Ever thought about the logic behind the value of real estate? Why should a three bedroom home in L.A. cost hundreds of thousands more than a similar three bedroom home in Nashville? It can be disorienting to compare homes, but there’s a method to the madness.
Research and statistics go into determining what a home’s worth. Independent research organizations and government agencies track tons of data regarding the real estate market. Where and what kind of homes are selling, and what people across the country are paying for property.
Home appraisals are pretty standard for any home bought with a mortgage loan. If a bank lends you $300,000, it wants to be certain that the value of your home choice is at least worth the amount of your loan.
There is first an appraisal inspection, not to be confused with a home inspection. The appraisal inspector is looking to confirm basic things like: Habitability, amount of included land, obvious signs of damage, accurately reported updates, etc. The inspector will assess the home exterior, all interior requirements, and will consider any features that may or may not play a role in their assessment.
Pulling data on similar homes in your neighborhood is the next step. These homes are all comparables or comps. Appraisers look for homes that match bedrooms and square footage. Lenders often have specific requirements for comp homes: Within close proximity, sold within the past 6 months, etc. Sometimes there may not be enough sales in a particular neighborhood, so the appraiser must dig deeper to find suitable comps to supply to the lender.
Lastly, the appraiser provides the lender with a final appraisal report. This report will combine all information from the inspection and comparable homes, resulting in the homes “market value.” This value is the true value of the property in its current condition. It is impartial, fact based, and intended to help the lender weigh the risk of approving the borrowers loan.
All Real Estate is Local
The U.S. is a big country with hundreds of major cities and thousands of small towns, each unique. What’s going on at the local level often determines what a home is worth.
Supply and Demand
How many homes are up for sale and how many people are looking to purchase in that area plays a huge role in worth. When there are plenty of homes available and few buyers, prices drop. The opposite occurs when an area is very desirable, but there are not enough homes.
A nice park, trendy retail area or restaurants can be worth more than a similar home that is further away. School districts have a sizable effect, too. Homes in a top school district often hold their value better in an economic downturn.
Local Comparable Sales
In a neighborhood where homes have sold for more than asking, a similar home may be able to command an up-sized price point. This can work against you. If nearby homes sold for less than they’re worth, you may end up with lower bids.
Unusual features or history, investment or renovation potential may sell a home for more. High interest rates, weak job sector, or tightened requirements for borrowers also come into play sending prices higher or lower.
How Homes Get their Price Tag
An appraiser considers all data records and local perks to determine price. A lender will require this report to ensure the loan they provide is not worth more than your new home.
Automated valuation models (AVM)
An automated valuation model can speed up the property appraisal process. It takes time for an appraiser to research comp homes that fit specific requirements and longer yet to compile a final report. With an AVM, all that work can be completed in a few moments, giving an estimated property valuation to a lender, agent, appraiser, and the buyer, instantly.
An AVM is a computer model that is comprised of a series of algorithms that crunch multiple sources of data to answer the query. This means finding online records of comparable home sales and property details, tax assessment data, and pricing trends.
The pros and cons of AVMs
AVMs are quick and reduce cost for lenders, agents, or appraisers looking for a reliable property estimate. They’ve been around for 20 some years, and have become much more sophisticated over time. Current data records are easily accessible online, algorithms more refined, and there is a strong track record of reliability.
Like anything, AVMs have limitations. The most obvious is the lack of physical property assessment. While this saves time, there is no appraiser to verify square footage, factor in a broken furnace, etc. Beyond this in person inspection, an appraiser can easily catch mistakes in a tax assessment, spot unique trends in the local housing market, and make rational choices from conflicting data.
Valuation estimate vs. appraisal
While AVMs haven’t yet replaced the appraisal process altogether, they’ve greatly expanded access to reliable price estimate data for lenders, brokers, and appraisers, not to mention buyers and sellers as well. So enjoy the access to this new technology. But just keep in mind that when it comes to AVMs you’re getting an estimate, which may differ from a more thorough home appraisal.
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