To anyone whose only experience with real estate has been restricted to buying residential properties it may seem like property appraisers do little more than agree with the sellers' asking price and then collect a paycheck. While this may or may not be true in some cases the methodology employed by appraisers, the good ones at least, should serve as a powerful analysis tool for anyone seriously considering an investment property.
Professional appraisers are required to have passed rigorous tests and usually go through a sort of school for appraiser and may even have some continuing education. The function they perform in the real estate market is an important one that is part determining the value of a property and part just documenting it. Of course the best appraisers have a sense of integrity and a rigid adherence to their methods, but an unexpected appraisal at the last minute can ruin a potentially profitable deal. So while it may be worthwhile to pay for a consultation from a professional appraiser, called an appraisers opinion because it is technically not an actual appraisal, the techniques they use are available to anyone diligent enough to apply them.
Comparable Sales
This is essentially the same appraisal technique used in residential real estate. Basically the appraiser will find some properties that are as similar as possible to the one being appraised. To make the appraisal as realistic as possible, they will ideally include some properties for sale, some that are recently sold, and even some that are pending. Since two properties are rarely very similar, however, the appraiser will make adjustments as necessary, adding or deducting a certain amount based on the presence or absence of the properties' features: swimming pool, plus $1,500; no garage, minus $3,000; etc. This is basically the same procedure used for income properties with a few minor exceptions; depending on the property price per square foot might be a strong factor to consider or for multi-unit residential properties price per unit often comes into play. The drawback of this approach is that many areas are too small to find a suitable group of properties for comparison, and in a quickly changing, up or down, market it may not be very relevant.
This is essentially the same appraisal technique used in residential real estate. Basically the appraiser will find some properties that are as similar as possible to the one being appraised. To make the appraisal as realistic as possible, they will ideally include some properties for sale, some that are recently sold, and even some that are pending. Since two properties are rarely very similar, however, the appraiser will make adjustments as necessary, adding or deducting a certain amount based on the presence or absence of the properties' features: swimming pool, plus $1,500; no garage, minus $3,000; etc. This is basically the same procedure used for income properties with a few minor exceptions; depending on the property price per square foot might be a strong factor to consider or for multi-unit residential properties price per unit often comes into play. The drawback of this approach is that many areas are too small to find a suitable group of properties for comparison, and in a quickly changing, up or down, market it may not be very relevant.
Cost to Replace
This is an older technique that is really only useful in special cases, such as new construction. The idea behind this approach is too determine how expensive it would be to rebuild the building from scratch. To arrive at this conclusion the appraiser first determines the inherent value of the land, given its current zoning, minus any buildings or structures on it, then estimates, usually on a cost per square foot basis, the price to build an exact replica of the current structure. Again, this approach is most relevant for new construction, since the depreciation of the existing structure must be deducted from the estimated building cost.
This is an older technique that is really only useful in special cases, such as new construction. The idea behind this approach is too determine how expensive it would be to rebuild the building from scratch. To arrive at this conclusion the appraiser first determines the inherent value of the land, given its current zoning, minus any buildings or structures on it, then estimates, usually on a cost per square foot basis, the price to build an exact replica of the current structure. Again, this approach is most relevant for new construction, since the depreciation of the existing structure must be deducted from the estimated building cost.
Income Based
The single most rational approach to appraising an income producing property, the income based approach actually looks at the NOI, net operating income. The NOI is the gross income minus the vacancy rate minus any expenses, but not including the mortgage. By dividing the NOI by the sales price the CAP rate, or capitalization rate, is determined. Typically for any area there is an average CAP rate for any given type of property, retail may be 7%, office may be 6%, etc. Once the CAP rate is determined, however the appraisal essentially reverts to a simple comparison, based this time on the differing CAP rates.
The single most rational approach to appraising an income producing property, the income based approach actually looks at the NOI, net operating income. The NOI is the gross income minus the vacancy rate minus any expenses, but not including the mortgage. By dividing the NOI by the sales price the CAP rate, or capitalization rate, is determined. Typically for any area there is an average CAP rate for any given type of property, retail may be 7%, office may be 6%, etc. Once the CAP rate is determined, however the appraisal essentially reverts to a simple comparison, based this time on the differing CAP rates.
Although it takes some schooling and a considerable amount of experience to reach the level of a skilled, professional property appraiser, with an awareness of the techniques they employ anyone can become a much savvier investor.