By financen | October 1, 2007 - 8:35 am - Posted in Personal Finance, Real Estate

To begin with let us first look at what a real estate appraisal means.

Simply, it is a judgment of property value. This value is arrived at by a certified or licensed appraiser by following process of analytical comparison along with use of comparable sales and information regarding the property that is appraised, its neighborhood & community.

Why an appraisal is needed?

There can be many reasons that a person need to know value of his property. Let us look at some of the most common reasons for which an appraisal is sought:

  • Appraisal is necessary to validate property’s purchase value for obtaining a mortgage.
  • Taxing authorities like Internal Revenue Service (IRS) require appraisal for establishing estate’s value when a death occurs.
  • Appraisal is essential to contest annual appreciation increases asked by insurance companies if such an increase in insurance coverage leads to unrealistic premium amounts.
  • Sometimes insurance agents also order appraisal if their standard cost service manuals are found inadequate for a typical home or structure.
  • At times, a government entity may need land owned by an individual for public use. An appraisal is ordered and landowner is offered purchase of his land for the value indicated in the appraisal.
  • Property owners who feel that their property is being assessed too high by taxing authorities can order appraisal by a qualified appraiser to contest such property assessment.
  • When buying the house with owner carrying the loan, it is important to get appraisal done to make sure that buyer does not pay more than what the property is actually worth.

The appraisal report provides an objective judgment of property’s market value. Normally appraisers compute the market value by using one of the three approaches:

  1. The Sale Comparison Approach
  2. The Cost Approach
  3. The Income Approach

Let us now look at these three approaches:

  1. The Sale Comparison Approach

In this appraisal method price of properties having similar size, location and quality recently sold are examined. And price is adjusted to take into account the differences between comparables and the appraised property for determining the correct value. The sales comparison approach is considered as most reliable when adequate comparable sales data exists.

  1. The Cost Approach

It was formerly known as summation approach. In this appraisal approach it is considered adequate to sum up land value & depreciated value of improvements to arrive at the value of any property. The abbreviation RCNLD is used to refer to the value of improvements where RCNLD stands for replacement cost new less depreciation. Replacement cost means the cost of building the house or making improvements which have the same utility but are done using modern design, materials & workmanship.

Mostly the methodology in use for cost approach is a hybrid of cost & sale comparison approach. As an example, the replacement costs for constructing a building can be ascertained by adding material, labor & other costs; depreciation and land values have to be arrived at from analysis of comparable data. This method is considered reliable if used for new structures, but it tends to become less reliable if used for older properties.

  1. The Income Approach

The income approach is used to value investment & commercial properties. It provides an objective estimate to an investor about what he will have to pay based on the net income the property produces.

Where a property produces commercial income this appraisal method capitalizes an income stream into a present value. This is done by using single year capitalization rates of NOI (Net Operating Income) or revenue multipliers. The NOI is GPI (Gross Potential Income) less Vacancy & Operating Expenses (but excluding depreciation charges that are applied by accountants).

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This entry was posted on Monday, October 1st, 2007 at 8:35 am and is filed under Personal Finance, Real Estate. You can follow any responses to this entry through the RSS 2.0 feed. Both comments and pings are currently closed.

1 Comment

  1. March 29, 2009 @ 4:14 pm

    My father is selling two parcels to the BLM. Gold has been found on both. The price paid is basd on the appraised fair market v
    value. How do I find the additional value the gold brings to the property?
    He wished to retain the mineral rights but BLM said gov regs did not allow that.
    Are their professional appraisers who can value the increased value ot the properties.
    ( 300 plus acres of river property in Nor CAl.)
    He has hired an appraiser for the property but appraiser has no training on gold, mineral value.

    Posted by Eleanora Arbini