Introduction to appraisal

When a buyer locates property and contracts to buy it, the property needs to be qualified as collateral when mortgage financing is involved. As collateral, the property needs to provide adequate security for the repayment of the mortgage in the event of a default.

This task of valuation falls to a third-party to the transaction who is indirectly hired by the lender. This individual is known as a real estate appraiser.

An appraisal is an individual’s opinion or estimate of a property’s value on a specific date, reduced to writing in an appraisal report.

The appraisal report contains data collected and analyzed by the appraiser which substantiates the appraiser’s opinion of the property’s value. The value of a parcel of real estate, given as a dollar amount, is the present worth to an owner of the future flow of net operating income (NOI) generated by the property.

Factors used in the appraisal process to determine a property’s value include:

  • demand – the number of buyers for the property;
  • utility – the property’s possible uses;
  • scarcity – the availability of similar properties; and
  • transferability – the seller’s ability to transfer good title to a buyer clear of all encumbrances itemized in a title insurance policy.

Collectively, these are known as the elements of value and can be memorized with the acronym of DUST.

Further, there are forces that influence value, including:

  • physical considerations – the property’s proximity to commercial amenities, access to transportation, the availability of freeways, beaches, lakes, hills, etc;
  • economic considerations – rents in the area, vacancies and the percentage of homeownership, as well as employment opportunities lost or gained;
  • government considerations – property taxes, zoning, building codes, and local services such as police and fire protection; and
  • social considerations – crime rates, school ratings, shopping and recreational opportunities.

These forces that influence value can be memorized with the acronym of PEGS.

Factors not used to determine a property’s value include the present owner’s:

  • acquisition cost;
  • listing price;
  • mortgage financing; and
  • equity in the property.

There are many different types of values assigned to a property. In real estate appraisal, the most common type of value used is market value, also called fair market value (FMV).

The FMV of a property is the highest price on the date of valuation a willing seller and buyer would agree to, both having full knowledge of the property’s various uses. [Calif. Code of Civil Procedures §1263.320]