The following article is one I have frequently given to clients when appraisal issues have arisen. Hopefully it will help you understand a little more about the process and what goes into an appraisal.
Many consumers are often frustrated when they have a home appraised. Often, they feel that their home is worth more than the appraised value. In many cases they are right! This does not change the fact that real estate appraisers must adhere to very specific rules and guidelines that are dictated by the lender. A few years ago, lenders added a requirement to appraisal guidelines, stating that the intended use of the appraisal must be indicated in each appraisal report. This is simply because appraisals can be used for different purposes, each having different values and rules.
In determining value for the purpose of a finance transaction, appraisers must follow guidelines set by the lenders, which in many cases results in a slightly more conservative estimated value. Everything that an appraiser adjusts for positive or negative must be bracketed and supported by the comparable sales. For example, if a home is purchased for $100,000 and the owners choose to add a pool at a cost of $30,000, the value of the home does not automatically increase to $130,000. The appraiser must determine through a paired sales analysis what the market will support for a pool. If, in the same marketplace, a comparable home without a pool sold for $100,000 and a comparable home with a pool sold for $115,000, then the appraiser can only support a $15,000 adjustment. This is the case with any features that an appraiser can adjust for, not just a swimming pool. There is no set figure for any feature like a view, pool, spa, square footage, bathroom upgrades, etc it must always be bracketed.
On homes two to three years old or newer, upgrades typically can be recovered in an appraised value at actual cost, as the only way for new homes to have these upgrades is to pay actual cost. This is typically reflected in higher selling prices. However, when dealing with older homes, upgrades usually do not recapture their full cost for the same reasons indicated in our previous example dealing with the addition of a pool. Here is an extreme example: If a 40 year old home in average-to-good condition is purchased for $100,000 and the buyers choose to tear down the existing dwelling and build a new house at a cost of $100,000, the value is not automatically $200,000. The reason for this is because the original structure had value. Unless the home is in very poor condition, the sales price reflects value for the subject improvements. Therefore in this case, if the value of the original dwelling was $50,000 with the remaining $50,000 being land value, the new estimated value would be closer to $150,000, meaning that when the existing structure was torn down, that constituted a loss of $50,000 in value. The same applies to a kitchen or bathroom remodel, in that the original kitchen or bathroom had value in its original condition. This is why the cost of upgrades or remodeling of older homes can rarely be fully recaptured. Again, there is no set figure only what the market will support for an upgrade or remodeled home vs. one that is not.
State and lender guidelines require appraisers to base value on closed and verified comparable sales. Although property values are increasing in most areas of the country, typically lenders will not allow time adjustments to be made on comparables that sold within the past 6 months. In regards to pending sales and listings used as comparables in a report, some lenders actually require appraisers to use both a pending sale and a listing. This is not for the purpose of supporting a higher value in the lenders eyes; it is only to show that current market activities still support the closed comparable sales used. When using pending sales or listings as comparables, lenders want to see an adjustment made for possible negotiations. (Yes, even though many homes over the past couple of years have sold above their list prices!) Typical adjustments are usually between 5% and 10% off of the list price. This guideline is a safeguard to prevent appraisers from appraising too high. Furthermore, guidelines also indicate that appraisers can only base their opinion of value on sales that have closed escrow, and the pending sales and listings can only be used to support the closed sales.
If the appraisal were completed for a reason other than a mortgage finance transaction such as to determine a reasonable list price, you would likely see a higher estimated value. As in this case, listing and pending sales would be the primary support for the value estimate. When property values in a given marketplace are in the process of a drastic increase, this allows an appraiser to value property in real time based upon current pending sales or listings rather than sales that, although they may have closed within the past three months, have actually gone into escrow four to six months prior.
It is also for this reason that, when appraising a home that has just sold within the past three or four months, a lender will not accept an appraisal at a significantly higher value than the previous purchase price based upon the passage of time alone, unless documentation can be provided that indicates the property sold below market value at the time it was originally purchased. The only way to show an increase in value is to provide documentation that supports upgrades or remodeling completed by the current owners since the last sale transaction took place. For example, if a buyer purchases a home in November of 2002 for $600,000 and the new owners have added $55,000 in upgrades, given the fact that it is a new home, the appraiser will likely be able to get full value for the $55,000 in upgrades. If the appraisal is documented properly, the appraisal on the home is likely to be $655,000.
Although there is nothing in writing, appraisers are typically given 5% margin of error by lenders. Any more than that and the value will most definitely be cut by one of the lenders appraisal review staff personnel. Therefore, an appraiser can fudge a couple of percent. While the reviewer will know when an appraiser is pushing its value, if it is within that 5% range, they will most often let it slide. If an appraiser pushes beyond the 5%, lets say to 6%, 7% or 8% above and beyond what it is truly worth based upon comparable sales, the reviewer in charge of the file will take it all away and cut the value by the full 7%. Keep in mind that every single lender in todays mortgage marketplace has a review department. Therefore, given the example just mentioned, it would not be in the appraisers or the clients best interest to push the value too much. It could end up exposing the property evaluation to a severe appraisal review!
