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Valuation Methods

Appraisers use three different methods to value residential properties: the market value approach, the replacement cost approach and, for investment properties, the income approach. Using these three different methods, an appraiser frequently comes up with slightly different values for the property. Using judgment and experience, the appraiser reconciles the difference and assigns a final appraised value.

The market value approach is the most important valuation method in appraisal because a property is worth only what a buyer is willing to pay and a seller is willing to accept. The market value is based on the actual sales prices of nearby similar homes that sold recently. These are known as comparable sales.

Appraisal reports are very detailed. (See Appendix (i for copies of the Fannie Mae/Freddie Mac forms.) For the property being appraised (the subject property in appraisal terminology), they include:

• General information – Legal description, title restrictions (if any), real estate taxes, and zoning information

• Site description – Lot size and shape, availability of public utilities, improvements such as sidewalks, curbs and gutters, and streetlights

• Neighborhood analysis – Includes population density (urban, suburban, rural), development growth and other changes, price stability (rising, falling, or stable), availability of public amenities (schools, shopping, transportation, recreation, police and fire protection, employment), and nearby land use (single-family homes, apartments, commercial)

• Home description – Size, design, construction materials, number and type of rooms, appliances, adequacy of heat- ing/cooling/plumbing, and overall quality of workmanship

• Other factors affecting value – Garage or carport, swimming pool, and other improvements

In addition, the appraiser must report on obvious construction problems such as leaking roofs, termite damage, dry rot, and exterior and interior damage that affect the salability of the property. If construction problems do exist, most lenders require that they be repaired prior to the sale or before the entire loan amount is fully disbursed. This is intended to protect the lender, but it also protects the buyer from problems that might not otherwise be recognized.

To value the property, the appraiser reviews the details of recent comparable home sales near the subject property. Those properties most similar to the subject property are used for comparison, detail by detail: size, date of sale, location, site, design, quality of construction, age, condition, heating and cooling, and other relevant improvements.

The appraiser adjusts the price of each comparable sale (up or down) depending on how it compares (better or worse) with the subject property. He or she then reconciles the different prices to determine the market value of the property.

As an additional check on the value of the property, the appraiser also estimates the replacement cost for the property. Replacement cost is determined by valuing a vacant lot and determining the cost to build a house of similar size and construction. Finally, he or she reduces this cost by an age factor to reflect deterioration and depreciation.

It is very common for the appraised value on a property to be exactly the same as the amount of your sales contract. This is not a coincidence, nor does it indicate malfeasance on the appraiser's part. Your sales contract is the most comparable sales transaction there is. It represents what a buyer is willing to offer for the subject property and what the seller is willing to accept. Only when the comparable sales differ greatly from your sales contract is the appraised value very different.

In the mid-1980s, appraisals caused problems for consumers in two ways. First, many appraisers were unable to keep up with the heavy workload that lower interest rates caused. Some had backlogs as long as two months, delaying loan approvals. Second, in some areas of the country where home prices were rising rapidly, appraised values were lower than asking prices. In the early 1990s, low appraisal values often caused problems for homeowners who wished to refinance. This often occurred when the homeowner had used maximum financing (e.g., 95-percent LTV) to acquire the property and the value of the property had not appreciated enough to refinance (most lenders will not refinance a home for more than 90-percent LTV). It also occurred in situations where the value of the property dropped since the time the property was acquired, or was last refinanced. If you are purchasing a home and the appraised value comes in lower than the purchase price, you may have to increase your down payment to qualify for the mortgage. Ask your real estate agent for advice on local appraisal conditions.

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