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Although appraisals conducted on the same house on the same day can range depending on the available market data (e.g., $300,000-$320,000), the conclusion of any particular appraiser must be an adequately supported opinion, not just any old opinion. The method of gathering evidence to support this opinion is a well-defined and rigorous process when undertaken properly. To obtain a residential appraiser’s license you need thousands of hours of education and experience in addition to passing the licensing exam.
THE ART OF APPRAISALS
How developed is the area in terms of municipal infrastructure as well as housing units and retail? How long does it take to get to the nearest convenient store? Are the stores upscale? Are the sidewalks paved? Are there traffic signals? These are important considerations for homebuyers and an overly enthusiastic developer can get too far ahead of necessary infrastructure. So the pace of growth is a factor.
Appraisers are required to opine on not just the current state of market values but also the direction of the market. Are property values increasing, stable or decreasing? This is important as lenders determine their risk and loan products based on their confidence in the market.
Market direction is heavily influences by the housing supply versus the demand for housing. So, the appraiser is required to state where there is housing shortage, a housing surplus or a balance in the market. Excess supply equals falling prices. Excess demand equals appreciation because the supply of housing relative to the demands dictates how long the property will sit on the market before it sells. The longer the time on the market the more likely sellers will entertain price reductions. The appraiser must note, therefor the average time on market.
The feel of the neighborhood plays a role in buying decisions. Is the property in a conforming neighborhood of residential property or are homes mixed in with commercial buildings? Is there ready access to freeways and employment centers? Is Ontario Mills close by or any landmarks that make the neighborhood desirable?
The analysis of comparable properties that have recently sold (Comps) is the cornerstone of the residential appraisal process. The use of this sales approach in an appraisal goes beyond a comparative market analysis (CMA) undertaken by a realtor. A CMA is a useful way of determining an appropriate sales price by quickly comparing similar properties that have recently sold in the area but is more of “rough estimate” approach.
Distance – Comps should be located within approximately a one-mile radius of the subject property. Guidelines such as the one-mile radius rule should not, however, be followed mechanically. They are intended to provide accepted standards for the appraiser to follow but do not eliminate the need for further analysis. Every property within a one-mile radius is not a viable comp. Neighborhoods can change dramatically over the course of a few blocks. Housing tracts in new developments can vary greatly; two homes within a one-mile of each other but in different housing tracts might not be comparable at all. The one-mile radius guideline simply reflects the fact that beyond a mile one can expect the neighborhood to change enough that the relevance of the comp is undermined. If nothing comparable to the subject property has sold recently within a mile it is sometimes acceptable for an appraiser to look beyond a mile to find sales. The appraiser should proceed with caution in looking beyond a mile and hold the potential comps to a higher standard.
Age – Typically, Comps should not have sold more than six months prior to the date of the appraisal. Again this is a guideline that should not be followed blindly but should inform the overall analysis. If for example, an appraiser is analyzing comps in a rapidly declining area, sales that are six months old may no longer reflect the current state of the market. In this case, it might not be advisable for the appraiser to go back more than two or three months. In instances where the change in pricing is at such a rapid rate the appraiser might have to consult active sales (properties on the market that are for sale) and/or pending sales (properties in escrow) to really get a read on current market value.
DEFINITION OF VALUE
The determination of market value is the heart of the appraisal. So what exactly does market value mean? The appraisal tells is in pretty uncertain terms that by market value it means:
The most probable price which a property should bring in a competitive open market under all conditions requisite to a fair sale, the buyer and seller, each acting prudently, knowledgably assuming the price is not affected by undue stimulus…under conditions whereby: (1) buyer and seller are typically motivates; (2) both parties are well informed or well advised, and each acting in what he or she considers his or her own best interest; (3) a reasonable time is allowed for exposure in 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.
If all of the conditions above are met, the appraised value will often equal the purchase price. But, that number routinely never matches. This definition gives some clues as to how that might happen.
A “competitive and open” market is an economist’s way of saying that anyone that is potentially interests in buying the property is made aware of the sale and given the opportunity to make an offer (whether they avail themselves of this property or not). One of the most time-tested methods of ensuring a competitive and open market is the auction style sale where a sale date is announced in a paper of general circulation and interested parties are invited to come and bid. For this reason, court ordered sales or sales of government property are sold auction style to ensure that market value is achieved. If few potential buyers are aware of a sale (because a property is poorly marketed by not being listed on a multiple listing service for example) it is possible that a deal could be struck below market value. Even if a property is exposed to the maximum number of potential buyers, the seller might not receive market value for the property if seller accepts the first offer presented. For personal reasons, the seller might be more interested in a fast sale than the highest price.
“Motivated” means money motivated; it means the seller motivated to maximize the sales price and a buyer motivated to minimize the sales price. Life sometimes intervenes with normal economic incentives and in these times profit is no longer the priority. Contentious divorce, ailing parent, gambling habit are all life pressures that can affect the seller’s willingness to hold out for maximum market value.
The purpose of value adjustment is to put a dollar figure on the remaining differences between the subject property and the comps once the nest comps have been found. Adjustments are based upon whether the market data indicates that buyer assign value to a particular difference. Here’s what that means:
Subject property has a 6000 square foot lot and the comps 6500 square foot lot—a difference of 500 square feet. The inclination is to think that figuring out the price per square foot of the land in the area and multiply that price by 500 to arrive at the necessary adjustment. That is not quite what appraisers do. Instead appraisers use the local sales data to try to determine whether there is any evidence that buyers are willing to pay more for a house with a 6500 square foot lot versus a 6000 square foot lot. If there is no such evidence, the appraiser might not make an adjustment at all for the difference in square footage.
Bedroom/Bathroom Count – although the addition of an extra bedroom typically adds value to the house, the additional value is not always the same. For example, for many buyers the difference between a 2 bedroom house and a 3 bedroom house is more significant (i.e., more valuable) than the difference between a 3 bedroom house and a 4 bedroom house. A third bedroom is often perceived to be a necessity for a growing family. A fourth bedroom tends to fall more into the category of luxury space, but not a necessity. Similarly, where two bathrooms might be a must, a third bathroom might add little to no value. Whether the additional bedroom will increase the value of the house at last as much or more than the cost of the bedroom will depend on several factors. Was the additional bedroom created by adding square footage to the house or was it the result of the reconfiguration of existing space? Additional square footage typically ads more value unless the house is overbuilt for the area. Was the additional bedroom a master bedroom or a guest rom? Master bedrooms are more valuable.
Upgrades – A common question is whether upgrades to the house will increase the sales price—the granite in the kitchen, hardwood floors, the steam shower. There will never be a dollar fro dollar correspondence between money spent on upgrades and an increase in purchase price if any. The impact on value, again, will depend on the buying preferences. For example, let’s assume a home is located in the number one school district in the sate and the price per square foot for the area is extremely high because buyers are willing to pay a premium for the school district. Well, installing hardwood floors in the family room of a house in this area might have absolutely no impact on the value. In the final analysis, the answer will always boil down to how much more buyers in that market will pay for certain features.
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