When purchasing real estate, one constant that often perplexes even the savviest of investors is the appraisal.
An appraisal can be the deciding factor in real estate transactions, potentially altering the course of your investment strategy. But what exactly is contained in those pages, and how do you decipher the numbers, comparisons, and comments? You’re not alone if you’ve ever wondered how to read an appraisal!
Follow along as I’ll cover the basics of an appraisal, the types of common appraisal reports you may come across, how to read an appraisal line-by-line, the essential elements of a credible appraisal, and what to do if you find an issue. Let’s dive in! Or, you can jump right into how to read an appraisal.
What is an Appraisal?
The Uniform Standards of Professional Appraisal Practice (USPAP) defines an appraisal as the act or process of developing an opinion of value. In the case of real estate, that opinion of value would be for real property. But why is this number so critical?
At its core, an appraisal provides a snapshot of the market value of a property. Whether you’re looking to buy, sell, or refinance, this number is the foundation for the transaction. For buyers and investors, it can affirm if you’re making a sound investment or potentially overpaying. For sellers, it can validate your asking price or suggest the need for adjustment. In the case of refinancing, lenders often rely on appraisals to determine the amount they’re willing to loan.
But it’s not just about a single number. The appraisal report provides a comprehensive look at how that value was determined, considering everything from the property’s physical characteristics to its location, comparable sales in the area, and current market conditions. It’s a rich document, full of insights if one knows how to read and interpret it.
Types of Appraisal Reports
Different reports come into play depending on a property transaction’s purpose, complexity, or specific requirements. Let’s explore some of the most common types:
Uniform Residential Appraisal Report (URAR):
- Overview: This is the most common report type, primarily used for single-family homes, including those with accessory dwelling units (ADUs).
- Usage: Lenders typically require this form when determining a loan amount for a home mortgage.
- Components: Includes details about the subject property, comparable sales, a sales comparison approach, and often the cost and income approaches to valuation.
Commonly used forms: Fannie Mae 1004 or Freddie Mac Form 70
Small Residential Income Property Appraisal Report:
- Overview: Geared towards smaller multi-unit properties, typically those with 2-4 units.
- Usage: This form is used for sales or refinancing transactions involving small residential income properties.
- Components: This uses the income approach and standard valuation methods to assess the property’s value and potential income.
Commonly used forms: Fannie Mae 1025 or Freddie Mac Form 72
Condominium Unit Appraisal Report:
- Overview: As the name suggests, this report is for individual condominium units.
- Usage: Lenders often require this when financing a condo purchase.
- Components: Similar to the 1004 or Form 70 but tailored to condo-specific factors, such as homeowner association fees and shared amenities.
Commonly used forms: Fannie Mae 1073 or Freddie Mac Form 465
Manufactured Home Appraisal Report:
- Overview: This report is tailored explicitly for manufactured homes often built off-site and placed on a permanent foundation. Note: Manufactured Homes do not qualify for investment property purposes if using a conventional loan.
- Usage: When purchasing, selling, or refinancing a manufactured home, this report is often required by lenders.
- Components: While it shares similarities with the 1004 report used for single-family homes, the 1004C emphasizes factors unique to manufactured homes. This includes the home’s production date, manufacturer, and HUD certification labels. It considers the quality of the home’s foundation, its location, and how it’s anchored, among other specifics.
Commonly used forms: Fannie Mae 1004C or Freddie Mac Form 70B
Exterior-Only Inspection Residential Appraisal Report:
- Overview: This more streamlined appraisal focuses only on the property’s exterior.
- Usage: Often used when a complete interior inspection isn’t necessary or feasible, such as for refinancing or home equity lines of credit.
- Components: While less detailed than a full report, it still considers comparable sales and other essential factors, relying heavily on external data sources.
Commonly used forms: Freddie Mac 2055
Knowing which report you’re handling is crucial as we venture further into the appraisal process.
Related: Does a Hard Money Loan Require an Appraisal?
Next, let’s get into reading an appraisal report.
How to Read an Appraisal
The average appraisal will be about 20-30 pages long. Here’s a breakdown based on the Freddie Mac Form 70 with insight into the most important sections:
Subject
This section introduces the property being appraised:
- Property Address: The physical location of the subject property.
- Borrower: This will list the borrower’s name and the owner of public record.
- Legal Description: The legal boundaries and description of the property, including current property taxes.
- Neighborhood Name: The name of the subject property’s neighborhood.
- Occupant: States whether the property is occupied by the; owner, tenant, or is vacant.
- Property Rights Appraised: Specifies whether it’s fee simple, leasehold, or another type of ownership.
- Assignment Type: Defines whether it’s a purchase transaction, refinance, etc.
- Lender Client: Here, you’ll find information about the lender that ordered the appraisal.
Contract
Relevant if the property is under contract for sale.
- Contract Price: The agreed-upon sale price between buyer and seller.
- Date of Contract: When the property went under contract.
- Financial Assistance: Includes information about any loan charges, seller concessions, gifts, or down payment assistance that will be paid by someone other than the borrower.
Neighborhood
This section describes the broader context of the property’s location.
- Neighborhood Characteristics: Defines the:
- Type of neighborhood; urban, suburban, or rural.
- Describes how built-up the area is; a metropolitan city would generally be over 75%.
- Growth of the neighborhood. It is measured as; rapid, stable, or slow.
- Housing Trends: Here, we’ll see the current trends in the neighborhood. This section includes property values, demand/supply, and marketing times.
- Housing: Reveals the; low, high, and predominant ranges for values in the neighborhood and the age of homes in the area.
- Present Land Use: Itemizes the percentage of land use in the neighborhood. Land use includes; single units, 2-4 units, multi-family, commercial, and other uses.
- Neighborhood Boundaries: Defines the limits of the neighborhood.
- Neighborhood Description: The name of the neighborhood and its features.
- Market Conditions: Factors to support what was selected in the “neighborhood characteristics” and “housing trends” sections, including the neighborhood type, urban/suburban/rural, the growth rate, financing trends, and an analysis of current market demand and housing supply in the neighborhood.
Site
This section focuses on the specific plot where the home is located.
- Site Dimensions: The size and shape of the property lot.
- Zoning: The property’s specific zoning classification and description.
- Zoning Compliance: Specifies whether the property’s zoning is; legal, a grandfathered use, has no zoning restrictions, or is illegal.
- Utilities: Lists the present utilities – water, sewage, electricity, etc.
- Off-site Improvements: Things like streets, sidewalks, and other amenities not on the property but impacting its value. One thing that always had me stumped was the term “macadam,” but it turns out that it’s just another word for asphalt.
- FEMA Flood Zone: Here, you’ll find out whether your property is in a designated flood zone, the FEMA map number for your property, and the FEMA map data used.
Improvements
This section discusses the features and conditions of the actual house/building.
- General Description: Here, you’ll find some of the general features of your home, including; the number of units, the number of stories, whether your house is detached, attached, or semi-detached, the architectural style, and the year built.
- Foundation: Description of the type of foundation and if there was any evidence of dampness.
- Exterior Description: Specifies the types of materials used on the exterior of the home and the condition of those components.
- Interior Description: Specifies the types of materials used on the interior of the home and the condition of those components
- Attic: Describes the features of the attic (if one is present).
- Heating and Cooling: Here, you’ll see the specifics of the heating and cooling systems, along with the fuel used for the heating system.
- Amenities: The amenities include fireplaces, pools, decks, etc.
- Car Storage: Specifies if there is any on-site car storage.
- Appliances: Lists the appliances present at the time of inspection.
- Finished Area: Your above-grade square footage, bedroom, and bathroom counts will be listed here.
- Description: The condition of the property, including; needed repairs, renovations, or remodeling. Below this section, you will find statements regarding any adverse conditions affecting livability and if the property conforms to the neighborhood.
Sales Comparison Approach
This is the meat and potatoes of your property’s valuation. This is where the appraiser will show the comparable sales they used and any adjustments they made to arrive at their opinion of value. Let’s explore this line by line:
- Comparable Properties Offered for Sale: Here, you will see the total number of similar properties offered for sale near your property and the price range.
- Comparable Properties Sold: This will tell you how many comparable properties sold near your property within the last 12 months and the sales price range.
Comparable Sales
Next, we’ll find a grid that consists of our property on the left and three comparable properties to the right:
- Features: In this column, you’ll find a list of features generally impacting a property’s valuation. These features include;
- Location,
- View,
- Design,
- Quality of construction,
- Actual age,
- Condition,
- Square footage,
- Room count,
- Heating/cooling and,
- Other amenities.
- Comparable Sales: Listings of similar properties recently sold, their sale price, and adjustments made to account for differences.
- Adjustments: This section shows the value changes made based on the differences between the subject property and the selected comparables. Adjustment figures vary from location to location and are derived from what’s known as a paired sales analysis.
- Net Adjustment (Total): This is the sum of all the adjustments made to a particular comparable. In the example above, Sale #1 has a series of adjustments, but they equal $10,000 when added together.
- Adjusted Sale Price of Comparables: This is where the adjustments are added to the sales price of the selected comparable sale. In the example above, Sale #1 has a net adjustment total of +$10,000; this is then added to the sales price of $166,500, giving us an adjusted sales price of $176,500. Conversely, Sale #2 has a net adjustment total of -$540; when added to the sales price of $145,000, the adjusted sales price of this comparable becomes $144,460 ($145,000 + (-$540) = $144,460).
Data Sources, Transfer History and Indicated Value
Next, on the second half of this page, we’ll find information regarding prior sales of the comparables and a summary of the sales comparison approach:
- Data Source: Lists the data sources used for the selected comparable sales
- Prior Sale or Transfer History: Specifies sale dates, prices, and data sources for the subject and selected comparable sales. As you can see, a lot of forced appreciation is happening here. Sale #1 sold on 05/04/2022 for $60,000 and, after repairs and renovations, sold again in April 2023 for $166,500. Sale #3 sold on 12/07/2021 for $64,000 and was sold in June 2023 for $135,000. The same is true for our subject property; it was acquired in October of 2021 for $45,000 and appraised at $145,000.
- Summary of Sales Comparison Approach: Here, the appraiser will summarize the methods and techniques used to determine the value of the subject property.
- Indicated Value: This is where you will find the opinion of value for your property using the sales comparison approach. This may not be the opinion of value used by the appraiser.
In the next section, we’ll explore how the appraiser will determine the value of your property.
Reconciliation
- Reconciled Value: This is where the appraiser combines insights from various valuation methods to arrive at the final appraised value; these methods include; the sales comparison approach, the cost approach, and the income approach.
- Appraisal Conditions: Determines if the opinion of value in the next section is “as-is” or subject to other conditions such as; completion, repairs, alterations, etc.
- Opinion of Value: The determined opinion of value and effective date.
Cost Approach
The Cost Approach is a valuation method that estimates the value of a property by calculating the cost to replace the existing structure with a similar one, accounting for depreciation. At times an appraiser will also complete this portion of the form to help support their opinion of value:
- Support for the Opinion of Site Value: Here, the appraiser will provide a statement to support their opinion of the property’s land value
- Building Cost: Estimated cost to construct a similar building minus depreciation. Appraisers will often use cost manuals to determine new construction costs.
- Indicated Value by Cost Approach: The combined value from the land and building cost provides one perspective of the property’s worth.
Income Approach
The Income Approach assesses a property’s value based on the potential revenue it could generate, typically through rental income:
- Estimated Monthly Rent: Here, the appraiser will enter the market-supported rent or the rent on the lease if the subject property is tenant occupied.
- Gross Rent Multiplier: The Gross Rent Multiplier (GRM) is a valuation metric representing the ratio between a property’s price and gross rental income. To calculate the GRM, you divide the rent by the property value. In the example above, the appraiser used a GRM of 109 based on market data such as predominant sales prices and rental values for similar properties.
- Indicated Value by Income Approach: This results from multiplying the rent by the selected GRM.
- Summary of Income Approach: The appraiser will describe how they determined the GRM and monthly rent to support their income approach calculation results.
PUD Information
Project Information: If the property is part of a Planned Unit Development, this names the project, the total number of phases, and the number of units. This section will also disclose if there is a homeowners’ association (HOA).
Comparable Rent Schedule
Usually, when refinancing or purchasing a rental property, the lender will require a rent schedule to be completed. Much like the information found in the “Sales Comparison Approach” section, the “comparable rent schedule” section helps an appraiser determine market rents by selecting comparables and applying adjustments to them:
- Item: In this column, you’ll find a list of features that generally impact rent values most. These features include;
- Location,
- Design and appeal,
- Age/condition,
- Room counts and,
- Square footage.
- Comparable Rentals: Listings of similar properties that were recently rented, their rent contract price, and adjustments made to account for any differences.
- Indicated Monthly Market Rent: The adjusted rent price of the selected rental comparables.
Next, we’ll explore what is usually the last major component of an appraisal, a market condition analysis.
Market Conditions
In this section, we’ll find an in-depth analysis of the subject property’s market:
- Inventory Analysis: This section provides insight into; the total number of comparable sales settled, the absorption rate (how quickly homes are selling in the area, indicating market demand), the total number of similar active listings, and the housing supply.
- Price Trends: Information on the median sale & list prices, total days on the market, and the sale-to-list price ratios.
Now that you understand how to read an appraisal report let’s jump into the essential elements of a credible appraisal.
Essential Elements of a Credible Appraisal
For any appraisal to be effective and reliable, especially when making significant real estate decisions, it must uphold specific standards of credibility. Here are the foundational aspects that set apart a credible appraisal:
- Impartiality: A reputable appraiser approaches each task without bias, ensuring an objective evaluation free of external influences or pressures.
- Competence: An appraiser must have the necessary skills, training, and qualifications to appraise the specific type of property in question accurately.
- Data-driven: A reliable appraisal is grounded in factual data, from comparable sales to local market trends and conditions.
- Transparent Methods: Every decision or adjustment made in the appraisal process should be transparently presented and explained within the report.
- Consistency: The appraisal’s findings should remain consistent throughout, with all data and methodologies aligning to support the final value conclusion.
- Regulatory Adherence: The appraisal should adhere to all industry standards and guidelines, such as the Uniform Standards of Professional Appraisal Practice (USPAP).
- Verification: All data sources, especially when it comes to comparable sales or rental data, should be verified for accuracy.
Ensuring these elements are present in an appraisal upholds the report’s integrity. It builds trust among all parties involved in a real estate transaction. When these foundational elements are in place, you can proceed confidently, knowing the appraisal’s insights are accurate and professionally sound.
What to do if You Find an Issue With Your Appraisal?
Even with the best intentions and standards, appraisals sometimes contain errors or overlook certain details. Suppose you, as a real estate investor, believe there’s an issue with the appraisal you’ve received. In that case, handling the situation promptly and professionally is crucial. Here’s a guide to navigating such circumstances:
- Review the appraisal Thoroughly: Before raising concerns, ensure you’ve read the entire report thoroughly, familiarizing yourself with the appraiser’s methods and conclusions.
- Document Specific Concerns: Highlight any areas of contention, whether they are factual errors, questionable adjustments, or omitted relevant data. Clear, specific points will make your concerns more actionable.
- Provide Additional Data: If you can access recent comparable sales or other pertinent data that the appraiser might not have considered, share it. It can support your case and offer a basis for reconsideration.
- Engage with Your Lender: If the appraisal was for financing purposes, communicate your concerns and any evidence you have to your lender. They might have processes in place for addressing appraisal disputes.
Remember, the goal is to ensure the appraisal accurately reflects the property’s market value. By approaching any issues with tact, evidence, and professionalism, you’ll be better positioned to achieve a resolution.
Frequently Asked Questions
The Wrap Up
Understanding how to read an appraisal is invaluable for any real estate investor. With this knowledge, you’ll be better equipped to evaluate a property’s worth, negotiate deals effectively, and ensure that your investments are sound. An appraisal doesn’t just offer a snapshot of a property’s current value; it provides a detailed breakdown of the factors contributing to that valuation.
Always approach appraisals with a discerning eye. Look for the essential elements that denote credibility, and feel free to raise concerns if something seems like it needs to be corrected.
