Appraisals - The Three Most Common Approaches in Determining Value

Today, home buyers and sellers are constantly inundated with information from a variety of sources. Finding an answer to a simple question is sometimes very difficult. For example, one question that comes up frequently is how is the value of a home determined? The short answer is that there are several different approaches. One approach is to seek an appraisal.

An appraisal is an opinion or estimate regarding the value of a particular piece of property at a particular point in time. Typically, the appraisal is requested by a lender when a buyer has applied for a mortgage. The lender will use the appraisal to determine whether or not the property is suitable security for the mortgage, and the maximum amount to be loaned. Appraisals can also be used by buyers and sellers to determine a fair asking price.

There are three standard appraisal approaches that are typically used. Each approach has various pros and cons. The first type of appraisal is the Cost Approach. This is a useful approach when trying to appraise a unique or special property or new construction when no comparable sales are available. First, the appraiser will estimate the cost of replacing the subject property’s existing improvements. Second, the appraiser will estimate and deduct depreciation. Finally, the appraiser adds the estimated value of the site to the depreciated value of the improvements. Keep in mind that this approach can lose accuracy as the improvement ages.

The second type of appraisal is the Income Approach. First, the appraiser estimates the property’s potential annual gross income, based on the current rental market. Next, the appraiser will deduct a vacancy factor and arrive at an effective gross income for the property. Finally, the appraiser will estimate the operating expenses for the property and deduct them from the effective gross income.

The third type of appraisal is the Sales Comparison. Probably the most widely used method for appraising single family homes, and the one most familiar to the general public. The appraiser will look at recently sold properties which are similar to the subject property. The appraiser will then make the appropriate adjustments (up or down) taking into account the differences in the two properties. For example, if the subject property or home has 3 garages, and the comparable property that recently sold only had 2 garages, the value of adding an additional garage stall would have to be taken into account and reflected in the comparison (the home with 3 garages is worth more, and that amount is measurable).

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