What Is a Property Appraisal
A real estate appraisal is an important tool used by investors and lenders to ensure that the buyer is not paying too much when buying a bank owned home. It is an independent, unbiased, neutral third party opinion prepared by a licensed real estate appraiser.
A home appraisal is completed to determine the market value of a piece of property. The market value is the most likely price a buyer and seller would agree upon as long as there is no extra motivation (such as a foreclosure) and no creative financing (such as a property exchange).
Different Types of Real Estate Appraisals and Property Valuations
Not all property evaluations are the same and there are many misconceptions about them. Here are the main types of property valuations that would affect a bank owned home (REO) or foreclosure purchase:
Broker’s Price Opinion (BPO)
This is not prepared by a licensed real estate appraiser. This home value estimate has been prepared by a licensed real estate broker or agent. Though a real estate agent may be familiar with his or her market, they have not received the extensive training in property valuation. A BPO is good for determining the listing price of a home but cannot be used in obtaining bank financing. Many times this is a free report provided by real estate agents.
Automatic Valuation Model (AVM)
This is not prepared by a licensed real estate appraiser. An AVM is a property value estimation based on a mathematical formula using a database of property information. There is no property inspection and thus the computer has no idea on the specific condition or features of the bank owned property. Its purpose is to provide a general idea of the going house values in the same neighborhood.
Online Free Home Appraisals
There are plenty of online sites that offer property valuations. These valuations are similar to AVMs and are often based on old and irrelevant data or even listing prices rather than sales prices. These sites can give a general idea of what a property is worth but should not be relied upon in making a purchase decision.
Real Estate Appraisal
This is prepared by a licensed real estate appraiser. It is usually includes all three approaches to property valuation: the cost, sales comparison and the income approaches. This is the most comprehensive and most accurate appraisal method and the one relied up by lenders.
What is included in a Bank Owned Home Appraisal?
A complete appraisal will include a detailed description of the property including the legal description, lot size, size and construction of the buildings along with pictures. The appraiser will do a basic check of county records to confirm the legal description, ownership and sales history.
The REO home appraisal process includes using all three methods of valuation:
This determines the value of the property based on the cost of construction (less depreciation) plus the value of the land. This method is the most accurate on new construction and may not be used on older properties.
Sales Comparison Approach
This approach is based on sales of recent properties that are similar in size, location and condition to the property being appraised. Adjustments are made to each comparable based on the differences between the subject property and the comparable sale. For example, if the subject property has 3 bedrooms but the comparable sale only has 2 bedrooms, the appraiser will increase the value of the sale according to the local rate for a bedroom.
The appraiser will analyze the income and expenses of the property. The annual net income is turned into a market value by applying a typical rate of return demanded by investors. Often this is not completed on single family residential properties.
How to Order a Home Appraisal
Typically a home appraisal value is required if the buyer will be obtaining bank financing. Federal guidelines require that the lender order the appraisal. This helps to make sure that the appraiser has not received pressure from either the seller or the buyer to “hit” a certain value.
Who Pays for the Home Appraisal? the Buyer or the Bank?
Though the lender orders the appraisal and will use the appraisal as a basis for their loan decision, it is the buyer who pays for the appraisal. A home appraisal costs around $300 to $600 depending on the type of property and will be part of the closing costs.
Improving my Home Appraisal
If a seller wants to help complete the purchase, there are a few things they can do to help the appraiser:
Remodel and renovate properly
Not all improvements add equal value. Finishing the basement will not add as much value per square foot as converting an attic. Though converting the garage into a recreation center may seem like a good idea, it could have a negative effect on value. Before starting a project, it may be a good idea to talk to an appraiser first.
Provide proof of improvements
Tell the appraiser about any recent renovation projects or new features. If possible, even give them copies of how much you spent on the improvements.
Talk about recent sales
Appraisers rely heavily upon sales in the Multiple Listing Service (MLS). If you know of a recent comparable sale you would like them to consider, mention it to the appraiser, especially if it wasn’t a listed sale.
What Happens if the Appraisal Comes in Too Low?
First, do not jump to the conclusion that the appraiser is wrong. The appraiser has been hired to provide their professional opinion of value. They are not emotionally involved in the transaction nor are they motivated to close the deal. Here are a few reasons why the appraisal may be low:
The market is moving too fast
In some very active markets, prices are appreciating rapidly. Though the appraiser knows exactly what is happening, their appraisal must be based on past sales, not active listings. Lenders do not want to see an adjustment for price appreciation – they fear it may cause overvaluation if the market drops. Thus, the lender has tied the hands of the appraiser and is forcing the buyer to fund the market appreciation rather than making the lender finance it. In this case, you will need to settle on a lower price or bring more money to closing.
Seller considerations affect market value
There are a lot of creative financing options out there. The appraiser must determine the market value without any creative financing such as seller considerations, wrapped in closing costs or owner financing.
The home is overpriced
Both the sellers and the buyers hate to hear about this, but at times it is true. Just because the seller and the buyer have agreed to a price does not necessarily mean that is the market value. An appraiser steps away from the transaction details and states the average price of the property.
Bank owned home appraisals are an important part of the lending process. Do not look at the appraiser as your enemy but rather as an added protection to completing a successful transaction.