An appraisal is the process taken by a licensed, professional, third-party appraiser to value a piece of real estate. Appraisals are done for many reasons, but typically the purpose is to find a fair market value. The most common type of appraisal is done in order to value the property to secure a loan for a new purchase. An appraisal is different than a Broker Price Opinion (BPO), which we’ll discuss in detail in the next chapter.
Most lenders require that a property be appraised before they will fund a loan. Why? So they know their investment is protected. A bank knows that the home is collateral for the loan, so they need it to be worth more than the loan. That way, in the event of default, they can sell the home and get their money back.
When an appraiser does an appraisal for a property purchase of a single family residential unit they will typically use the Uniform Residential Appraisal Report. This is an appraisal report that has become industry standard, for its ease and efficiency. When appraising a property the appraiser must first state the purpose, because depending on the purpose, the value could be different.
The appraiser can value the property using three different methods: the cost approach, the income capitalization approach, and the sales comparison approach. The appraiser uses his professional expertise and experience to determine which method is best for the subject property.
Typically the cost approach is used for properties that are unique or very infrequently sold (such as a hospital). The income capitalization approach is generally used for income producing properties (such as an apartment). The sales comparison approach is the most commonly used for single family real estate sales where many substitutes and competitive properties exist.