What is an Appraisal?
I want to start by explaining the basics of what an appraisal is and why we need them. An appraisal is an estimation of a home’s current fair market value based on similar, recently sold properties in the same area. Knowing the value of a home is important. It protects the buyer’s investment. No one wants to pay more for a property than what it is worth. Otherwise you’ve immediately got negative equity. In real estate investing that is the last thing a homeowner wants. Whenever a buyer is assuming a loan through a lender for the purchase of a home, they have to get an appraisal.
In order to understand how the appraisal process works, you must first understand what comparable sales or “comps” are. Comps are recently sold homes similar to the one that is being bought/sold in terms of the features on the home, lot size, location and condition. By using the comparison approach, licensed appraisers can determine an accurate number for the fair market value of the home.
Once a buyer and a seller have agreed on a purchase price and a contract has been signed, the lender will order the appraisal. Neither the buyer or the seller has a say in who will appraise the property. It must be an unbiased, neutral party to everyone. In most cases, the lender will hire a third-party appraisal management company (AMC). They will manage the appraisal process and order the appraisal for them. The appraiser will usually pull 3 comps. They will be somewhere within a mile of the home. They will have been sold in the last 90 days to get the most accurate valuation of the home.
What do Appraisers Base their Final Number Off of?
So what exactly are they looking at on the home that factors into the final estimated value? They look at items that are part of or permanently attached to the home. If you’re worried about a messy bedroom or dishes in the sink lowering that final number for you, you shouldn’t. They are concerned about physical characteristics like age, square footage, number of bedrooms and bathrooms. Also, lot size, location and condition of the home.
Techniques Used if there are no Comps Available
What if there are no comps in my area for the house that I am selling/buying? There are many techniques that appraisers can use in evaluating the homes FMV. They could use the cost approach and figure how much it would cost to start building the house from scratch. This includes cost of materials, labor, and builder’s profit. They could widen the search parameters. Even though the information won’t be as accurate to a home a half a mile to the subject house, it will still give the appraiser a general idea. Another option is looking up the assessed value of the home in the county assessors recorded documents. Every so often they will assess the home’s value for tax purposes. There are several other ways they can give an informed opinion on the value of the home without comps. But this should give you a general idea of some other techniques that are used.
Rent to Retirement Specific Appraisal Process
Now that we’ve discussed general practices of appraisals, I want to educate specifically on how Rent to Retirement handles our appraisals. Appraisal results can be very subjective and can vary from appraiser to appraiser, as again, there is no exact science on how to come up with the final number. Rent to Retirement wants to help their investors gain instant equity from purchasing investment properties so we try to price the homes a little below market value or right at. We do our research on the best markets to operate in so that we can set our investors and ourselves, up for success. Which brings me to my next point; low appraisals.
Low Appraisals and How to Handle Them
The vast majority of appraisals will come back right where we need them to be. Rent to Retirement has a pretty solid idea about where our investment properties should be priced at because we have been in these markets for a long time and sell hundreds of houses a year in these same locations. But let’s say we have a home listed on our website for $150,000.00 and the appraisal comes back at $145,000.00. It is not our policy to make the investor pay the difference of $5,000.00 in cash. There are several options that we like to offer in the case of a low appraisal. Because of a buyers due diligence period, the investor always has the right to back out of a contract based off of a low appraisal and still get their earnest deposit back.
If the appraisal is very low, we can always contest the results. Appraisers do several appraisals a day and it is possible that they made a mistake. Maybe they didn’t have updated accurate information as far as a new roof or an added on bedroom or they possibly put in the wrong square footage. We just need to make sure they were provided all information associated with getting the final market value number. If they have everything they need but the final number is not where we thought it should be, we can get a second opinion with another appraiser. If the number comes back and it is still lower than the sale price of the home, we can negotiate the price so that it makes sense for both the buyer and the seller.
“True” Market Value
Many times, appraisals come back at exactly the sale price number. This does not mean that there is not immediate equity in the home. This simply means that the appraiser wants you to know that the home is adequately priced. The appraised value might not necessarily be the “true” market value. There is no exact “method to the madness” when it comes to getting the fair market value of a home. But there are techniques that are used that can give appraisers an informed opinion on how much the home is worth. If good comps are ran before a home is listed, more than likely the appraisal will come out in your favor. But if it doesn’t, they can be challenged if proper information is provided.
So there ya have it! I hope this could give you a general idea from start to finish. If there was anything that I didn’t cover or that you wanted to know more on, please feel free to reach out to Rent To Retirement with any of your questions and we would be more than happy to answer them!