Understanding the basics of property Appraisals

Chris Carter is a Mortgage Advisor and Originator with Geneva Financial LLC Mortgage Bankers in Naples, Florida and has written this great overview of the appraisal process and has graciously agreed to allow me to post in on the website as a resource for my customers. This is a must read.

Even though an individual Appraiser's local knowledge and experience contribute to an appraisal,
the entries in it must conform to certain standards in order to be consistent, dependable, and uniform.
 
Appraisers look at the home or condo being valued (subject),
gather info on recent comparable sales (comps), then evaluate both the differences and similarities between them. Just about all residential Appraisals use this Comparable Sales method. 
  
All residential lenders require an independent appraisal of value to determine the Loan-To-Value ratio, an integral part of their risk management. It's also a good idea on all-cash deals, especially if the buyer is considering Delayed Financing.
  
This discussion covers Appraisals for conventional financing. Government-insured loan programs (FHA, VA, USDA) have additional Appraisal considerations which we will discuss in a future newsletter.
  
Interesting note: There are already a few cases where some
lenders allow an Appraisal Waiver in the underwriting and approval process. This practice which accesses public records to estimate value instead of using an actual Appraisal is still in its early stages and does not yet apply to the majority of mortgage applications.

To maintain the accuracy and quality of property appraisals, the Uniform Appraisal Dataset (UAD) was developed, which is a set of standards used to bring conformity to the appraisal process.
  
The UAD not only requires the use of specific standardized Appraisal forms, it also dictates the definitions, abbreviations, ratings, methods, and entry formats used in the report.

Let's look at the Condition (C) and Quality (Q) general rating scales:

COST:
 
   C1 - Recently constructed; not previously occupied; new
           components, fixtures, and mechanical systems

   C2 - No deferred maintenance; minimal physical deterioration;
          recently renovated / upgraded to current standard / style

   C3 - Well maintained; normal wear and tear; some (not all)
           components updated / renovated (first replacement cycle)

   C4 - Minor deferred maintenance; normal wear and tear;
           adequately maintained; minor repairs needed

   C5 - Obvious deferred / lack of maintenance; larger repairs
           needed; livability reduced due to condition

   C6 - Substantial damage; lack of maintenance; condition
           causes safety / structural concerns; major repairs needed
  
QUALITY:
  
   Q1 - Architecturally designed / custom-built; extremely high
           quality materials / workmanship / finishes / fixtures

   Q2 - Often custom designed or highly upgraded / modified
           from basic plans, often in upper-level developments;
           high quality materials / workmanship / finishes / fixtures

   Q3 - High quality construction; slight upgrades from standard;
           above-average workmanship / materials; well finished

   Q4 - Standard design from available plans; code-compliant,
           builder grade workmanship / materials / finishes; industry
           standard; few upgrades

   Q5 - Basic design / functionality / floor plans; code compliant;
           below average workmanship / materials / finishes

   Q6 - Basic quality / cost; may not be suitable for full-time
           occupancy; limited electrical, plumbing, mechanical
           systems; "DIY" type workmanship; possible safety issues

Based on his or her observations, the Appraiser categorizes the subject property as to Condition and Quality using these recognized groups.

Usable comps should be in the same general Condition and Quality categories as the subject property, and must be recent closed sales. Those sold and settled within the past 3 months and located within a mile of the subject are most suitable when available.
  
In fact, all lenders require a new Appraisal when the one being used for mortgage underwriting becomes 120 days old. Appraisals over 90 days old are closely studied and lenders may request a more current one.
 
Here in South Florida, we have many planned communities and organized neighborhoods with resident services, amenities, and an HOA. The most accurate comps for Appraisals are those located within the same community as the subject property.

Remember that Active, Pending, Withdrawn, and Terminated listings cannot be used as comps in independent Appraisals.
  
Only closed sales can be included as comps when performing a residential Appraisal for a lender.
  
Most residential real estate markets have around a 3 month rolling "memory", meaning that current market trends and pricing are influenced by the most recent 3 months of closed sales.
   
An Appraisal is NOT a home inspection.

Appraisal = Opinion of Market Value

Home Inspection = Report on Property Condition

Not many properties are exactly the same, even between the same model in a development, or the same type condo in a building. That's where adjustments to value enter the picture.

Appraisers make value adjustments to account for the differences between the subject and chosen comps based on :
 
                       -  Age
                       -  Lot size or condo floor level
                       -  Livable square footage (total and "under air")
                       -  Number of rooms
                       -  Amenities such as pool and garage
                       -  Desirability factors such as view and exposure
                       -  Upgraded kitchens, bathrooms
                       -  Fixtures, finishes, and other factors.
 
These adjustments are restricted as to how much they can affect the difference in valuation. This is to ensure that essentially similar properties are being compared, because if too much adjustment has to be made, it isn't a suitable comp.
 
Even after Condition and Quality considerations, then thinking about adjustments, a subject property's value can't be appraised quite yet. Its contract price is fixed as the baseline for comparison. The comps' values are adjusted in worksheet fashion up or down to determine value relative to the subject.

If the comps' values end up higher than the subject's purchase price, the subject's appraised value may increase to approach the comps' values in the appraiser's final evaluation (known as "reconciliation" on the report).

If the comps' values are lower than the subject's price, the subject's appraised value may be lowered to approach the comps' values in the reconciliation.
 
Under the Comparable Sales appraisal method, it is impossible for a subject property to appraise higher than the highest valid comp. 
 
As you may remember from previous newsletters - lenders use the lower of contract price or appraised value when calculating Loan-To-Value ratios.Help your sellers understand the Appraisal process a bit better by explaining the basics during the listing appointment. Future appraised value can influence both asking and final contract prices.
 
"Providing exceptional service for Naples, FL buyers and their Realtors®" 

Chris Carter                         Mortgage Advisor and Originator
239 898-5455 cell                                                                NMLS 861361
CCarter@GenevaFi.com

 
Geneva Financial LLC
   Mortgage Bankers

Corporate Headquarters:
1018 E Guadelupe Rd
Tempe, AZ  85283
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