Appraisals are a large component of being approved for a loan. There are a variety of appraisal methods used to evaluate property value. These appraisal methods vary based on the type of property you’re purchasing. Whether you’re purchasing a single-family home, a property with income potential or commercial property your appraisal is going to look a bit different.
Here are 3 common home appraisal methods used to assess property value:
1. The Sales Comparison Appraisal Method
The first appraisal method used to assess property value is the sales comparison method. This method is used for standard, single-family homes and is the most common method as the information collected is required for a typical mortgage. How a sales comparison appraisal works is similar homes in the surrounding area, also know as “Comparables” are pulled to get an idea about the value of surrounding similar properties. Then, adjustments are made to the appraisal value based on differences between the house you’re purchasing and the comparables pulled. For example, let’s say the house you’re trying to purchase has a newly remodeled kitchen that is of higher quality than the properties it’s being compared to. This will increase your appraisal value. On the other hand, if the home is in worse shape, or on a smaller lot than the comparables, it will drop the appraisal value. This method helps ensure that a fair value is determined for the home, and that a bank can move forward with offering a loan for the purchase that’s backed by value data.
2. The Income Appraisal Method
The second appraisal method used to assess property value is the income approach. The income approach is used to evaluate properties that have income potential. This includes apartment buildings or office buildings that will have tenants, and single or double family homes with rentable space. Using an income approach, the appraiser with evaluate the property’s income potential. Let’s say it’s an apartment complex with 10 rooms. The property buyer could give data about what rate those rooms will be rented at to give an idea about the gross income potential. From there that number is compared to the costs associated with acquiring the property and other overhead costs to figure out what the property’s value is.
This approach is also used for single or double family homes that could potentially have income property. First, the value of the property is calculated using the sales comparison method outline above. Then the “Gross Income Multiplier” is calculated, or in other words the monthly income that could be made by renting out the property. Once the GIM (GIM = Sales Price/ Rental Income) is calculated, the appraiser will then calculate the value of the property by multiplying the GIM by the rental income potential. This allows the property value to be adjusted according to non-commercial income potential.
3. The Cost Appraisal Method
The final appraisal method used to assess property value is the cost appraisal method. This method is typically used for commercial property that will not be used as an income property, or larger properties that have to be built from the ground up or drastically remodeled. It’s also used for properties that aren’t sold as frequently as a single-family homes. How the cost appraisal method works is the land and property are assessed separately to get an understanding of what the overall value would be. Next, the depreciation that could potentially take place over time is taken into consideration and deducted from the value amount. Similar existing buildings will also be assessed to ensure that the value is on par in comparison to other properties. Once all of these things are taken into consideration an overall property value will be calculated.
Overall, when buying a new home, the appraisal method you’re dealing with is the sales comparison method. However, the other appraisal methods are used if you have a property with income potential or are making a commercial purchase. An appraisal is a key component to getting approved for the right loan amount so having a better understanding of what a home appraiser takes into consideration can help you be better prepared for the appraisal.
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