Although the appraisal report is primarily a lender’s tool, would-be buyers can get a lot of great intel from one. And, while a bank always sends their own appraiser out to a property, investors can also hire an appraiser. While the appraisal process and resulting reports are different for residential and commercial real estate, they are useful for the same reason: to make sure neither bank nor borrower pay more money than a property is worth.
What is an appraisal?
An appraisal is an unbiased professional opinion of a property’s value. The appraisal is one component of a lender’s due diligence on an asset. The lender assumes that the seller’s asking price is subjective to the point of wishful thinking, and the real estate agent’s listing is written to pique interest, not to be 100% truthful.
An appraiser evaluates a property using industry-standard methods and calculations. They also typically use one of a few standard reporting forms -- the most common for residential properties being the Uniform Residential Appraisal Report.
What is the purpose of an appraisal?
The core purpose of an appraisal is to determine an asset’s worth in the current market before offe. Two key questions it answers: the amount can it sell for and its actual worth.
These two questions may seem repetitive, but they often have two different answers: one in commercial real estate, when a property’s current use may not be the same as its highest and best use; and in a competitive housing market, when buyers might be so driven to outbid each other that they lose sight of the property’s actual value.
For an investor, an appraisal report can be the reality check that’s needed, midway through the process, to remind everyone of an asset’s true value, and let investors reassess their business plan and their offer based on the valuation.
What is an appraisal report?
An appraisal report is the written report based on the appraiser’s inspection of the property. It specifies what the bank should be willing to loan for someone to purchase the property and why. There are a few different appraisal methods used to calculate value:
- Sales comparison approach: By far the most common for residential properties, this evaluates the property against multiple comparable properties recently sold in the neighborhood. This is by far the most popular method for a home appraisal.
- Cost approach: In this method, the value of real property is determined by what it would cost to rebuild if the building were destroyed or to build an equivalent structure. This is used for new construction properties as well as luxury properties and unique properties.
- Income approach: This is how commercial properties are appraised. It reveals the amount the property can be sold for as well as how much income it can generate. The income approach entails more calculations and projections and therefore is a more time-consuming appraisal process than simply calculating comp sales.
What’s in a residential appraisal report?
The report has a property description page that covers the essentials of the house: exterior description, foundation, materials used in the interior, and the condition. Some of these fields are multiple choice, and others are fill-in-the-blank sections where the appraiser puts their own impressions based on visual inspection. The report also has a page for scoring the neighborhood. Very relevant in the post-COVID-19 era, there’s a section for self-reporting on how the appraiser reached their conclusions. It used to be expected they would do so in person, but this is (perhaps temporarily?) no longer the case.
A sales comparison report contains a section comparing the property with comparable homes or comparable properties that have recently sold in the area. It has several criteria to directly compare, including Quality of Construction, Number of Bedrooms/Bathrooms, and Actual Age. As you can see, some of these criteria are fact-based (e.g., Actual Age) and some are more reliant on the appraiser’s professional expertise. Then there are categories like Number of Bedrooms, in which some surprises might turn up, like a third bedroom that was advertised in the listing turning out to actually be an unpermitted garage conversion.
How can an investor use a home appraisal report?
There are four main factors that a home appraiser looks at to determine a property’s value. Two of them, square footage (specifically living space) and condition, might contain significantly different information in the appraisal report than was in the listing. This can potentially matter a lot to an investor--beginning with any major discrepancies between listing value and appraisal value.
Say that you, an investor, plan on buying a duplex with two 1,100-square-foot units, that’s listed as “Move-in ready! Just bring your toothbrush!” and your plan is to live in one side and rent out the other. An appraisal report evaluates the duplex as only 900 square feet per unit, and spots some unpermitted work. This could significantly change the property’s appeal, even beyond its monetary value, which goes down due to the diminished livable space. Unpermitted work means a lot of potential headache for a new owner to bring up to code. It means potentially doing the work over. It means negotiating with city building inspectors for weeks. It definitely doesn’t mean “Move right in, get some tenants, earn fast money.”
What happens when total appraised value differs significantly from asking price?
If it’s a bit lower, this could be good for the potential buyer -- but a significantly low appraisal might be tied to a major issue the appraiser discovered in the home.
If the appraised value is higher, this could provide leverage for the seller to increase their asking price to the higher amount.
Either way, though, the next steps are clear for both sides: Contact the lender to request a copy of the report, read it through to understand, and, most likely, get a second appraisal. A buyer can get their own independent appraiser and, in fact, can get one prior to making an official offer, although most don’t take the step until the lender sends in their appraiser.
The appraisal report is worth a second look
Although sellers generally dislike the appraisal process for obvious reasons, investors have much reason to like it -- and the more conservative the appraiser is, the better. While certain criteria, especially the view and the cosmetic upgrades, can carry a different emotional price tag than a bank would assess, many other elements of a home’s value actually have a dollar value. It’s the appraiser’s job to notice things that escape most people’s scrutiny and to put those things into the appraisal report.