How to Read an Appraisal Report

One of the most important elements of private lending is evaluating collateral. Anything can serve as collateral, but in real estate, collateral is typically real property such as residential homes, commercial buildings, or land. While both the lender and the borrower use various sources of information to estimate the property’s value, the final value is determined by an appraisal report produced by a licensed appraiser. As a real estate investor, you must be adept at reading appraisal reports and that involves understanding various elements related to property valuation.  Let’s look at appraisal reports together to make sure you understand their key components and what they mean for your real estate transaction.

Who are real estate appraisers?

Real estate appraisers play a critical role in ensuring that property transactions are based on accurate and reliable valuations. Their expertise helps both buyers and sellers make informed decisions and facilitates the smooth functioning of the real estate market. In many jurisdictions, including Maryland, Virginia, and Washington DC real estate appraisers are required to get licensed which included completing education, training, and experience requirements.

How do appraisers conduct real estate appraisals?

A real estate appraisal is conducted through a systematic process that involves collecting data, analyzing market trends, applying valuation methods, and arriving at an estimate of the property’s market value. The process typically follows these steps:

1. Engagement: The appraiser is engaged by a client who needs an appraisal, such as a lender, homeowner, buyer, seller, or legal entity. The appraiser and client establish the purpose of the appraisal and its specific requirements. For example, the majority of orders task the appraiser with determining the value of the property in its current, or as-is, condition. However, if an appraisal report is ordered by a private lender like New Funding Resources, it typicallys asks the appraiser to determine the future value of the property. The future value of the property is influenced by the scope of renovation the real estate investor plans for the property. In such cases, a detailed scope of work must be provided by the appraiser in order to complete the appraisal report.
2. Conducting Property Inspection: The appraiser physically inspects the subject property. This involves measuring the property, noting its layout, taking photographs, and assessing its condition and features. The appraiser identifies any special amenities or unique characteristics that could affect the property’s value.

3. Collecting Data: The appraiser collects data on comparable properties (comps) recently sold in the area. Comps should be similar to the subject property in size, location, condition, and other relevant features. If an appraiser is working to determine the after-repair value of the property, he would look at the recently sold comps that have been rehabbed to the same extend that a real estate investor plans to rehab to. Public records, Multiple Listing Service (MLS) listings, and other sources provide information about recent sales.

4. Doing Market Analysis: The appraiser analyzes local market trends, supply and demand, economic indicators, and factors that might influence property values. This analysis helps the appraiser understand the broader market context.

5. Choosing Appropriate Valuation Methods: The appraiser selects the appropriate valuation methods based on the property type and availability of data. The three main methods are the Sales Comparison Approach, the Cost Approach, and the Income Approach.
   • The Sales Comparison Approach is the most commonly used method. It involves comparing the subject property to comps and making adjustments for differences. This most commond method to estimate the current value or the after-repair value.
   • The Cost Approach is used to estimate the value of a property by calculating the cost to replace it with a similar property. It’s often applied to new or unique properties where comparable sales are limited. The appraiser estimates the cost of the land, plus the cost to construct a similar building, minus any depreciation due to wear and tear.
   • The Income Approach is used primarily for income-producing properties like rental apartments or commercial buildings. Appraisers analyze the property’s potential income stream and apply a capitalization rate to estimate its value based on the expected income and prevailing market rates.

6. Making Adjustments: If using the Sales Comparison Approach, the appraiser adjusts the sale prices of comps to account for differences between the comps and the subject property. Some adjustements are straight-forward and use predetermined formulas. Others are based on an appraiser’s professional judgment and opinion and might differ from appraiser to appraiser. As a real estate investor, you should be aware of the following adjustments:
   • Physical Characteristics:
     • Size: Adjustments are made for differences in square footage or acreage between the subject property and the comps.
     • Number of Bedrooms and Bathrooms: Differences in the number of bedrooms and bathrooms are adjusted, as these significantly affect a property’s value.
     • Garage/Carport: If the subject property has a garage or carport while the comps don’t, an adjustment might be necessary.
   • Condition and Age:
     • Condition: Adjustments are made for differences in the condition of the properties. A newly renovated property will have a higher value than a similar property in poor condition.
     • Age: The age of the properties can affect their value. Older properties might require more maintenance and updates.
   • Location:
     • Proximity: Adjustments are often made based on the subject property’s proximity to amenities such as schools, shopping centers, parks, and transportation.
     • Neighborhood Quality: Properties in more desirable neighborhoods might have higher values. Adjustments account for the desirability of the location.
   • Lot and View:
     • Lot Size and Shape: Adjustments can be made for differences in lot size and shape. Larger, well-shaped lots might have higher values. Bear in mind that sometimes a property survey might be needed to determine the correct size and shape of the lot.
     • View: Properties with scenic views, such as waterfront or city skyline views, might have higher values.
   • Features and Amenities:
     • Upgrades and Features: Adjustments are made for upgrades and features like hardwood floors, granite countertops, fireplaces, pools, and more.
     • Special Amenities: If the subject property has special amenities like a tennis court or a custom-built entertainment area, adjustments are made.

7. Putting Togehter Appraisal Report: The appraiser compiles the collected data, analysis, and valuation methods into a comprehensive appraisal report. The report typically includes the following sections:
   • Property Information including it address, legal description, size, and any special features.
   • Effective Date: This is the date at which the appraiser’s opinion of value is valid. Real estate market conditions can change, so the effective date is important.
   • Appraiser Information: Look for details about the appraiser, including their name, certification number, and contact information.
   • Methods of Valuation
   • Comparable Sales: If the Sales Comparison Approach was used, there will be a list of comparable properties that have recently sold. Pay attention to the similarities and differences between the subject property and the comparables.
   • Adjustments: The appraiser makes adjustments to the comparable properties to align them with the subject property’s features. These adjustments account for differences in size, condition, amenities, and more.
   • Market Analysis
   • Value Conclusion: The report should clearly state the appraiser’s final opinion of the property’s value. This could be a single value or a range, depending on the appraiser’s confidence in the estimate.
   • Photos and Maps: Look at any photographs of the subject property, comparables, and neighborhood. Maps can provide a visual context for the property’s location and surroundings.
   • Legal and Zoning Information: Check for any legal or zoning issues that might affect the property’s value or use.
   • Assumptions and Limitations: Appraisal reports often include assumptions made by the appraiser and limitations of the appraisal process. These can provide important context for interpreting the report.
   • Additional Information: Look for any additional information or supporting documentation that might be included, such as property sketches, floor plans, or other relevant data.

If you receive a real estate appraisal report and need help understanding the information presented, feel free to take steps to clarify the issues. Understanding the appraisal report is crucial, especially if it’s related to a significant financial decision such as buying an investment property. We are deeply familiar with the real estate appraisal process at New Funding Resources and will be glad to answer any of your questions.