There are different methods of establishing real estate value: a real estate sales agent may establish a listing price based on a comparative market analysis (CMA), which may include closed sales, pending sales and available listings, whereas an appraiser will establish market value based upon the analysis of comparable closed sales. Value conclusion of income producing properties may also be based on the capitalization approach, and/or replacement cost.
Other valuation methods may include insurable value, and assessed value for property taxation purposes. Both of which will be discussed in a later article.
When a realtor is approached by a prospective seller, the realtor will usually issue a comparative market analysis. To do this the realtor compares properties with similar characteristics and amenities that have sold, or are currently on the market for sale, to establish an estimated value. The seller and the seller’s agent make a negotiated decision about value based on multiple factors, including motivation and knowledge by all parties, and other input which may be generally subjective.
Many variables contribute to a perceived value: location, property condition, age, interior and exterior amenities, pool, views, trees and hardscape, noise, site variables such as topography, ingress/egress, garages, appurtenant structures, on-site parking, access to utilities, above ground vs. below ground electrical and telephone lines, ability to produce income, etc. Zoning, architectural style and land size also contribute to the analysis. Also, building setbacks which are local government ordinances that govern distance from curbs, property lines, bluffs and waterways. In my opinion, it is reasonable to expect a 10% fluctuation to a resulting asking price.
The prospective buyer and the buyer’s agent have an opportunity to assess all the above characteristics, including their own personal circumstances, timing needs, shopping, medical facilities, community personality, schools and the availability of reasonable and acceptable financing.
The appraiser, on the other hand, has a different task and attempts to be less subjective and more objective. The appraiser operates mostly from information on past closed transactions, with considerations of all the above property characteristics, to establish what he/she considers an appropriate appraised value. The appraiser would generally skip distressed sales, and non-arm’s length transactions. Most appraisers are trained to use the Uniform Standards of Professional Appraisal Practices which promote quality control standards applicable to appraising real property, personal-property, intangibles and businesses in the United States and its territories. It is a resource that should be used by mortgage professionals when evaluating property and in deciding whether there is a need for a review of an existing appraisal or if a new independent appraisal is required.
The use of USPAP standards and the resulting appraisal can, in some cases, be flawed due to a lack of competence or negligence of the appraiser. Two appraisers cannot both be correct when they are more than 100% apart on the value determination.
Here is an example I observed recently: a lender received a call from a mortgage broker with a request for a loan on a property in a ritzy beach community. The property totaled 20 acres with an older home, a barn and equestrian riding arena, and distant ocean views. The borrower’s broker presented a completed appraisal which was ordered by the borrower, and had been made out to a law firm, as explained by the borrower, for the expressed purpose of a property settlement in a divorce. The borrower requested a cash out second mortgage based on their personally obtained appraisal. The lender explained that it was a custom and practice not to use a borrower’s appraisal unless there was extraordinary assurance that it was an arm’s length appraisal. The lender required a new independent, third party appraisal.
The appraisal obtained by the borrower was from an MAI licensed appraiser who appraised the property at $3,400,000. MAI means Member of the Appraisal Institute, a high-level designation. The appraisal ordered by the lender approved licensed general appraiser, rather than an MAI, was for $1,400,000. This radical difference in value lead to the prospective borrower threatening to sue all parties, including the new appraiser.
The question becomes was there was negligence and/or incompetence on the part of the first appraiser, or the second appraiser?
Most of the comparable sales were more than 1.25 miles away from the subject property. Most of the comparable sales were closer to the beach than the subject property. Most of the comparable were in existing high value luxury residential neighborhoods. Two of the comparables included plans and permits for 10,000 square foot homes, citing arbitrary adjustments. All the comparables had high value un-obstructable ocean views.
All comparables were close to the subject property. All comparables had a more ranchette and rural setting, with a distant ocean view. As the subject property was on the outskirts of the more metropolitan areas, these comparables provided a more accurate assessment of valuation.
Appraisal #2 was unacceptable to the prospective borrower, and the lender decided against making the loan.
Lenders should read appraisals carefully, and focus on hiring competent appraisers who are familiar with the area. They should also make certain that the appraiser is selected in an arms-length fashion with no pressure from the borrower to increase the value, and they should consult with their attorney if they have difficulty.
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