Property Appraisals
You’ve made it through inspections! Now comes the appraisal. This can be a challenging time for buyers and even sellers. Often times, uneducated participants in a transaction do not see the need for an appraisal. I’ve heard the following phrase in one form or another so many times: “If I want to buy this house for $500,000, then I should be able to.” or “The market price is whatever someone is willing to buy it for, so what’s the need for an appraisal?”. While these types of remarks are common, they are significantly misguided, specifically by many real estate agents in the industry. In addition to this, many homeowners (and even some uneducated agents) use Zillow’s notorious “Zestimate” as a value tool for their property. While this is a great feature to try to automate, the appraisal process is not even close to simple enough to accomplish this task accurately. Although the algorithms used by Zillow are somewhat accurate to determine market conditions, there are far too many variables that cannot be identified without evaluating the subject property (i.e., physical deterioration, functional obsolescence, external obsolescence, etc.). The true value of the “Zestimate” should be specifically used to determine baseline guidance on whether an area is appreciating or depreciating (and on a less confident level the actual percentage of appreciation/depreciation based on market conditions).
When dealing with mortgage loans in order to obtain a home, the unfortunate reality is that buyers are using, in large part, someone else’s money (or an institutions money) to purchase a home. Furthermore, buyers in the United States typically have significantly less than 50% equity upon purchasing a home. This means that the mortgage lender has more skin in the game than the actual buyer. If the home is destroyed, condemned, or even overpriced, then the mortgage lender would take the biggest hit upon resale or foreclosure. Therefore, an appraisal is an unbiased way of conducting business in real estate to ensure a sound investment and allow mortgage lenders to comfortably move forward with lending transactions. In summation, the appraiser is not there to benefit the buyer or the seller. They are strictly hired by the mortgage lender to unbiasedly determine market value (i.e., what the typical buyer would pay for a given property).
Depending on the property at hand, there are three common methods to determining market value.
· Sales Approach: By far the most common of the three, this method analyzes the property at hand (the subject) and cross references it with previous sales with similar location and specs. This can be looked at as a much more detailed and robust CMA that a knowledgeable real estate agent could put together.
· Cost Approach: This approach uses the costs of materials and labor associated with building a home and cross references that with the specs of a subject property. Land value would then be evaluated separately. This approach is typically used for newer builds in purchase transactions and determining insurance premiums.
· Income Approach: This approach uses rental data of the subject and the market area to determine the value of a property. Exclusively used for rental properties.
Let’s fast forward. You, the buyer, have received the appraisal report back on the home of your dreams. It’s the last hurdle of getting your loan approved, but the appraisal came in $10,000 short of the contracted purchase price. Now what? Unfortunately, there are only a few options, and none are very ideal. The mortgage lender will not finance the difference. Therefore, either the seller, the buyer (most common), or a combination of the two will have to cover the difference. If the appraisal comes in over the contracted purchase price, then that is great news for everyone (especially the buyer)! This means the loan will not get held up for the buyers and they will have instant theoretical equity above and beyond their down payment! On the other side, the sellers will get paid what they want and be able to close on time as well!
While I hope the above was helpful, it is by no means a solve all for appraisal issues. We are here to help you from start to finish in the home buying process. Give us a call today with any questions.
