Appraisal methods, the how and why?

<<>> There are quite a few appraisal methods taught to appraisers. Most of them are never used, because once they are applied to the real world, they just don't work. More and more home owners are trying to figure these things out because they just got their appraisal back and they are disappointed about their home value. This article will go over the major ways and explain what's most important when determining home value.

There are three basic appraisal methods appraisers will use to determine your home value. The cost approach, the sales comparison approach and the income approach. For most residential homes, the only two approaches that appraisers use is the cost approach and the sales comparison approach.

And as it turns out, the cost approach is used just as a basic guide to use for the underwriters and the appraiser just to make sure that the value is at least somewhere in the ball park. Let me explain.

Sales comparison approach to value

Most of the value of your home will be determines by one approach. The sales comparison approach to value. This is when an appraiser will look at your home and find other home sales that have occurred in your market area and that are the most similar to your home. Next, the appraiser will confirm these sales by looking in public record information and MLS and they will transfer this data to an appraisal form. From here, they will look at the amenities and make minor adjustments until they conclude to the value of your home.

Cost approach to value

Next they will complete the cost approach to value. Now in this approach, the appraiser will look in a little book that will tell them what is will cost per square foot to build your home. Most builders know that this is one of the least accurate ways to bid on a job, so it is not very accurate. Next, they will determine the value of the land by finding comparable sales in your market area. From this they will derive a value to build your home and subtract depreciation. From these calculations they will get another value from the cost approach.

Looking at both values

Now you have two values. One from the sales comparison approach to value and the other from the cost approach. The sales comparison approach to value will always be given most of the emphases when determining the value. This is because the market is telling the reader what the home is worth and this is the best indication of value in almost every case.

For newer homes

If it is a newer home, the cost approach to value should be pretty close to the sales comparison approach to value, but not always. In a downward market, you'll be able to buy a home for less money than it may cost to build. The cost approach to value is less accurate because of the basic method that the value is determined.

The income approach to value

The income approach to value is when the appraiser looks at rentals in the area and determines a value based on the ratio of what the home sold for and what the home rents for. This will give them a number that is used to determine the value of the property. In almost all cases, this number is becomes less and less accurate based on the available rentals in the area. This is because single family homes are usually not used for rentals and the rentals are losing money every month, so they will not reflect the value of the home.

Here is how it is determined. The larger the pool of rentals in the area, the more accurate this will be. The appraiser will collect homes that are similar to the subject and that are rented. From this data they will take the sales price of several homes. The more homes that the appraiser has that are like the subject, the better probability that the income approach to value will be of use. Once they get this number, they'll use the following formula.

Sales price = GRM= gross rent multiplier. Gross rents

Lets say the appraiser found five sales and similar rental and the numbers look like this.

Sales price Gross rents GRM 125,000 750 166.66 120,000 650 184.62 135,000 685 197.08 142,000 700 202.86 115,000 750 153.33

The GRM will be picked by looking at the most similar properties to the subject. Sometimes these numbers my be averaged together if the homes are all really similar. But in most cases, you'll have a few of the rentals that are most like the subject.

Once the GRM is found, the appraiser will use the market rent of the subject and the GRM to determine the value of the subject. If the market rent is determine to be 700 and the most similar GRM is 185 then the value is 700 x 185 = 129,500. This method is, usually, never used when appraising single family homes. So of the three appraisal methods, the sales comparison approach is the most used method that is used to determine home value.

Best way to pick comps for newly built homes

When a development is just beginning and there are no real comparable sales, the appraiser will rely heavily on the overall quality, square footage and lot size of the home and any other major amenities that will determine the value. Since there are no close comparable sales, the appraiser will select comparable sales and listing that are usually 1 to 3 miles from the subject that offer newer homes with similar quality and amenities to the subject. From this data, they will write an appraisal. This is how the value of the first homes in the development get their value. From this point, the next appraisers will use the sales in the immediate market area to determine the market value. Once there are enough sales, banks will use other computer valuation methods to determine the home values.

The how and why

Many appraisal methods really come down to questions. How, why, and the availability of comparable sales. An owner called me today and thought that there appraisal value was too low. As it turns out, this appraisal was completed over a year ago. I told her if she has better comparable sales, go ahead and email them to me and I'll take a look at the sales.

I reviewed the comparable sales that the “Realtor friend” gave to her. Here's what I found. She selected what she thought were comparable sales, but in fact she just selected a range of sales in the area regardless of the square footage and averaged all of them together to come up with a value. If you do any sort of statistics or appraising, you can quickly see why this is the incorrect method. Here are the two issues.

The Realtor did not select recent sales. When markets are declining or increasing, it is important to select recent sales and this is the best data to determine today's value. The Realtor selected non-comparable sales. If your realtor is picking comparable sales that are 1000 square foot larger than your home when there are better sales with similar square footage, your realtor is doing you a disfavor.

Now back to my questions. How did the comparable sales get selected? They must be selected based on square footage, design and appeal, bed room count, and recent sales first. If your home offers something really unique, like water frontage, this may be the exception.

The next question is why did the appraiser or Realtor pick the comparable sales. If I complete a comp search and find that there are better sales than what the Realtor used, I'll have to ask the question, “why did the Realtor use these sales? Or Why did the realtor ignore the better sales? Or Why did the realtor use non-comparable homes and average them together to bring the home value upward?

Do you want to learn more about appraisal methods when determining land value.

You are welcome to link to any of my articles. Please provide a live link. Please do not copy my articles word for word and put them on your site. Thank you.