Real estate appraisals are complicated - but necessary to buy a house

One of the most confusing aspects of buying and selling a home is the appraisal.

When an appraiser delivers a market-value estimate to the lender, it can either make or break the deal. If a home doesn't appraise for the purchase price, people often have to renegotiate the deal to secure a mortgage loan. That is why it is so important for buyers and sellers - and their real estate agents - to understand how an appraiser estimates a home's value.

Although appraisers base all determinations on information from the local real-estate market, even they admit that their decision is ultimately an opinion, an experienced opinion, Missoula appraisers say.

"An appraisal is an interpretation of market behaviors," says residential real estate appraiser Steven Hall. "If there is a good consistency in the market - quantity and quality of data."

After 26 years in the business, that's the opinion of Hall, a certified general member of the Appraisal Institute (MAI CCIM Appraiser), and an owner of Hall-Widdoss & Co. PC Real Estate Appraisers and Consultants.

Tom Stevens of MAI says, "(Lenders) trust dealing with you for a period of time. You have proven that you have been right a majority of the time, over a period of time, the majority of the time." Stevens leads Stevens & Co., A Real Estate Appraising & Consulting Group. He is a senior residential appraiser who has been appraising property in Missoula since 1978.

He is quick to say, however, that it is not the appraisers who determine market value of homes and other property.

Who does establish the value? Buyers and sellers in the current market establish value. And market value is what banks or mortgage companies are most interested in. Lenders order a market-value appraisal, as assurance that if a borrower defaults on a mortgage, the home has enough value for the lender will recover the loss.

Michele Turner, consumer loan officer at First Security Bank of Missoula, explains that the lending institution hires and pays the appraiser, and is reimbursed by the borrower through a fee paid at closing. The lender owns the appraisal, but the borrower is entitled to a copy and signs a form stating "this report was made solely for the lender's benefit," acknowledging that they received a copy.

Now to the tricky part: How does an appraiser estimate that value? Appraisers don't just pull numbers out of a hat. Appraisers estimate value the same way - through the cost approach and sales-comparison approach.

Both approaches begin with an on-site inspection of the home to determine its size and overall condition. When the inspection is through, the appraiser goes back to the office to see how the house measures up under both appraisa1 methods.

The first method - the cost approach - begins with an estimated value of the land under a house. The cost of building the house is added on, and depreciation (such as required maintenance) of the home is subtracted. Then the depreciated cost of such items as fencing and landscaping is added.

The sales comparison, or market approach, involves comparing the home with similar properties sold in the same neighborhood in the past year. Because Montana law does not allow public access to all real estate transfer documents, Stevens says the Missoula County Association of Realtors Multiple Listing Service and local home builders are an appraiser's best source of information.

But no two houses are a1ike, making it impossible to compare apples to apples. Appraisers must make adjustments to the comparable homes' values to make that equal to the subject home's value.

If the home being appraised has a garage and the comparable home does not, the appraiser must add the value of the garage to the comparable home's value. That same adding and subtracting would be done for every extra feature of the subject home until both properties are equal. How does an appraiser know how much every feature is worth? Every adjustment is market-derived. It is how much a buyer is willing to pay for an extra. The appraiser's experience indicates what buyers will pay because of all the information gathered from the MLS on the three to six comparable sales.

It's not subjective experience. It takes many years and stacks of MLS figures to know how the market reacts.

All appraisers will agree that the most difficult part of appraisals is developing adjustments to the comparable sales. Once the adjustments are made, an appraiser can determine a value range, keeping within a 5 percent to 10 percent bracket.

Once the value range is estimated, the only task remaining is to reconcile that sales-comparison value with the cost-approach value to determine the most probable price that the property should bring in the current market. With that final figure, the appraisal report is sent to the lender.

Hall and Stevens agree that it's the high-end custom homes that throw appraisers a curve because there are no directly comparable homes to use in the MLS database. Stevens explains, "Generally those homes have such distinct features that the data for comparative analysis are very scarce."

He says that applies to lower-priced homes as well, with homes under $150,000 and above $350,000 making up only one half of 1 percent of the Missoula real estate marketplace.

Stevens says one of the toughest appraisals he ever did involved converting a University Area home to a private residence once again. There simply were no comparable sales for such an enormous project, he says. His adjustment grids comprised a half-inch thick folder of documents for the lender.

For newly built custom-home appraisals, Stevens often turns to builders, who he says are very open and understand the appraiser's need for reliable data. Then the cost approach can be used to determine the home's value more accurately. Then you add the cost of the land on which the home was built.

Hall explains that when determining the value of raw land, "The only thing you can do about land is the sales comparison approach."

He says there are basic questions to ask. Is there water frontage; are there utilities existing on the property or how close are they; what is the size?

"It falls back on how much data is available for you," he continues. "You can bracket. Find a site that is comparable for you. You can't do a cost approach or income approach. You can only do a value and exchange."

Another thing residential appraisers are sometimes asked to do is appraise property for homeowners for reasons other than buying or selling a home. Though it doesn't happen often, Hall says, in cases of litigation outside of a recognized lender, in cases of divorce or estate planning, he will get called.

"Sometimes people just want an unbiased, outside, third-party opinion," he says.

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