Appraisal: What It Is and How Is It Calculated?

Strictly speaking, the definition of Market Value is what a willing buyer would pay a willing seller for a particular property. To ensure the accuracy and reasonableness of a particular transaction. lenders typically require an independant appraiser to render an opinion on market value.When you're buying or selling a home, understanding the appraisal process is crucial. An appraisal determines the fair market value of a property, ensuring that the purchase price aligns with its worth.

The process begins with the appraiser both inspecting the subject property and doing some data analysis of similar homes (comparable properties) in the neighborhood.The best candidates for these comparable homes are to be as similar in size, bed and bath count, amenities, condition, quality of construction, lot size, and location, and to have sold recently, to reflect current market trends. The most reliable method appraisers use to accurately determine market value is the Sales Comparison Approach. While no two properties are the same, this method attempts to adjust for differences.

1. The Sales Comparison Approach (SCA)

The Sales Comparison Approach (SCA) is a widely used method in real estate appraisals. Here’s how it works:

1. Objective: The SCA compares the subject property (the one being appraised) to recently sold properties (comparables) in the same area. This is the Science part.
2. Characteristics Considered:
3. Location and Neighborhood: Proximity to schools, parks, highways, and pollution levels impact value.
4. Recently Sold Listings: Baseline numbers for property values.
5. Features: Bedrooms, bathrooms, garages, square footage, and lot size.
6. Price per square foot.
7. Age and Condition: Similar age and soundness.
8. Upgrades and Improvements: Properties of similar style and condition.
9. Determining Value: By comparing these characteristics, appraisers make value adjustments based on all these nuances to arrive at a value for the subject property. This is the art portion of the equation.

2. The Market Value Approach

1. Market Value: This approach estimates a property’s value based on recent sales data from similar properties. It takes into consideration trends in the location for the subject property. While much of this approach overlaps with the Sales Comparison Approach, the two dove-tail to provide as accurate a conclusion as possible.
2. Active Market Requirement: The approach assumes an active market for comparable properties. It considers properties listed for sale to get a feel for the future trends in the neighborhood.
3. Comparable Sales Data: Appraisers collect data on recently sold homes with similar features (bedrooms, bathrooms, square footage, etc.).
4. Adjustments: Appraisers make adjustments to account for differences between the subject property and comparables (e.g., if the subject property has an extra bedroom).
5. Final Valuation: The adjusted values of comparables help determine the market value of the subject property.

3. Mortgage Lenders and Appraisers

1. Independence: To avoid conflicts of interest, mortgage lenders cannot directly communicate with appraisers.
2. Third-Party Appraisal Management Companies (AMCs): Lenders engage AMCs to select appraisers. This ensures independence.
3. No Influence on Valuation: Lenders cannot pressure appraisers to hit a specific value. Appraisers remain impartial.

Since the mortgage lender is going to base the maximum loan amount upon the lesser of the contract purchase price and the appraisal, the appraisal is a key element to financing.An accurate appraisal protects the lender from lending more than the value of the property warrants, thus creating undue risk exposure. It also protects the overexuberant buyer from paying far more than a property is worth.