What's It Worth? Says Who?

One of the most confusing aspects of buying and selling a home is the appraisal. When an appraiser delivers a market-value estimate to the lender, it can either make or break the deal. If a home doesn't appraise for the purchase price, people often have to renegotiate the deal to secure a loan. That is why it is so important for buyers and sellers and their Realtors to understand how an appraiser estimates a home's value.

Although appraisers base all determinations on information from the local real-estate market, even they admit that their decision is ultimately an opinion, an experienced opinion. Because appraisers look at data consistency in the market, a value can be determined.

However, it is not the appraisers who determine market value of homes and other property. Who does establish the value? Buyers and sellers in the current market establish value. And market value is what banks or mortgage companies are most interested in.

Lenders order a market-value appraisal as assurance that, if a borrower defaults on a mortgage, the home has enough value for the lender and will recover the loss. The lender hires and pays the appraiser and is reimbursed by the borrower through a fee paid at closing. The lender owns the appraisal, but the borrower is entitled to a copy.

How does an appraiser estimate that value? Appraisers don't just pull numbers out of a hat. Appraisers estimate value the same way: through the cost approach and sales-comparison approach.

Both approaches begin with an on-site inspection of the home to determine its size and overall condition. When the inspection is through, the appraiser goes back to the office to see how the house measures up under both appraisal methods.

The first method, the cost approach, begins with an estimated value of the land under a house. The cost of building the house is added on, and depreciation (such as required maintenance) of the home is subtracted. Then the depreciated cost of such items as fencing and landscaping is added.

The sales comparison, or market approach, involves comparing the home with similar properties sold in the same neighborhood in the past year. Association of Realtors Multiple Listing Service and local homebuilders are an appraiser's best source of information.

But, no two houses are alike, making it impossible to compare apples to apples. Appraisers must make adjustments to the comparable homes' values to make that equal to the subject home's value.

If the home being appraised has a garage and the comparable home does not, the appraiser must add the value of the garage to the comparable home's value. That same adding and subtracting would be done for every extra feature of the subject home until both properties are equal. How does an appraiser know how much every feature is worth? Every adjustment is market-derived. It is how much a buyer is willing to pay for an extra. The appraiser's experience indicates what buyers will pay because of all the information gathered from the MLS on the three to six comparable sales.

It's not subjective experience. It takes many years and stacks of MLS figures to know how the market reacts.

All appraisers will agree that the most difficult part of appraisals is developing adjustments to the comparable sales. Once the adjustments are made, an appraiser can determine a value range, keeping within a 5 to 10 percent bracket.