Why should a seller get a home appraisal prior to settling on a listing price?
Many real estate appraisers provide pre-listing appraisal reports for sellers. Having an appraisal done is an investment that can help save you from overpricing your home or even underpricing it. Agent provided comparable market analysis (CMAs) can work well but often the CMAs that I see are haphazardly thrown together. This is particularly true when dealing with custom homes and markets with few or no recent comparable sales.
I cannot tell you how many times I am struggling with valuing a home that had a questionably supported CMA. I have also seen questionable appraisals in similar situations as well. I have been hired many times at the request of real estate agents due to the complexity of the home or complexity of the market a property may exist in. So, let’s discuss what you should look for when hiring an appraiser for this purpose.
So, what should you try and find in an appraiser that will do a pre-listing appraisal for you?
1. Market Competency
Is the appraiser familiar enough with your market to perform the work competently? It is acceptable to request how many assignments the appraiser has performed recently in your market.
2. Property Competency
Has the appraiser ever appraised a home like yours before? If you have unique features such as a green home (High performance home), custom built home, a swimming pool, an in-law suite, water or mountain view, or even features that may be seen as a negative such as close proximity to non-residential use (commercial property, industrial property, rail roads, busy highway) or maybe you have an utility easement running across the lot. Maybe you have an excessively large lot for the neighborhood. There are many things that can make your home unique in such a way that unless the appraiser has some background with that feature, they may not understand how to address it.
3. Assignment Type Familiarity
Does the appraiser have experience working on pre-listing appraisals? If the appraiser has never done pre-listing work, you may want to be careful. There are many appraisers out there that only have experience doing mortgage related work, and while that is valuable experience, trying to suggest a listing price is a nuanced assignment type. Mortgage related work often can be extremely myopic on only retrospective sold comps.
While sold comps are extremely important, with a pre-listing appraisal report, there needs to be a well-supported market analysis that looks at sold comps, actively listed comps and the likelihood of how the subject property may or may not absorb in the market.
Ultimately, each appraisal report that is written should be written for the client that will be using the report. This means that the author of the report should be writing the report to the client’s understanding of the valuation process. When writing a report for lender that looks at hundreds of reports a week, it is different than writing a report for someone that is relatively new to the valuation process.
Some words of caution should be exercised with non-residential appraisers as well. If the appraiser normally does non-residential property types (gas stations, retail centers, medical office, etc.) they would possibly be unqualified to perform this type of work on a home. Residential valuation is nuanced and a specialty practice that requires experience. One would think that a certified general appraiser may be more qualified than a certified residential appraiser, but that is often not the case. While there are some great certified general appraisers that are perfectly competent to value residential homes, it is still important o understand the background of the professional that you are hiring. It is like trying to get diabetes advice from a plastic surgeon: they are both doctors, but you may want to speak with an endocrinologist because they have superior experience in that expertise.
That gives you a bit of background on what to look for in a professional appraiser. Well let’s look at another list:
Now what are some of things that you should look for in the report itself?
1. Report Type
The type of report that is written matters. A pre-listing report should never be performed on a report used for mortgage financing. This includes the Fannie Mae forms such as the 1004, the 1073, the 2055, the 1075 or any other form written to comply with mortgage regulations and loan types. Every appraiser out there uses some type of software forms provider that has other types of forms besides mortgage use forms. These are sometimes referred to as general purpose forms or non-lender forms.
2. Completeness of the Report
While many residential appraisers use pre-formatted reports, the reports should be much more than checked boxes and short statements describing the property and its characteristics. The standards that licensed and certified appraisers follow require that the reports contain summary explanations of how the conclusions are made and opinions are supported. Many appraisals that I review have all the boxes checked but have very little commentary at all. In the case of a listing use appraisal there should be summary comments explaining the following areas in more detail:
a. There should be a thorough market analysis. The reader of the report should understand exactly where the appraiser is coming from. This should include a property productivity analysis: an explanation of what the subject property is and how it fits in the market. This should include what are typical and ideal improvements for the market. This explains how well the subject should compete in the market.
i. What is the market area? This is more than stating what neighborhood or subdivision the home is located in. It should discuss the overall and direct competing market the subject exists within.
ii. There should be a cogent demand analysis that discuses the most probable end user (owner occupied or tenant), tastes of the consumers regarding housing features and styles, and an analysis of historical growth and absorption information.
iii. There should be a supply analysis as well. What is currently on the market competing directly and indirectly with the subject property? Is there a possibility of competition with new construction alternatives?
iv. There should then be an analysis of how supply and demand are interacting. Once supply and demand are identified for the competitive market, how are they working together?
v. The final step in the market analysis is forecasting the subject capture. This means that all the previous information used to develop an opinion of how well the subject may or may not perform if listed for sale.
b. Highest and best use
An opinion of highest and best use is required by standards. This is simply a four-step process that is carried out to develop an opinion of what the best use of the property is or is not. The four steps include legally possible, physically possible, financially feasible and maximally productive. This is arguably the most important step of the appraisal process and one that many residential appraisers spend too little time on of at all. In the end, it is a series of tests that will discuss if the subject property is more valuable as it is, or maybe it would be better if altered or even torn down and something else done with the land besides the current use. For an improved property with a house on it, two sets of tests are normally done one “as is” and one is a hypothetical test discussing what could or should be done if the property were vacant. The other thing that should appear with this step is the timing of the opinion of highest and best use.
c. Approaches to value
The approaches to value will be the most read and discussed part of the report by normal consumers requesting the report. This is where the opinion of value is discussed and supported. There are three approaches to value:
i. The cost approach is a series of steps that takes into account the cost to purchase the land, improvement the land and the cost to build the home. If the home is existing there is always some depreciation that then must be applied. While this approach is not something many consumers consider when buying existing homes, it is still a required approach that must be considered by the appraiser. The premise of the approach is why would anyone pay more for a home then they could reasonably build one just like it?
ii. The income approach is an approach that considered the rental potential of the home in the market where it exists. Could the home be rented if there is adequate rental demand? If the answer is yes, then the appraiser develops and opinion of market rent and uses a capitalization technique to develop and market value based on rental potential. This is not used often in residential single- unit appraisals. Nevertheless, it is an approach that the appraiser must at least consider and explain why it is not being used. I do often see this approach overlooked in many markets.
iii. The sale comparison approach is the most important approach, normally, when dealing with housing. Most markets have adequate sales and active inventory to allow a supportable opinion of value to be developed. This is where the appraiser compares the the subject property to other homes that have sold are on the market. The appraiser makes adjustments to the comparable properties for inferior and superior features. Most homeowners understand this concept well enough, but where I see it fall apart is when the appraisal reports do not support what they are doing. The adjustments made should not be manifested out of the ether. They should each be based on a methodology or technique. When an appraiser makes an adjustment for gross living area that adjustment should be supported by research and technique. In other words, how did the appraiser come to the conclusion that the dollar amount used for the adjustment is the correct one? On a typical home in my market I usually end up writing at least a page of information explaining the sales comparison adjustments, and often times it can be two or more pages if the home is complex in any way. Appraisal standards require that at minimum, the appraisal report must have summary commentary for all opinions, conclusions and adjustments.
iv. The last step before writing out the opinion of value is the reconciliation of the three approaches. This does not need to be a long section, as the previous three approaches should have been discussed adequately enough that the reader of the report has a good understanding of where the appraisal report is headed. In this section each of the approaches are discussed and weighted according to how well supported each is.
Pre-listing appraisal reports are different. They are not the same as a report prepared for mortgage lending. Much of what I have discussed here are really nuances that should differ from what many residential appraisers normally work with when doing lending use work. It certainly helps to utilize an appraiser that does lending use work, because the appraiser can also consult on whether the home needs any repairs or maintenance work that would typically be required for loans underwritten by FHA, VA or USDA. I hope this blog has offered something to take away.
Woody Fincham, SRA, AI-RRS, RAA. Member of RAC is a well-known and well-respected real estate appraiser in the Charlottesville, VA area. He has an extensive background in residential valuation specializing in complex residential properties that include mansion, equestrian hobby farms, hobby farms, resort, waterfront and high-performance home certifications such as HERS, Pearl and LEED. He is one of the few valuers in Virginia that specializes in the valuation of PV Solar systems on homes. He is a qualified FHA and VA Panel appraiser. He has been qualified as an expert witness and has a background in real assessment within the Commonwealth. His clients have included VDOT, private wealth management firms and lenders, attorneys, state agencies, federal agencies, and municipalities.