What is an appraisal

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A home purchase is typically the largest investment most people will ever make.  Whether it's a primary residence, a second home or investment property, the purchase of real estate is a complex financial transaction that requires multiple parties to complete.

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 an informed buyer might expect to pay, and an informed seller might expect to receive for the real estate involved in the transaction.  To be an informed party, most people turn to a licensed real estate appraiser whose job is to provide them with the most accurate estimate of the true value of the property.

The Inspection
So what goes into a real estate appraisal?  One of the first steps is the inspection.  The appraiser inspects the property being appraised to ascertain the true status of that property.  The appraiser notes the number of bedrooms and bathrooms and prepares a sketch of the property to ensure the proper square footage.  The appraiser takes notes on the subject's quality of construction, its condition and its features that an informed buyer would be willing to pay for.

Once the property has been inspected, the appraiser uses one, two or all three of the following approaches to determe the value of the property: the cost approach, the sales comparison approach, and in the case of a rental property, the income approach.

Cost 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 value often sets the upper limit on what a property would sell for.  Why would you pay more for an existing property if you could spend less and build a brand new home instead?  While there may be mitigating factors, such as location and amenities, these are usually not reflected in the cost approach.

Sales Comparison
Instead, appraisers rely on the sales comparison approach to value these types of items. Appraisers get to know the neighborhoods in which they work.  They understand the value of certain features to the residents of that area.  They know the traffic patterns, the school zones, the busy throughways; and they use this information to determine which attributes of a property will make a difference in the value.  Then, the appraiser researches 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, extra bathrooms, hardwood floors, fireplaces or view lots (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 fireplace 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 half-bathroom and the comparable does not, the appraiser might add a certain amount to the comparable property.

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.

Reconciliation
Combining information from the applicable approaches, the appraiser is then ready to stipulate an estimated 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.