What is an Appraisal?

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Definition:

An appraisal is an estimated valuation of a piece of real estate, a company, or another asset by a trained and certified expert.

🤔 Understanding an appraisal

An appraisal is a way of valuing a piece of property for the purpose of setting a sales price, determining how much a property should be taxed, or figuring out whether a piece of real estate serves as sufficient collateral for a home loan. Appraisals are conducted by experienced individuals in their fields, and these professionals often are required to go through extensive training and certification processes. Unlike the market value, which is whatever price a buyer and seller agree to in a sale, a property's appraised value is a theoretically objective, third-party estimate of its value. The market value and appraised value will not always be the same. Instead, the appraised value serves to help buyers and lending institutions determine if the sales price is reasonably close to the sales price.

Example

When a homebuyer takes out a home loan, their mortgage lender will usually request an appraisal to check that the buyer isn't borrowing more money than the home is appraised for.

To determine a reasonable value for the home, a licensed appraiser will visit the property and inspect its current condition and features (number of bedrooms, square footage, etc.). Then, they'll compare it to other similar properties in the area, called comparables, to determine the property's appraisal value.

If the requested loan amount falls in line with the home's appraised value, the lender may approve the loan (assuming the borrower's credit history is okay).

Takeaway

An appraisal is like an Olympic judge's opinion...

The audience may love one figure skater's performance, but it's the scorecards the judges hold up at the end that determine its value. Similarly, imagine a homebuyer loves a house and is willing to pay $500,000 for it (its market value). If a licensed appraiser performs a home appraisal and determines that it's appraised value is $450,000, the homebuyer likely won't be able to get a loan for the full amount from their lender.

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What is an appraisal?

An appraisal is a certified professional's independent opinion of an asset’s value. Appraisals are conducted on many different types of assets, including real estate, collectibles, antiques, and even businesses and intellectual property.

Appraisals are most commonly conducted to determine:

  • The fair market value, or selling price, of a piece of property or a business
  • The cost of the damages in an insurance claim
  • Whether a piece of real estate serves as sufficient collateral for a home loan in a mortgage
  • How much an owner owes in taxes (such as property taxes)

Of these, home appraisals are the most common because practically everyone who buys or owns a house will need one. Home appraisals are generally required when applying for a home loan because the lender needs to confirm that the borrower isn't overborrowing (borrowing more than their home is worth).

Home appraisals are also used to verify that the home serves as sufficient collateral for the mortgage loan. If the borrower defaults and the value of the loan is higher than the value of the home, the lender will lose money. Since banks are usually the ones that order these appraisals, they are also referred to as "bank appraisals."

Home appraisals are also performed to refinance a home loan or to determine a property's value for tax purposes. But be careful: The valuation of a home for tax purposes is usually called an "assessment," and the value is called the "assessed value."

Technically, an assessment entails an appraisal. But a home's appraised value and assessed value are not the same: The first represents a home's fair market value; the second describes its value for tax purposes.

But appraisals aren't just conducted on homes. Whenever something is being sold, be it a business, a piece of real estate, or a collectible, an appraisal can help determine a fair value for the item in question.

For example, if someone is selling a rare baseball card for $1 million, an interested buyer may hire an appraiser to give an objective opinion as to whether that's a fair price. Or, if one business is considering acquiring another, it may hire an appraiser to determine how much the company is worth.

In short, appraisals have many applications. But no matter if it's a multi-million dollar business or a rare painting that's in question, the value of an appraisal is that it's conducted by an unbiased, disinterested, third party. This ensures that the appraised value is free from any biases toward either the buyer or seller, and helps individuals, lenders, insurance companies, and businesses make informed decisions.

How do appraisals work?

Regardless of what's being valued, the appraisal process basically stays the same: A certified appraiser evaluates the item in question and determines a value for it.

The keyword here is "certified." A valuation that isn't performed by a state-certified appraiser is not an appraisal. To become an appraiser, individuals must take specialized USPAP (Universal Standards of Professional Appraisal Practice) courses and then pass certification tests in their state.

When an appraiser evaluates a piece of property, like real estate or a collectible, they'll inspect the items in consideration, compare them to other similar items (aka comparable sales), and assess the current market conditions to determine the items' fair market value. They may write up an appraisal report that details their findings.

When it comes to business appraisals, there are four ways that an appraiser can go about it:

  • Fair market value: The appraiser sums the value of all the business's equipment, vehicles, furniture, and intangible assets. This type of valuation assumes normal market conditions, i.e., both the buyer and seller are willing and not under any unusual pressure.
  • Liquidation value: Unlike the fair market value, liquidation value is the estimated sale price if the business went under and had to sell (liquidate) all its assets very quickly. It will usually be lower than the fair market value.
  • Capitalization of earnings value: This type of appraisal looks at how much a business is currently worth based on its predicted future earnings.
  • "Going concern" value: This appraisal assumes that the business is still operating normally. It is often used in acquisitions and usually has the highest value because it's the ideal situation in which to buy a business.

What are the different types of appraisals?

The most common types of appraisals are:

  • Property appraisals: An appraiser values property (usually real property) to determine its fair market value. It's often conducted when applying for a mortgage loan or refinancing an existing mortgage.
  • Bank appraisal: A bank appraisal is an appraisal that is ordered by a bank. Usually, they are conducted during the home loan and mortgage process. (An appraisal can be both a bank appraisal and a property appraisal if it’s valuing a home at the request of a bank.)
  • Collectible, art, and antique appraisals: An appraiser values a specialty item such as a collectible, antique, or work of art, to determine its fair market value. This is usually done to find a selling price or for insurance claims when a valuable collectible is lost or damaged.
  • Business appraisal: This type of evaluation determines the value of a business either for sales/acquisition purposes or when a company is filing for bankruptcy.
  • Insurance appraisal: An appraiser determines the value of an asset or piece of property, as well as whether a policyholder's insurance claim is covered. This type of appraisal is common for home and car insurance claims.

How can I prepare for an appraisal?

There isn't much you can do to prepare for an appraisal outside of making sure everything is working normally.

If you're having your home appraised, you can do this by hiring a home inspector to perform a home inspection before the appraisal. It's also generally a good idea to tidy up, but cleanliness should not affect your home's value.

It's often recommended to have your real estate agent attend the appraisal. Still, an appraisal is an objective look at a property's value, so your realtor isn't going to be able to do much to change the result.

What do appraisers look for in an appraisal?

Appraisers are generally looking at two things: the innate features of the object they're valuing and the prices of comparable items.

In short, appraisers don't operate in a vacuum. If you're having your home appraised, for example, the appraisal will first take note of home characteristics, its locations, and any standout features like a pool or sauna.

Then, they'll compare it to other recent sales of similar properties in the area, which are referred to as comparable sales or comparable properties — "comps" for short. They'll use these comps to assess your home's value, given the current market conditions.

What happens if the appraisal comes in low?

Appraisers are human, and they do make mistakes from time to time. Unfortunately, you don't have much recourse if you (as a buyer) get a low appraisal. If you think the appraiser overlooked or completely missed an essential feature of the items in consideration, you can let them know of their oversight.

Otherwise, you can always pay for a second appraisal, just like getting a second opinion from a doctor before surgery.

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