In today’s blog, we will dive deep into the intriguing world of real estate appraisals. If you’ve ever found yourself puzzled by the seemingly mysterious outcomes of property appraisals, you’re not alone. Appraisals can be confusing, but understanding how they work and the impact of constraints is crucial.
The Varied World of Appraisals
First things first, let’s acknowledge that not all appraisals are created equal. The value assigned to a property in an appraisal is not a fixed number; rather, it can vary significantly depending on the desired outcome.
When a lender orders an appraisal, the crucial question is whether they are requesting an “as-is” appraisal or a valuation based on the property’s highest and best use.
As-Is Appraisal looks backward, considering the property’s historical use. It’s like a rearview mirror assessment – whereas Highest and Best Use Appraisal conversely takes a forward-looking view, often used for proposed projects, and explores the property’s potential.
But wait, there’s more.
There are various types of property appraisals, each serving distinct purposes. For instance, one type focuses solely on the land’s value, excluding any structures or improvements on it. Another kind is tailored for lending purposes, adhering to the lender’s financial model, potentially yielding a different value if the borrower provides their own model.
Consider a situation where a lender insists on a 12-month lease while you intend to use the property for short-term rentals; this could significantly impact the appraised value.
In some cases, the city might order an appraisal for condemnation or eminent domain, leading to evaluations based on different criteria compared to an appraisal for a bank loan.
Appraisals can also be sought when buying out a partner or spouse, with the appraisal constrained to reflect the highest market price, regardless of how long the property stays on the market, or, conversely, aiming for a quick sale under distressed conditions.
Land assemblies might necessitate combined property appraisals, while comparing properties with differing utility accessibility introduces complexities regarding who foots the bill for offsite improvements, influencing the property’s valuation.
It’s important to note that appraisers are experts in property valuation, not development experts, so their understanding of the development process may be limited.
Finally, if an appraisal is needed to rebuild a home lost in a fire, the criteria considered will differ from those used for loans or sales.
Constraints Shape the Outcome
These constraints significantly impact the appraiser’s bottom-line valuation. Here’s the subtle but essential nuance most people miss: the method used for appraisal and the constraints imposed on it affect the property’s value determination.
In general, an appraisal will look at three different methods for valuing the property:
- Comparable Sales. Evaluating the property’s value by comparing it to similar properties recently sold.
- Income Approach. Using multiples of net income or cap rate to assess value, which is particularly relevant for income-generating properties.
- Replacement Cost. Determining value based on what it would cost to replace the property.
The choice of method depends on the appraisal’s constraints, and, more importantly, the constraints can influence the final value assigned to the property.
The Challenge of New Zoning Regulations
One of the trickiest scenarios for appraisals involves new zoning regulations. When a city introduces new zoning codes, it can be an exciting time, with the promise of new property possibilities. However, if you’re among the first to embrace these changes, you might be in for a surprise when your appraisal comes in lower than expected.
Why? Because the appraiser lacks historical data on comparable properties. Instead, they relate the new product to existing buildings in the market. Even if these old examples don’t exactly match the new product, the appraiser often sticks to their assessment. They are often unwilling to challenge their own precedent in valuation.
Understanding the Power of Constraints
As a conclusion, it’s essential to grasp that, when properly constrained, you can steer an appraisal to align with your goals. The key lies in comprehending the constraints placed on the appraiser’s work.
So, the next time you find yourself in the world of property appraisals, remember that it’s not just about the numbers; it’s about understanding how those numbers are derived within the specific constraints of your situation. With this knowledge, you can navigate the appraisal process with confidence and clarity.
