Three different appraisal methods
Any licensed state real estate appraiser will utilize three different approaches when analyzing investment property valuation. Since it’s a different animal than a standard home appraisal, the melding of the three approaches helps unify an appraiser’s valuation, giving it more weight. While appraising is more an art than science, and no two appraisers will value a property exactly the same way, they will (or in theory, should be) very close in analyzed market value for any given investment property.
Of course, the more specialized the property (a specific-use manufacturing plant, for example) the more rigorous and difficult the analysis will be. The three approaches most often used are the market value approach, the cost approach, and finally, the income approach. Naturally, each type of approach requires different methodology and information for the appraiser’s analysis. They then determine what weight to place on each individual approach, based on what data is available to them, and then they pull all three approaches together in one last analysis to come up with an investment property valuation amount.
With residential rental property, the income approach tends to be weighted the greatest. When rents and expenses are completely known, this approach works best. Even when a rental property is vacant, or only partially rented, this approach works well, since there is usually plenty of data to show what market rents in the same area will throw off in terms of likely income for the building.
The cost approach would then be used to determine what a like building would actually cost to build to create the same amount of rent. Another part of both approaches takes into account the time necessary to build from scratch, as well as the time to expand to full capacity rentals.
The market approach is used as another qualifying way of determining an investment property valuation, or the real market value. It helps the appraiser see just how in line the other two approach valuations truly are. Market approaches (also known as comparative market values) are commonly done for home appraisals. With residential multi-family properties, the market approach may still be weighted highly if there are enough good, recent sales data available of like properties for comparison’s sake. However, this approach is usually weighted less than the other two approaches when non-residential real estate is being appraised.
Reconciling the approaches
Once the three approaches are reconciled, one market value is arrived at by the appraiser for the income producing property. This is known as the appraiser’s “opinion of value.” The appraiser’s report not only contains all three approaches, but details how he has weighted them, as well as his analysis of how he related each to the other.
Commonly, lenders rely on the appraisal to help qualify the purchase price of a property they are considering offering a mortgage on. If the appraisal comes in below the purchase price, some lenders will allow a second appraisal to be done. But others will simply not make the loan – or will require the buyer and seller to “re-negotiate” the purchase price, based on what the lender will allow for a mortgage. In some cases, the buyer may make up the difference in appraised value and purchase price with their own cash, just to make the deal happen.
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