The Appraisal Process

A real estate appraisal starts with a physical inspection of the property being appraised. Number of bedrooms and bathrooms are important to ensure that they really exist and are in reasonable condition. Also, the inspection ensures the proper square footage and layout of the property by including an illustrative drawing. Obvious defects to the structure of the property affect the value negatively. This may included a leaky roof or hole in the wall.

Once the property has been inspected, the appraiser chooses from three approaches of property value. The cost approach, sales comparison approach, and income approach.

The Cost Approach

The cost approach is a method based on the replacement cost (new) of improvements, plus the market value of the site (land). For this reason, this approach is most reliable when improvements are fairly new. The older the structure, the less relevance the cost approach will be. This is due to the greater subjectivity involved in estimating accrued depreciation. Location and amenities are usually not reflected in this approach. In theory, this approach is the easiest to understand.

The Income Capitalization Approach

In respect to income producing properties, the income capitalization approach is used. Appraisers use this approach while concentrating on two factors. The rents that a property can be expected to earn and the resale value when a property is sold. This approach converts anticipated cash flows into present value by capitalizing net operating income using a capitalization rate. The amount of income the property produces is then used to arrive at the current value of those revenues over the foreseeable future.

The Sales Comparison Approach

The sales comparison approach derives value by comparing the subject being appraised to similar properties in the area that have sold recently. This approach is based upon the theories of supply and demand, balance, and substitution. In general, supply and demand forces tend to move toward equilibrium in the market. Adjustments are made to comparables for differences in such factors as time of sale, location, quality, condition, and amenities. The adjusted values of the comparables are then reconciled into a value conclusion for the subject.

The Appraised Value

The appraised value is used as a guideline by lenders who will not loan a buyer more money than the property is worth. It is very important to note that this appraised value may not be the final sales price. Bidding wars and seller motivation may adjust this price above or below this value