What Every Seller Needs to Know About the Home Appraisal Process

The home appraiser’s in your house.

You hear footsteps on your back stairs, see the lights flick on and off in the front entry. You sit in your living room with nervous hands, your foot taps the hardwood floorboard in your living room. The steps get closer, and the music from a classic 80s horror movie plays in your head. You turn around and try not to shout,

“What’s my home worth?”

The value of your home was predetermined months (or even years) before the appraiser ever set foot on your front porch.

Similar homes in your area, how much it costs to build in your location, and if your property is commercial and/or generates income all affect your home appraisal.

That’s not all, though. The ultimate number of your home’s value is based upon the opinion of your appraiser, which means that (thankfully) there are a few steps you can take to get a leg up in the home appraisal process.

We’re going to walk you through exactly how your appraiser figures out the value of your home and what you can do to make sure your home appraises at the top of its fair market value.

Why Do You Need a Top Market Value Appraisal?

You want your home to sell for top dollar–that’s a given. There’s a difference between how much a buyer is willing to pay for your home and how much the bank is willing to pay for, though. When you list your home and buyers bid on the price, the house could sell for one price and appraise for lower. You want to avoid that at all costs.

For example, let’s say a buyer puts an offer on your home at the national average home sale price for November 2016.

The buyer is willing to pay $234,900 on your list price of $240,000.

That’s great–you accept the offer and you think you’re all set to go, but then your home appraiser stops by. She appraises your home for $229,000–that’s a $5,900 difference.

Now, because the bank won’t loan more than the appraised value (in this case $229,000), the buyer is going to have to make up the difference. Some contracts have clauses that let buyers out of a deal where this happens because it means they’re a. paying way too much or b. can’t afford to pay the difference.

Suddenly, with a low appraisal, you’ve had your buyer back out of the sale.

You also could try and salvage the sale by paying the difference yourself as the seller but that’s cash right out of your pocket.

We’ve got the tips and tricks to keep you informed on all aspects of the appraisal process so that you don’t get faced with that problem.

Let’s start with the basics.

At what point does the home appraisal process actually happen?

The appraisal happens after the seller and buyer both sign the purchase agreement. That means that the seller has listed the house, the buyer has made an offer on it, and the seller either accepted the offer or finalized negotiations with the buyer.

The appraiser will spend anywhere from 15 minutes to 3 hours looking around depending on the size of the home.

What’s the difference between a home appraisal and a home inspection?

The home inspection is where a home inspector examines your house for safety. A home inspector will look for problems like mold, cracks in the foundation, termite damage, roof instability, and more.

During the appraisal, the appraiser assesses the value of your home.

A home appraiser uses three methods in combination to settle on the fair market value for your home.

You need to understand all of these methods and ensure that each one is working in your favor so that you aren’t stuck in a situation where your home appraises for less than the sale price you and your buyer agreed on.

woman crunches the numbers using a calculator during the home appraisal process
Source: (wutzkohphoto / Shutterstock)

Method 1: The Sales Comparison Method

(What is the fair market value of other homes in the area?)

This sales comparison method, which is also known by many as the “market data approach” is the most commonly used method by appraisers in determining what your home is worth. It is similar in nature to how an investment bank would determine company valuations in a market of sparse data.

Simply stated, this method involves analyzing 3 or 4 comparable properties that have recently sold (this is important!) in order to determine the value of your home.

In doing so, the appraiser may compare dozens of attributes, including but not limited to:

  • Location (down to the smallest surrounding area with statistically significant data)
  • Square footage
  • Property condition
  • Number of bedrooms and bathrooms
  • Interesting physical components (swimming pool, garages, guest house, etc.)
  • Recent market trends and sale prices
  • Other distinguishing characteristics (traffic exposure, proximity to freeways and schools, cul de sac, etc.)

For example: if you live in a condo, since most condos in the same building have similar square footage, floor plans, and amenities, using the sales comparison method will get you extremely close to the condo’s real value.

Single family homes on the other hand, however, provide a difficult challenge. Beyond newly built tract housing communities, most existing homes are not alike. As a result, the appraiser will need to use many of the variables in the sales comparison method but they’ll need to throw in a number of other considerations to really make an appropriate judgement.many of these variable to reach an appropriate comparable as well as some other methods we’ll discuss below.

In most cases, after they go through the process of comparing your home with your neighbors’ homes, the appraiser will use Fannie Mae’s Uniform Residential Appraisal Report to complete their comparable analysis.

Sections of this report include a detailed street map displaying both the home being considered as well as the comparables used, an explanation of square footage calculations, a sketch of the building exterior, and clear photographs of different angle inside and outside the home. Other useful data such as market trends, public land records and public tax records may be included as well.

What steps can you take?

Property condition is the main factor in your control here. Here are a few measures you can take to make sure your property shines on the day your home appraiser arrives.

Declutter everything

You might have gorgeous skinny molding in your closet that old shoe boxes cover or beadboard in the living room your bike rests up against. Make sure you remove excess clutter so that the appraiser notices the features of your home and not just the junk hiding them.

Clean like your mother-in-law is coming to visit

Vacuum and deep clean carpets if they need it, clear grime off of your windows and tile, scrub bathrooms and kitchens, wash all of your bedding and make the beds. Your house should feel as fresh and clean as a luxury hotel.

Mow the lawn

A freshly cut lawn gives your appraiser the first impression that your home is well maintained.

Air out the house

Make sure the house smells fresh and clean. You don’t want a bad odor to signal disrepair to your appraiser or make her miss key features because she ran out to avoid the stench of a week-old litter box.

Make small fixes

Noticed that the grout in your bathroom tile is disintegrating? The window doesn’t shut properly? Call in a handyman to make small fixes you’ve noticed over the years.

sunlight shines through open roof beams on new housing construction
Source: (Dakota Roos / Unsplash)

Method 2: The Cost Approach

(Would it cost more or less to build a new home with the same features from scratch?)

The cost approach method is a “bottoms-up” approach that attempts to assess your home’s worth utilizing the following formula:

(Cost of land) + (Cost of building on top of land) – (Depreciation) = Your House Value

This methodology is most often used in commercial or newly constructed property, but also may be employed as another data point by your appraiser. It’s typically less effective for older properties due to issues around accrued depreciation.

Let’s breakdown each of the formula components so we understand how an appraiser might assign value to each.

Cost of Land

The best way to assess empty lot (that is, land that hasn’t been built on) values is to use the sales comparison method. Typically, appraisers will assign this value based on their interpretations of the “best use” of this land (e.g., could it be used for rental properties, a beach side resort, or multi-story single family home).

In addition, similar to the sales comparison method, appraisers will measure a land’s worth based on comparable empty lots with similar zoning and usage requirements. Other considerations here when valuing the land itself are factors such as:

  • Usability of land (e.g., are there sloped hills or bodies of water)
  • What type of soil or vegetation exists (for more farming-centric communities)
  • Is there access to water, sewage and other amenities (for urban communities)
  • How much of the land is paved/has concrete

In general, valuing land provides a conservative baseline for any property valuation and can provide a lower bound for any type of pricing analysis for your home.

Cost of Building

The next component of the Cost Approach Method is assessing the existing value of the building on top of the land. The most common way that appraisers determine this value is by using the notion of “replacement cost”. The straight definition of replacement cost, is the cost required to replace the existing structure utilizing materials and labor available in the current market. There are three methods by which replacement cost is typically calculated:

Per square footage cost: The building cost per square foot is taken from a recently built comparable in your neighborhood. Once determined, it is multiplied by the number of square feet you are planning to construct.
Unit in place method: The individual components of your architectural plans are considered and added together. This may include details around required materials, labor and other construction related costs.
Quantity survey method: This is the least used method and often the most expensive (typically reserved for more complex buildings with historic architecture requirements). This method actually breaks down the costs of the materials and labor and adds them together in a painstaking, detailed manner.
Index method:This method uses the original construction cost of the property and then “indexes” vs. inflation/changes in pricing in materials and labor costs since the property was built. This is typically the least accurate method of determining replacement cost due to large fluctuations in wages and technology innovations.

Depreciation

The last component of the Cost Approach formula is the calculation of depreciation. In this case, depreciation refers to any factor that may have caused the property (excluding land) to be devalued. In some cases, land may be devalued due to changes in usability or zoning. There are generally 3 classes of deterioration:

Physical: Degradation of the property structure, typically due to wear and tear.
Functional: Obsolescence of property features once considered of value (e.g., outdated electricity, design, heating, etc.)
External: Factors that have changed external to the property that have caused loss of value (a new freeway, higher crime rates, stricter zoning requirements, etc.)

The timing of when depreciation occurred can be very difficult to calculate. Typical appraisers will use straight line or economics age-life depreciation. This employs the basic assumption is that depreciation is spread out evenly during the lifetime of the property’s existence.

Once the appraiser has complete information on the three components above, they can create an appraisal based on the cost method. Take a look at what the typical appraisal report looks like when using the cost method. You can really see how each minute detail, down to the foundation and the plumbing, is factored into the appraisal.

hat and sunglasses lay atop a bed in a simple white bedroom
Source: Kelcie Gene Papp / Unsplash)

Method 3: The Income Method

(Commercial, Investment, AirBnB Properties)

In cases where the primary use of the property is as a rental or other form of income, the most commonly used method to appraise the value of a property is the Income Method.

The Income Method uses a combination of both the net income generated by your property along with other factors to determine its final worth. If you believe the primary value of your home lies in its ability to generate income, you might want to do some further reading on the Income Method.

For example, the company Smartasset conducted a 2016 study on the top U.S. cities that had the most potential on AirBNB. There are three primary ways an appraiser may apply the Income Method to assess the value of your home.

Capitalization Rate

The most popular way to use The Income Method for home valuation is by using the notion of capitalization rate vs. your NOI (Net Operating Income). This basic formula used is:

(Annual rental income – Expenses) / Capitalization Rate = The Value of Your Home

To calculate the capitalization rate, you will need to do a comparable analysis of other rental properties that have sold in your area.

Gross Rent Multiplier

Another way to use The Income Method is via the Gross Rent Multiplier (GRM). The basic formula for home valuation under this approach is:

Annual Gross Income * GRM = The Value of Your Home

The GRM is calculated by dividing the average price that rental properties have sold for near your home (the comparable) by the annual rental income they receive. Once your have this ratio, you can then apply it to your own rental income to estimate your home’s worth.

Discounted Cash Flow

In certain cases (especially involving higher end, higher income properties), the most appropriate method for valuing an income property may be to conduct a discounted cash flow analysis (DCF). This is a method commonly used by investment bankers that sums the estimate of all future cash flows after applying a market discount rate (i.e., cost of capital). The end result is the Net Present Value (NPV) of the property under consideration.

The Reconciliation Phase

The final step for an appraiser is to complete the Reconciliation Phase of an appraisal. During this phase, the appraiser will evaluate all of the approaches they use in order to triangulate to a final value for your property. Based on your type of property, the appraiser may weigh certain approaches more heavily than others, but ultimately, the appraiser decides the final value.

The Home Appraisal Process is Unique to Your Home

One of the best (and easiest) ways to make a good impression on your appraiser is to be friendly and make sure the time of your appraisal is good for them (not just for you!).

Each home is different, with characteristics that represent the best (or sometimes worst!) traits of the current owner. These differences make the home appraisal process complex and unique to your property.

It is reasonable to expect complete reasoning and documentation from the appraiser, and keep in mind, the vast majority of appraisers are professionals who are seeking to arrive at the most objective valuation of your home.

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