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A home purchase is the largest, single investment most people will ever make. Whether it's a primary residence, a second vacation home or an investment, the purchase of real property is a complex financial transaction that requires multiple parties to pull it all off.
Most of the people involved are very familiar. The Realtor is the most common face of the transaction. The mortgage company provides the financial capital necessary to fund the transaction. The title company ensures that all aspects of the transaction are completed and that a clear title passes from the seller to the buyer.
So who makes sure the value of the property is in line with the amount being paid? There are too many people exposed in the real estate process to let such a transaction proceed without ensuring that the value of the property is commensurate with the amount being paid.
This is where the appraisal comes in. An appraisal is an unbiased estimate of what a buyer might expect to pay - or a seller receives - for a parcel of real estate, where both buyer and seller are informed parties. To be an informed party, most people turn to a licensed, certified, professional appraiser to provide them with the most accurate estimate of the true value of their property.
It all starts with the inspection (after some initial research). An appraiser's duty is to inspect the property being appraised to ascertain the true condition of that property. He or she must actually see features, such as the number of bedrooms, bathrooms, the location, and so on, to ensure that they really exist and are in the condition a reasonable buyer would expect them to be. The inspection often includes a sketch of the property and taking pictures, ensuring the proper square footage and conveying the layout of the property. Most importantly, the appraiser looks for any obvious features - or defects - that would affect the value of the house in either direction.
Once the site has been inspected, an appraiser uses up to three approaches to determining the value of real property: a cost approach, a sales comparison and, in the case of a rental property, an income approach.
The cost approach is the easiest to understand. The appraiser uses information on local building costs, labor rates and other factors to determine how much it would cost to construct a property similar to the one being appraised.
This is the most common type of method used. We look at recent similar sales in the same neighborhood. The more identical to the subject the better. In this approach it is very important for the appraiser to know the area, and use true comparables. A single family detached home could not be compared to a townhouse for example. Apples and oranges. Older sales are also avoided since the market changes and prices go up and down.
We research recent sales in the vicinity and finds properties which are ''comparable'' to the subject being appraised. The sales prices of these properties are used as a basis to begin the sales comparison approach.
Using knowledge of the value of certain items such as square footage, bedrooms, quality and condition of the property (just to name a few), the appraiser adjusts the comparable properties to more accurately portray the subject property. For example, if the comparable property has a Central AC and the subject does not, the appraiser may deduct the value of a fireplace from the sales price of the comparable home. If the subject property has an extra bedroom and the comparable does not, the appraiser might add a certain amount to the comparable property.
The Income Approach
In the case of income producing properties - rental houses for example - the appraiser may use a third approach to valuing the property. In this case, the amount of income the property produces is used to arrive at the current value of those revenues over the foreseeable future. This method is not often used.
Combining information from all approaches, the appraiser is then ready to form an opinion of the market value for the subject property. It is important to note that while this amount is probably the best indication of what a property is worth, it may not be the final sales price. There are always mitigating factors such as seller motivation, urgency or ''bidding wars'' that may adjust the final price up or down. But the appraised value is often used as a guideline for lenders who don't want to loan a buyer more money than the property is actually worth. The bottom line is: an appraiser will help you get the most accurate property value, so you can make the most informed real estate decisions.
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