Buying, selling or refinancing Real Estate can be one of the biggest financial transactions an individual or couple may face in life. Then why does it seem like the bank or our lender has all the say?

I find many of us struggle to find a way to accurately value our current holdings and future projects outside of actually hiring an appraiser or finding a Realtor to run a “Market Analysis” that is even remotely close to what a bank may be willing to accept as we approach a closing.

If you have found yourself asking this question or relying on Zillow Estimates, this blog, although a bit more technical than most of our blog posts, may be helpful.

My uncle taught Architecture and Drafting at a High School in Maine for 30+ years and he always said the same thing over and over. “I don’t care if any of my students become architects… If they do great. My real goal is to help students learn how to look at plans, read plans and better serve them when they go to renovate their future homes to be able to understand what they want, articulate what they want and ensure contractors deliver what they want”.

My goal with today's blog is roughly the same. You will not be a market expert by the end of today, nor will you be ready to apply for a role as an Appraiser. What I do hope is that you can talk the talk which will help you walk the walk when negotiating with banks, appraisers and potential buyers and sellers.

Let’s explore the three main ways appraisers come to a value on your property.

Sales Comparison Approach - 

The sales comparison approach is by far going to be the most common approach to valuing a home or investment property.

Like a realtor would, the appraiser typically finds 3 - 6 properties similar to yours but they tend to dive a bit deeper than a realtor would. An appraiser is going to look at a number of factors including -

Language from my appraiser - “The sales comparison approach to value involves direct comparison of the property being appraised to similar properties that have sold in the same or in a similar market in order to derive a market value indication for the property being appraised. 

Although individual sales may deviate from a market norm, a sufficient number tends to produce a pattern indicating the action of typical buyers and sellers. The resulting pattern provides a good indication of market value.”

Using the information they gather from the five bullet points above, they then use multiples to bring the other properties into a range where they feel good about your valuation. 

Example

Your property is 1,900 sq ft and the Comparison property is 2,000.

***The appraiser may take the 2,000 sq ft and multiply it by 0.95 to more accurately gauge your valuation based on square footage. This can be done for any category ranging from Sales Price per Square Foot to Physical Attributes (see chart at the bottom).

If you are going to jump on Zillow, I would recommend ONLY looking at “Sold” properties over the last 6 months as a starting point for your own comparables. Do NOT use current listings under any circumstance.

A good realtor with the right technology can also help you with a fairly accurate CMA or Comparative Market Analysis.

Income Approach - 

This is my favorite approach and if you are an active investor or want to be, this will be yours too. Why? Because YOU and YOU alone are in control of the value of your building. You don't have to wait for markets to shift, other people to sell or the stars to align.

The income approach only cares about one thing, income! Shocking right…

Language from my appraiser - “Income-producing property is typically purchased as an investment, and the projected income stream is the critical factor affecting its market value.”

To me, this simply means, if you can drive up rental income and/or drive down expenses, your property immediately becomes more valuable. Let’s look at the formula used to help us solve this problem.

Net Operating Income: Net operating income is the income remaining after all operating expenses have been satisfied.

Capitalization Rate: Metric that helps investors determine a potential rate of return on investment. Cap Rate Ranges are typically given, example below - 

Broker’s Opinions 7.0% to 9.50%

Sales Extraction 8.50%

Band of Investments 9.58%

Investment Survey (PWC) 8.61%

Investment Survey (RealtyRates) 8.56%

Using all of this information the appraiser will make a final decision on the number. 

Let’s say for this example, they settled on 9% and you know your building makes $57,245 after expenses every year (excluding mortgage). This allows us to quickly find the value of our building using the income approach.

You can also work the formula backward if needed to help you communicate you current CAP Rate to investors. For example, if you know you want $900,000 for a building that makes you $87,000 a year after expenses.

Net Operating Income: $87,000 / $900,000 Ask = CAP Rate of 9.66%

This can feel overly complicated the first time through but I promise you if you grab your calculator on your phone and try a few different examples on your own, you will not only understand this but you will be able to hold your own in a conversation with any investor, no matter how seasoned.

Cost Approach - 

This is not commonly used in today’s world due to the constantly changing landscape of construction and the cost associated. It is used so rarely now that it has not appeared in any of our last 4 appraisals.

Then why bring it up? If your bank or appraiser is having a hard time finding comps and if your property isn't necessarily designed to be an income producing property, then this may be the only good option left.

If you've made it this far, please know everything is negotiable. If you don't like the CAP Rate an appraiser uses to value your house, push back. If you don't like one of the comps they used in the comparable, ask them to toss it out or replace it with one of your choosing. If the appraiser won't budge on the valuation, maybe the bank will bend on their typical LTV (Loan to Value) with proper supporting documentation.

Now that you know what banks and appraisers are ultimately looking for, you can work to improve on your own situation before selling or use these points to your strategic advantage when buying.