value of their assets if they deal with properties as their normal mode of business.
Appraisals are required whenever a property is sold, mortgaged, taxed, insured, or even improved upon. Businesses love to keep tabs on exactly where all their money is, and appraisals are a way to do that. If a business owns several properties but has no idea what those properties are worth, then it can be hard to judge how much the company is worth as a whole.
Who Can Perform Real Estate Appraisals?
Real estate appraisals are performed by an appraiser that is not associated with the lender. The appraiser is intended to be unbiased when it comes to the property, and should not be connected financially or otherwise to any party.
In order to become an appraiser, you must meet several qualifications. The Appraisal Qualifications Board is the organization that determines what the minimum requirements are to become a real estate appraiser. These guidelines can be found here: The Real Property Appraiser Qualification Criteria
Real Estate Appraisers Are Not Perfect
Many people have the false assumption that what the real estate appraiser says is final, which is not always true. Although they are really good at their job, sometimes they miss something that could influence the market value of the property. Many buyers and sellers choose to get a second opinion if the results of the first appraiser were undesirable.
The profession of real estate appraiser is an interesting one. Something that sets it apart is the difficulty to get in. The United States has an excess of real estate appraisers, and because of this, the field is full of older workers. It is fairly common to see real estate appraisers that are in their 60’s and even their 70’s. The people that are doing this have a pretty standard way of doing things and have been doing this for a long time.
An Appraisal Is an Opinion
Although backed by evidence, a real estate appraisal is an opinion on what your home is worth. There are so many factors that go into this. For example, let’s say that two houses that were sold in the area both had extensive improvements that resulted in a higher sale price. That higher sale price could influence the appraisal because “similar” homes in the area were sold for much more than your home is worth. Although this isn’t going to happen every time, it can influence things. There are hundreds of factors that appraisers use in their analysis, and they could easily miss something.
Although paid for by the buyer, generally, the appraiser’s work is usually owned by the bank that called for it. They can choose who that appraiser is going to be shared with. Many people decide to contract out their own appraiser before going to any bank, and that way they can accurately judge the worth of their own home as well as show it to possible buyers in necessary.
What Influences a Real Estate Appraisal?
There are a lot of factors that influence an appraisers estimation of market value, but we are going to get into the main factors:
This seems like a really obvious one, but there is a lot more to this than just if the neighborhood is nice. This includes if the property has good access to well-rated schools, hospitals, grocery stores, local crime rates, and much more.
Sometimes the location has a huge influence on home prices, but sometimes other factors matter more. Generally, this type of research is done by the appraiser before even visiting the home.
Put simply, if a home is made out of nice material it is worth more.
The appraiser is going to pay attention to what type of wood, insulation, paint, etc. that your house is made of. The more modern the material, the higher the value of the home.
A great example of this is the kitchen. If the kitchen has a lot of really nice materials like granite, tile, and expensive custom cabinets, the home is going to have greater value.
Age of Home and Renovations
Typically the older the home is the lower the value is going to be. A lot of the things that come with age will be covered in the real estate inspection. The appraiser will know if the age of the home is influencing the value in any way. Renovations that are fairly recent will obviously improve the value of the home.
Style and Layout
This is the hardest to quantify in terms of value, but the appraiser is required to be familiar with your area and will know what style of home is popular. Some styles were popular in decades past, but have fallen out of style since then. Those types of homes are not as valuable as homes with a more popular style. If you are lucky, the style of your home is once again popular and will have a higher value.
This is pretty broad, but also very obvious. Many real estate agents will advertise how much square footage a home has, but in reality, the home only has a small amount of usable square footage and a lot of storage space.
Number of Bedrooms and Bathrooms
A lot of buyers are looking for a specific number of bedrooms and bathrooms or even just a minimum amount of both. Having more is generally better.
Having a good ratio is also important. Wouldn’t want ten bedrooms with only one bathroom, right?
People love places to store their stuff, so having storage space on hand is great. Storage space could include an unfinished basement, closets, a storage shed, and garage.
Having a garage that can store two cars plus some extra work space has a lot of value.
The Market and Comparable Homes
This is a really big one, mostly because it helps the appraiser understand the specific market. The specific market that your home belongs to is going to have its own value for different things, so the appraiser is going to look for comparable homes within a half-mile of yours that have sold recently. This will help him/her determine what your home will go for on the market because other homes have sold for that price.
This type of research could indicate that homes with a pool(or some other amenity that you have) have a lot higher value in your area than in other parts of the city or town.
What Is a Real Estate Inspection?
Real estate inspections are not real estate appraisals, but they are very interconnected.
Definition: A real estate inspection is performed to understand the current condition of a home. The inspector looks for things such as water damage, pest infestations, roof conditions, and a lot more. This inspection is used by the appraiser to determine the current value of the home.
Example: Mr. Smith was selling his home, and was showing it to potential buyers. The buyers decided to purchase the home, but before signing any papers, the real estate inspector went to inspect the home and discovered the presence of a mild termite infestation that dropped the value of the home. After some renegotiation, the buyer still decided to go through with buying the home but for a reduced price.
What’s the Difference Between a Real Estate Inspection and a Real Estate Appraisal?
A real estate inspection and real estate appraisal are very similar, but both have different goals in mind.
A real estate appraiser’s goal is to determine the market value of the home, while a real estate inspector’s goal is to discover any issues or problems on the property. A lot of the appraiser’s work can be done without looking at your home by researching other homes that have been sold in the area, while an inspector must visit the property to determine anything.
Generally, the inspection will happen first so that the appraiser can take a look at the results. If any problems are discovered during inspection, the appraiser will take that into account when determining the market value of the property.
Difference in Process
A real estate inspector will come to your home and normally ask the homeowner to accompany them. The purpose of this is so that you can know the reasoning behind any items in their report. A lot of things that they look for are not going to be obvious to the average person, so they want to be sure you understand. They will typically take 2-3 hours to investigate your entire home.
An appraiser may or may not ask you to show them around the home, but they have no real reason to. They know exactly what they are looking for, and if they do their job right there shouldn’t be any surprises when you get the report. The appraiser could take anywhere from a half-hour in your home to over 2 hours, depending on the size of your property.
Simply put, the real estate inspector is going to look for problems in each part of your home, while the appraiser is going to look at the value of everything.
Things a Real Estate Inspector Looks For
The real estate inspector will look a lot deeper than the appraiser will.
Here is a list of things that they are required to look at according to the American Society of Home inspectors:
- Insulation (if visible)
- Structural Components
- Electrical Systems
That is a lot of things to check, but they know what they are looking for. They are not going to take a sledgehammer to your walls to check the wiring, but they will do their best to check whatever they have access to.