A real estate appraisal is an objective, qualified, trained opinion of value of a real estate property. To render an accurate estimation of a property’s value, the appraiser requires significant knowledge and experience. Appraisers are schooled to look at the property objectively, not subjectively. They examine the house as if it were vacant. The appraiser will view the house as if empty with four walls, a roof and a floor. In many instances, a buyers perception of value can be influenced by the owners furniture and décor.

The report the appraiser provides is a comprehensive and detailed written commentary that shows how the property’s value was derived. Typically, significant weight is placed on recent sales in the immediate neighbourhood.

Why is an appraisal required?

There are many reasons why an appraisal may be required, including: refinancing, divorce settlements, probate (dealing with the will of a deceased), and challenging the value used in determining an owner’s property taxes.

Of course, the most common reason for an appraisal is to obtain a mortgage.

If the loan is a conventional mortgage (a mortgage with a down payment of 25% or more) a lender will order an appraisal to ensure the purchase price is equal to or greater than the appraised value. If the appraisal is less than the purchase price, the lender will only permit a loan based on the appraised value rather than on the purchase price.

On the other hand, if the loan is a high ratio mortgage (a property acquired with less than a 25% down payment), the insurer (Canadian Mortgage and Housing Corporation or Genworth Financial Canada) will determine if the property value is consistent within the neighborhood range. If it is then, in many instances, a full appraisal is not required.

If you are buying a home where the owner is taking back a first mortgage, it would be well worth the cost to hire an independent appraiser to ensure you are not paying more than the value of the property. The reason is, with a vendor take back mortgage, it isn’t necessary to obtain an appraisal.

Methods of Appraising Residential Real Estate

The most commonly used approach to valuing a real estate property is the direct comparison approach. This method relies on an analysis of recent neighbourhood sales, with adjustments made for any differences, such as square footage, number of bedrooms, number of fireplaces and the condition of the property, to name a few.

In this method, the appraisal report is very concise. The data is entered on a form and the assigned values for differences in the properties are recorded. After the adjustments are made, the appraiser will establish the value of the subject property. Generally speaking, the analysis should include a minimum of three verifiable sales and their photos. Properties that are on the market and expired listings do not establish market value and aren’t used in this analysis. While it is important as a seller to know what your competition is, the asking price of these properties have no bearing on your property’s value. Data of a seller that prices his home significantly higher than the prevailing market prices is meaningless to an appraisal report. The only statistics that are deemed relevant come from actual sales.

The other method used to determine real estate values is the cost approach. With this technique, the appraisal will determine the replacement cost of both the land and the building’s physical structure.

Unfortunately though, with both land values and constructions costs escalating, the replacement cost of a property may not accurately reflect its value.

For example, let's assume a 3,000 square foot home in Mississauga is selling for $600,000 (of course this figure will vary considerably based on location, improvements, etc.) Provided below is an illustration of the potential replacement costs:

Land cost: $250,000 to $350,000

Construction costs: $450,000 to $600,000

($150 to $200 sq. ft)

Total Costs: $700,000 to $900,000

(Land and construction costs vary widely.)

This example demonstrates the large disparity between the direct comparison approach and the cost approach. In most instances, the direct approach to determining a property’s appraisal is given the most weight as it more accurately reflects the property’s value in the open marketplace. However, one instance where the cost approach is utilized is with insurance companies because a figure needs to be established as to the cost of replacing the structure if it were destroyed.

I want to underline that it is important to understand the distinction between a CMA (current market analysis) and an appraisal. A CMA is prepared by a realtor to help sellers determine a realistic asking price. Although an experienced realtor’s opinion of the property’s value should closely match an appraised value, an appraiser’s report is typically more detailed and comprehensive. For financing purposes, the lender will only accept an appraisal conducted by a certified appraiser.

Inconsistencies in Appraisals

In theory, there should only be very small variations in appraisals that are conducted by different firms. This is particularly true with homogeneous (similar) type properties in subdivisions. However, there have been instances where two appraisers (both accredited) have derived figures that vary significantly. This may be the result of the appraiser using different data to establish the property’s value and/or the appraiser placing different values on the subject properties improvements/upgrades.

In my experience over the years, I have seen residential appraisals vary by as much as 25%. This is far too great of a disparity. When two appraisals are required (for example, in a separation or a divorce), these variances create problems for the homeowner(s). Unfortunately, in these rare instances, a third appraisal may be required. If you have an appraisal that you aren’t satisfied with, I would recommend reviewing comparable sales in your neighbourhood. If the appraiser isn't familiar with your immediate neighbourhood, he may be drawing off the "wrong" data.

I trust this article has helped give you a better understanding of the appraisal process.