How do appraisers make adjustments?
During a recent talk at a local real estate agents office I was asked a question about how do appraisers make adjustments. As a follow up they also wanted to know if these adjustments would be available to them to help in pricing their homes. This is a very good question and one that I have heard asked often over the years so I thought I would share my thoughts on this with you.
There is a misconception that there is one master list of appraisal adjustments that work for every appraisal, however this master list does not exist because every property is different. As you well know location is paramount in property values and each location will require a different adjustment based on what the market will pay for a particular feature. The appraisers job is to analyze the market and determine what the appropriate adjustment is for the property. There are several methods that appraisers use so lets take a look at them and house they are used.
Methods Appraisers Use To Adjustments
There are several methods I’ll share with you here and they include the Sales Comparison-Paired Data Analysis, Income Capitalization Approach, Cost Less Depreciation, and Buyer Interviews.
Sales Comparison-Paired Data Analysis
The sales comparison and paired data analysis is the easiest to do IF you have appropriate comparable sales. The idea behind this method is that you find two different sales that are alike in all features except for one. The sales prices are analyzed to determine the difference in price attributed to this one feature and then you determine if the feature is beneficial or detrimental. For example, if two homes sold, one for $150,000 and the other for $155,000, and the only difference was that the one that sold for $155,000 had a one car garage, you would then determine that this feature was beneficial, meaning that the house sold for more because it had a garage and the amount of the adjustment would be $5,000.
You can take this approach one step further by using additional sales to extract and support adjustments when there is more than one difference. After you find the adjustment amount for the first feature and adjust for it you can isolate the value difference for the secondary feature. The real estate market is not perfect because you have people acting on their likes, dislikes and emotions. If it were a perfect market all of the sales would have a similar adjusted sales price, however this is not the case and there are variations that the appraiser must reconcile when reporting their final opinion of value.
Income Capitalization Approach
This approach is based on the premise that differences in property features are reflected in the amount of rent that you can get for the property. It consists of collecting similar home sales, then adjusting for differences that affect the sale price but not the rental rate. After you have a cash equivalent value you determine the gross rent multiplier (GRM) by dividing the adjusted sale price by the monthly rental amount.
After calculating a GRM you then determine the rental difference that a feature causes. An example might be a three bedroom home compared to a four bedroom home. If the four bedroom home rents for $100 more per month than the three bedroom home, and the GRM is 105, the adjustments amount would be $100 x 105 = $10,500. This method is best used for properties in a market where there is numerous and reliable rental data.
Cost Less Depreciation
This method utilizes construction costs as well as depreciation estimates, which is value that is lost due to wear and tear on the component. This approach is usually the quickest and easiest to use because appraisers are very familiar with cost figures. It consists of calculating the cost of a feature and then deducting the depreciation from it to arrive at the depreciated value of the item. It is very important to be able to estimate every form of depreciation so that the adjustment is as accurate as possible. This approach would be handy when there is not enough sales data to do a matched pair analysis.
The last way an appraiser can come up with adjustment amounts is by interviewing buyers. When buyers are going through negotiations while buying a house they usually place varying degrees of value on different features. By speaking with the buyers and asking them how much value they placed on a feature we can develop an estimate of the features contributory value. This can vary between buyers depending on how they feel about the feature.
These are the various ways to come up with adjustment amounts and it will depend on the market you are in as to what method is the best to use. Appraising is not an exact science so adjustment amounts can vary, and as you can see there cannot be one book of adjustments that fit every house.
Do you have any questions about why appraisers do what they do, or how they do it? Leave me a message below and I’ll be sure to answer it for you.