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The appraisal process is an orderly and concise method of reaching an estimate of value. The process has six major steps which include: definition of the problem, preliminary survey and appraisal plan, data collection and analysis, application of the three approaches to value, reconciliation's of value indications, final estimate of defined value. This process assists the appraiser in reaching a sound conclusion. The major phase of this process involves the application of the three approaches to value which include the Market Data Approach, the Cost Approach and Income Approach. The three approaches are reconciled and the value via most applicable approach, in the opinion of the appraiser, is selected as the final estimate of value. In most residential appraisals, particularly those of single or two family dwellings, the direct sales comparison or market approach best reflects the actions of buyers and sellers and is the most convincing and defendable approach to value.
An arms length transaction is one in which both seller and purchaser act completely independently of each other and have no connection or relationship to each other.
Typically, highest & best use means the use or utilization that provides the most profitable return on investment. It is that use, selected from reasonably probable and legal alternative uses, which are found to be physically possible, appropriately supported and financially feasible to result in the highest possible land value.
Market value or fair market value is the most probable price that a property should bring (will sell for) in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller, each acting prudently, knowledgeably and assuming the price is not affected by undue stimulus. Implicit in this definition is the consummation of a sale as of a specified date and the passing of title from seller to buyer under conditions whereby: (1) buyer and seller are typically motivated; (2) both parties are well informed or well advised; (3) a reasonable time is allowed for exposure to the open market; (4) payment is made in terms of cash in U.S. dollars or in terms of financial arrangements comparable thereto; and (5) the price represents the normal consideration for the property sold unaffected by special or creative financing or sales concessions granted by anyone associated with the sale.
The appraiser does not create value, the appraiser interprets the market to arrive at a value estimate. As the appraiser compiles data pertinent to a report, consideration must be given to the site and amenities as well as the physical condition of the property. An appraiser may spend only a short time inspecting the property, however, this is only the beginning.
Considerable research and collection of general and specific data must be accomplished before the appraiser can arrive at a final opinion of value. Due to the many types of value, such as Fair Market Value, Insurance Value, Tax Value and Value In Use, the need to precisely define the purpose of the appraisal is essential
An appraisal is an opinion of value or the act or process of estimating value. This opinion or estimate is derived by using three common approaches, all derived from the market. They are:
The cost approach combines an estimate of land value with an estimate of depreciated reproduction or replacement cost of the improvements. The principle of substitution is the basis of the cost approach, in that no rational person will pay more for a property than the amount for which he can obtain, by purchase of a site and construction of a building, with undue delay, a property of equal desirability and utility.
A comparable sale is a property, that is similar to the subject property in most respects, is located in a similar (nearby) location, and has sold recently at arms length. The selection of comparable sales is in most residential appraisals, the single most important determining factor in establishing value. It is the appraisers responsibility to adequately research the local real estate market and determine which comparable sales best represent the value characteristics of the subject property.
The market or direct sales comparison approach to an estimate of value is a process of comparing market data, that is, prices paid for similar properties, prices asked by owners, and offers made by prospective purchasers or tenants willing to buy or lease. Typically a comparison grid is used and adjustments are made to each of the comparable sales used for major differences between the comparable and the subject property for such items as location, gross living or building area, lot size, condition/effective age, market conditions, degree of remodeling, construction quality and significant amenities, i.e.: fireplace, Jacuzzi, in ground pool, garage, deck, patio, porch and central air conditioning etc. In the market approach, the appraiser attempts to both gauge and reflect the anticipated reaction by a typical purchaser to the subject property.
The income approach to value is of primary importance in ascertaining the value of income producing properties and has little weight in residential type properties. This approach provides an objective estimate of what a prudent investor would pay based upon the net income the property produces.
There are many reasons to obtain an appraisal. The most common reason is for Real Estate and Mortgage Transactions, but we have compiled a list of other reasons you may need to order an appraisal:
In the real world, very few individuals order appraisal reports to establish an offering price or to substantiate a purchase price. At the point that an offer to purchase (in a typical residential transaction) is made, the price has been set by other parties, not the purchaser. The price has been determined by the seller, who wishes to obtain the highest price possible, or the agent, who receives a percentage of the price as compensation and often represents the seller in the transaction.
The real estate agent will typically perform a comparative market analysis (CMA). The appraisal laws in most states allow real estate agents to perform CMAs without an appraiser's license or certification. A CMA is a necessary part of the agent's preparation for a listing and consists of examining sales of properties in the area to arrive at a listing price. The reliability of the CMA depends upon the agent's experience and the characteristics of the property. The agent will suggest a selling price to the seller based upon the analysis. However, neither the seller nor the agent are bound by the results of the analysis, and the agent is not required to follow any formal procedure in completing the CMA. If a seller wishes to list the property at a price higher than the price suggested by the agent, then the agent may be forced to accept the listing at that price or risk losing a commission.
Usually, individuals applying for a loan are only interested in obtaining the loan and unfortunately are not worried about the prudence of buying the property at the agreed price. In fact, many purchasers will try to encourage appraisers to increase the appraised value so that they can purchase the home regardless of its value.
The majority of real estate appraisals are requested by mortgage companies to validate the property's purchase price for loan purposes. Except for periods of very low interest rates when everyone is refinancing, most loans are for the purchase of real estate and ordered after a sale price is negotiated. Purchasers mistakenly assume that mortgage companies are looking after their interests in the purchase transaction.
The law states that if the mortgage company orders the appraisal, the appraiser is responsible only to the mortgage company. We expect mortgage companies to be prudent and they should be, but being prudent is protecting their interest, not necessarily the purchaser's. The mortgage company's position:
Because much private, corporate, and public wealth lies in real estate, the determination of its value is essential to the economic well-being of society. It is the job of the professional appraiser to determine these values by gathering, analyzing, and applying information pertinent to a property.
Unquestionably, the professional opinion of the appraiser, backed by extensive training and knowledge, influences the decisions of people who own, manage, sell, purchase, invest in, and lend money on the security of real estate. And because the appraiser is trained to be an impartial third party in the lending process, this professional serves as a vital "check in the system," protecting real estate buyers from overpaying for property as well as lenders from over lending to buyers.
Most States requires all real estate appraisers to be, at a minimum, state licensed or state certified and have fulfilled rigorous education and experience requirements and must adhere to strict industry standards and a professional code of ethics as promulgated by the Appraisal Foundation. Check with your state for minimum requirements.
For legal advice, please call your own attorney. Law's vary from state to state and each case is different. This is general information only.