Understanding an Appraisal
The first thing that comes to mind when the topic of an appraisal comes up is value. Value is the foundation of our business, whether in purchases or refinances. It is important to remember that an appraisal is only as good as the logic behind it. Just looking at the appraiser’s conclusion on value without looking at the whole “picture” may lead to some very risky errors. The following is a brief outline of how to read an appraisal and analyze the facts.
(1) The first thing to ask is how much of the logic leading to the value conclusion is on display? If the answer is none, the appraisal is useless. If the answer is that there are some gaps in the logic, you have to decide whether or not to accept that degree of uncertainty. Ideally, the answer is very little.
(2) Next, take into consideration what is being appraised. Is it a home, a commercial building, a parcel of land? What are the basic specifications? Where is it located? Is it urban or rural? How desirable is the surrounding area? What is the functionality? What does the current zoning allow?
(3) Study the photos of the subject property and compare them to the photos of the various comparable properties. Are the comps in the same general condition as the subject property? Are they in the same general “class” as the subject property?
(4) The effective date of the value given is important, especially in today’s market. How current is the appraisal? General rule of thumb is the appraisal should be no more than 90 days old.
(5) Here is something that is often missed. The “subject to” items associated with the value. This will be indicated by checking a box that indicates the value is subject to certain additions, improvements, or modifications. Lenders do not like “subject to” on an appraisal, so address this immediately.
(6) Extraordinary assumptions made by the appraiser. The problem with most extraordinary assumptions is that they are indeed extraordinary. If a parcel of bare land is zoned rural agricultural, and an extraordinary assumption states that “The zoning will be changed to allow multi-unit residential at 8 units per acre.” … well, not good. Even if some serious local zoning change is in the works, the chances that they will come through and turn this property into gold are very unlikely.
(7) What method was utilized for valuing the subject property? A market sales comparison approach is normally the most reliable and should be the primary method. True value in a market economy is the amount that others are willing to pay for it, and the attempt to estimate market value by looking at recent sales is the safest approach we have that goes to the heart of the matter. Cost approach and an income approach are best used in commercial and income producing properties.
There is a great deal more that can be said about reading an appraisal. This just gives you a few things that you will not want to overlook.