What is an Appraisal?

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Traditional Purchase Appraisal - A home purchase is the largest, single investment most people will ever make.  Whether it's a primary residence, a second vacation home or an investment, the purchase of real property is a complex financial transaction that requires multiple parties to pull it all off.

Most of the people involved are very familiar.  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.

So who makes sure the value of the property is in line with the amount being paid? There are too many people exposed in the real estate process to let such a transaction proceed without ensuring that the value of the property is commensurate with the amount being paid.

This is where the appraisal comes in.  An appraisal is an unbiased estimate of what a buyer might expect to pay - or a seller receives - for a parcel of real estate, where both buyer and seller are informed parties. To be an informed party, most people turn to a licensed, certified, professional appraiser to provide them with the most accurate estimate of the true value of their property.

The Inspection
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. He or she must actually see features, such as the number of bedrooms, bathrooms, the location, and so on, to ensure that they really exist and are in the condition a reasonable buyer would expect them to be.  The inspection often includes a sketch of the property, ensuring the proper square footage and conveying 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 site has been inspected, an appraiser uses two or three approaches to determining the value of real property: a cost approach, a sales comparison and, in the case of a rental property, an income approach.

Cost Approach
The cost approach is the easiest to understand. The appraiser uses information on local building costs, labor rates and other factors to determine how much it would cost to construct 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 home instead?  While there may be mitigating factors, such as location and amenities, these are usually not reflected in the cost approach.

Sales Comparison
Instead, appraisers rely on the sales comparison approach to value these types of items. Appraisers get to know the neighborhoods in which they work.  They 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 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 view lots (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 valuing 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.

Reconciliation
Combining information from all approaches, the appraiser is then ready to stipulate 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.  But the appraised value is often used as a guideline for lenders who don't want to loan a buyer more money than the property is actually worth.  The bottom line is: an appraiser will help you get the most accurate property value, so you can make the most informed real estate decisions.

FHA Appraisals - An FHA loan is insured by the Federal Housing Administration, a federal agency within the U.S. Department of Housing and Urban Development (HUD). The FHA does not loan money to borrowers, rather, it provides lenders protection through mortgage insurance (MIP) in case the borrower defaults on his or her loan obligations. Available to all buyers, FHA loan programs are designed to help creditworthy low-income and moderate-income families who do not meet requirements for conventional loans. Remember, the FHA is different from the VA appraiser panel in that the lender can choose the appraiser.

FHA loan programs are particularly beneficial to those buyers with less available cash. The rates on FHA loans are generally market rates, while down payment requirements are lower than for conventional loans.

Relocation (ERC) Appraisal  - The Employee Relocation Council (ERC) Summary Appraisal Report is a form-style report that requires substantial narrative components and addenda to adequately address the clients' concerns and needs.  The form and guidelines for the relocation appraisal differ substantially from the traditional mortgage appraisal. 

Relocation versus Mortgage Appraisals - The typical mortgage appraisal uses the URAR, a two-page form that is a comprehensive analysis of the subject property's site and physical characteristics.  The relocation appraisal is completed on the ERC Summary Appraisal Report, a six-page report, which employs techniques similar to those used for the mortgage appraisal.  However, the appraiser must provide a much higher degree of analysis in the narrative portions to complete the form.

The mortgage appraisal's intended use is to assist the lender in evaluating a property for purposes of mortgage/bank loan underwriting.  The intended user of a mortgage appraisal is the client, generally a bank or mortgage company.  The intended use of the relocation appraisal is to help an employer facilitate the employee relocation process.  The intended users of the relocation appraisal are the appraiser's client (relocation management company) and the employer.  Although the report often is shared with the transferee, he or she is not an intended user.

The mortgage appraisal is used to develop an opinion of the market value of a property.  The relocation appraisal is used to develop an opinion of the anticipated sales price of a relocating employee's residence.  The primary differences between the appraisals are the marketing period, financing considerations, and the type of analysis (forecasting).

The mortgage appraisal's definition of market value states a "reasonable time is allowed for exposure in the open market."  This opinion of value is without limit.  For example, the property's marketing time could be under 30 days, or it could be over two years, of which the latter would not affect the property's final opinion of market value.  The relocation appraisal's definition of anticipated sales price requires the appraiser to consider a "'reasonable' marketing period, not to exceed 120 days and commencing on the date of appraisal (inspection), is allowed for exposure in the open market. The analysis assumes an adequate effort to market the subject property." This means if a property's neighborhood or marketplace has typical marketing periods exceeding 120 days, the subject will need to be discounted through the forecasting adjustment.

The mortgage appraisal requires cash equivalency with adjustments to the comparables if there are special or creative financing or sales concessions, but not for costs, which are normally paid by sellers as a result of tradition or law in a market area.  The relocation appraisal requires the appraiser to reflect a cash equivalency price with adjustments to the sales prices of the comparables. Dollar adjustments should be made for concessions such as: seller-paid points, buyer's closing costs, interest rate buy downs, seller financing, or any other terms that influence the final sale price.  These adjustments are not necessarily dollar for dollar and should reflect the effect on the sales price resulting from the concession.

The mortgage appraisal considers a retrospective analysis, looking at historical data as of the date of sale (or inspection if the property did not sell) without employing forecasting. The relocation appraisal considers a prospective analysis, which employs a forecasting adjustment. According to the ERC Summary Appraisal Report, the definition of forecasting is: ..."the process of analyzing historical trends and current factors as a basis for anticipating market trends. A forecasting adjustment is then applied to reflect any impact these trends will have on the subject property's marketing time and sales price."

To arrive at a forecasting adjustment, the relocation appraisal provides extensive room for the appraiser to include narrative data on supply and demand and overall market conditions. Furthermore, the appraiser studies other factors such as absorption rates; current inventory levels in the region, immediate area, or price range; and current competition from new construction.

The mortgage appraisal uses a long-term decision-making analysis for the life of the mortgage loan, sometimes up to 30 years.  The risk generally is lower as lending institutions build a loan default ratio (foreclosure) into their loan portfolios.  The relocation appraisal provides short-term decision-making analysis, typically a marketing period of as many as 120 days. The risk is very high because an accurate value in their short-term investment is a must, especially if a home makes it into a company's inventory.  A corporate owner of a home typically is the most motivated seller in the marketplace.

The mortgage appraisal identifies categories for the subject's condition, design, and appeal. These are most commonly considered "average" and "typical" in mortgage appraising assignments unless there are significant concerns about the subject property.  The relocation appraisal emphasizes the following as critical items for consideration: condition, design, appeal, interior d├ęcor, and repairs/improvements.  Condition includes modernization, restoration, repairs, and necessary improvements, whereas appeal includes construction upgrades or deficiencies, as well as custom or personalized decorating.  The appraiser is asked to address all of these factors pertaining to the subject property in the relocation appraisal in a narrative format, as well as recommend repairs and improvements to enhance the property's marketability.  If there are concerns, the appraiser is asked to estimate a cost to cure and address and approximate the market's reaction in the sales comparison grid section of the report.

Perhaps the most obvious difference between the mortgage appraisal and the relocation appraisal is the use of comparables.  A "comparable" is a similar property that the appraiser compares to the subject property.  The mortgage appraisal requires three closed sales to compare to the subject.  A common underwriting guideline is that these sales should have closed within the past six months and cannot have closed more than 12 months prior to the appraisal.

The relocation appraisal asks the appraiser to consider closed sales without limitation. Often, the best sale to compare the subject property to is a home that is the same model, located on the same street, that closed longer than 13 months ago, and that was personally inspected by the appraiser who is using the comparable.

One of the easiest adjustments for an appraiser to make and support is a market change/time adjustment. Furthermore, the relocation appraisal encourages the use of pending sales that are under contract if the information can be verified. Such information often indicates the most current market conditions. Finally, the relocation appraisal compares competing sale properties to the subject property. Appraisers use the competing properties to develop a competitive list price for the subject property and consider such properties when developing the final opinion of the anticipated sales price.

The relocation appraiser is asked to take sufficient time during the inspection to counsel and impart confidence to the transferee and communicate credibility and professionalism. The appraiser is frequently the sole visible representative of the client to the relocating homeowner. The appraiser is asked to accept any information the transferee presents and comment on this information if not used in the report. Because of the sophistication of modern housing and the typical profile of a transferring homeowner's property, the inspection and counseling is more extensive than it has ever been, often requiring more than an hour.

The appraiser who accepts a relocation appraisal assignment must take the time to write a competent report, discuss that report with the client, and respond to questions from the client. The relocation process is unique to other appraisals in that two or more professional reports are completed on the same property. Requests for review of data reported in another report also are part of the relocation appraisal process. During this review, the appraiser may be asked to analyze additional information to determine if it could have an effect on the original value conclusion.