The entire point of ordering an appraisal is to be more certain of the value of a property. It makes sense that if you’re going to order an appraisal, to look for reports that will reduce your risk. There are some simple things you can do to reduce the potential for claims due to faulty reports.
When the valuation comes in low, it not only undercuts the potential returns by limiting potential financing, it also creates complications with buyers, sellers, and agents who will call to complain about the report. For many parties to the transaction, including real estate professionals, a low valuation can mean a lost buyer and failed escrow if the buyer doesn’t have the funds to cover the difference between the purchase price and appraised value.
High Real Estate Appraisals
High valuations are the potentially more disastrous outcome of an inaccurate appraisal. If the value comes in higher than expected, look at the comp selection and the particular neighborhoods that the comparables are located in. If the appraiser isn’t familiar with the community, or hasn’t actually seen the community, comparables may not accurately reflect the economic factors influencing our subject. Although a comparable is similar in square footage, stories, or age, it may be in a more desirable community, or be in better condition. Check that the adjustments to the comparables are cumulatively negative when they are marked as superior to the subject, and positive when inferior.
Lack of Local Expertise
Appraisers without local knowledge will miss important market factors influencing the value of the property, both positively and negatively. It’s important that an appraiser have several years of experience in a particular market before being relied upon to provide the highest-level reports. As the real estate market’s cycle is long in scale, it takes years for a professional to understand market trends and how current conditions will precipitate future growth or decline. National appraisal management firms will often send an appraiser hundreds of miles if they don’t have a local appraisers on the roster (without mentioning the fact to clients).
Incorrect or Incomplete Valuation Approach
Are we taking the correct approach here?
I mean the comparison, income, and cost approaches to be clear. What’s the best methodology for your particular property type? It’s a common error when a multifamily property appraisal neglects to provide an estimate of value based on the income. To make quality investment decisions, we need to understand metrics including the gross rent multiplier, capitalization rate, rent to income ratio, and what they mean for the potential value of the property. If the property represents a relatively high degree of risk, the appraiser must utilize a cap rate that is appropriate considering what is currently demanded by investors.
High risk equals a high rate and demands a lower price. Low risk and low cap rates yield higher values. The only way to know what the prevailing cap rate is, is by researching the market and analyzing the outcome of similar recent transactions. You could also ask local investors what cap rate they expect, but closed transactions speak louder than words (try both). The income approach to valuation utilizes the cap rate and the annual net operating income to estimate the value. For properties that generate rental cash flow and are non-owner occupied, it is prudent to consider the income’s effect on value.
Neglecting to Adjust for Appreciation or Decline
It could be that the reason for the mysterious valuation result is a failure to adjust for fluctuations in market value. If the market absorption rate is less than 2 months, it’s a good signal that the market is moving quickly and adjustments for appreciation are in order. In the case of a declining market, adjustments for depreciation give a more accurate valuation. Also take a look at the adjustments to make sure that each makes senses and helps narrow the likely window of value. If the adjustments are excessive, it may indicate that the comparable is too dissimilar to be suitable for the report.
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