Appraisals are used by homeowners, real estate investors, real estate professionals -- we all use them to determine the objective market value of a property. Been ordering and delivering the actual appraisal report, an appraiser has much to do before reaching the final value. One of the major steps aprpaisers take to reach their estimation is analyzing the property from different angles. There are three methods appraisers use to analyze the property :
The Cost Approach
This refers to a value estimation based on the cost to replace or rebuild the property's structure and improvements as of the date of the appraisal. This final number is added to the intrinsic value of the land itself to come to a new number that would be estimate how much the is worth if it were newly constructed. To take into consideration the normal wear and tear of age, weather, etc., the appraiser must take the physical condition of the property into account. The main equation for this approach is :
+ Value of vacant land
+
Replacement cost of structure
+
Replacement cost of any improvements
- Structure's loss in depreciation, age, and obsolescence.
= Property Value
The Sales Comparison Approach
This method estimates the property's value based on the recent sales of other properties similar in size, quality, and location. The recently sold properties are called comps or comparables. Due to the fact that no two properties are exactly alike appraisers use recent comparables as a base value and adjusts the value of the property at hand according to the property differences. This method is the most commly used method to determine the final value of a property and most often gives the most accurate estimation. An example :
Property at hand = Property A
Comparable Property = Property B
Description: Property A is a 2 bedroom, 2 bath, single story house with a 2-car garage. There is a swimming pool in the backyard valued at $3,000.
Description: Property B is a 2 bedroom, 2 bath, single story house with a 2-car garage. 1 month ago this property sold for $350,000.
With this information, the appraiser arrives at a final value of $353,000 by taking the recent sales price and adding the $3,000 value of the swimming pool. This example is only using one comparable to produce a value estimate. All lenders require at least three comparables before even considering allowing the appraisal's value to stand without being contested.
The Income Approach
This approach is more often used for income properties or rental properties and rarely carried much significance for residential, owner-occupied homes. This approac takes into account the market rent for the property, the GRM or gross rent multiplier, and hte sales price of comparable properties. A general equation used for this method :
Comparables Sales Price / Gross Monthly Rent = GRM
Gross Rent x GRM = Market Value of Property
To actually put this method into practice, here is an example :
Property at hand: Property A
Comparable Property = Property B
Property B sold 20 days ago for $500,000. The property earns a gross rent of $2,000 per month. To find the property's GRM, we take $500,000 and divded that by $2,000, resulting in 250 as our GRM.
We then take the market rent for Property A, which let's say is $1,800, and muliply that by 250 GRM. This equals $450,000 which can now be considered the estimated value of the income-producing property, Property A.
Though all of these methods, besides the income approach, appear on the appraisal report for residential properties, the comparison method is usually the one that is weighed the most when detrmining the final value.
