How Is a Home’s Value Calculated?
When you buy a home, a mortgage lender will want to know whether the house you are interested in buying is worth the amount you are willing to spend. They need to check out the house for anything that can devalue or increase the property’s worth. To do this, they require home appraisals for all borrowers.
The bottom line: Thanks to an appraisal, you know you won’t be paying more than it’s worth. Period.
There are still risks with an appraisal.
Unfortunately, an appraisal won’t be ordered and completed until you’re already under contract on the purchase of the property.
If the home ends up appraising for less than your contract price states, the seller has two options:
Reduce the price of the home & amend the contract to reflect the appraisal value
If the seller can afford to this, then it may be amended without any need to compromise on the buyer’s end
If the seller can’t afford this option, the buyer may try to renegotiate the contract to help the seller arrive at a more comfortable option. (i.e. reducing the amount of seller-paid closing costs or removing a seller-paid home warranty)
— OR —
Take the home off the market
The seller may not be able to afford to reduce the price to the appraisal value. While this protects your long-term assets, your short-term assets could be affected in a few ways: You more than likely would have already invested money in a home inspection on a property that you no longer have the interest to purchase Since the appraisal has already been completed, the appraiser has done his job and must be paid. The cost of the appraisal is normally covered as part of closing costs, to be paid at closing. While it's common for the seller to have agreed to contribute to the buyer's closing costs, since the transaction would technically not be closing in this case, they are unfortunately not required to pay any “closing costs”. Therefore, the buyer would be responsible for covering the cost of the appraisal as soon as reasonably possible.
A Comparative Market Analysis can help.
A comparative market analysis is an examination of the prices at which similar, nearby homes have recently sold.
Unlike appraisals, CMAs don’t typically mention the home in question. Instead, the focus is on what is happening the local market. It details the value of similar homes in terms of age, condition, size, and several other traits. By looking only at sold properties — as opposed to homes that are currently on the market — CMAs provide factual evaluation of market values in the area.
These are completed by a real estate agent to establish a listing price for a seller, or for a potential buyer to help guide an offer amount.
When you’re interested in a property, I will conduct thorough research and prepare a comparative market analysis report that gives you information about houses similar to the subject property that have sold within a reasonably recent time period. CMAs, while based on data, are still very subjective. When looking at comparable properties, it may be hard to account for things such as curb appeal, desirability of the home’s architectural style, etc. This is where my expertise will come in.
A comparative market analysis can:
Help you determine an acceptable offering price
Potentially save you from investing in a property that won’t be able to appraise for the seller’s bottom dollar
How are listings compared?
Age— The homes being compared should have been built around the same time. A house constructed in the last 10 years may have a higher price than one built 40 years ago—even if they are next door to each other.
of Bedrooms and Bathrooms — High atop the wish-lists of many home buyers, the bedroom/bathroom count has a major influence on home value, no matter the size of the home. If you have a three-bedroom home in a neighborhood of mostly two-bedroom homes, that home will be at a considerable advantage.
Condition/Upgrades — A home’s condition can be subjective and difficult to quantify, but it’s crucial to note recent upgrades or dated features that can swing a home’s value up or down. A home that is in good condition will cost more than a property that needs a lot of work to become livable. The reason most automated home valuations miss the mark is because they don’t factor updates like a renovated kitchen or newly finished basement.
Amenities — Features such as a fence, workshop, sunrooms, and even an energy-efficient A/C unit may also raise the price of a house. For example, a home with a swimming pool may garner a higher price (unless, of course, it is in poor shape, which could detract from the home’s value). Keep in mind, the cost of adding these features to a home will likely be more than how much they increase a home’s sales price.
Location—This has the biggest effect on how much a home is worth. Although it’s largely a matter of the neighborhood—particularly the school district in which the property is located—there can even be differences within a single neighborhood. If one house has a corner lot or lake view, for example, it will have a higher price than a similar one facing a warehouse. Likewise, a property with a noisy freeway within earshot will affect marketability and desirability, which will directly impact its days on market and sales price. While it’s ideal to focus on properties that are within a one-mile radius of the subject property, if the property is located in a rural area, homes may be much more spread out, so a one-mile radius may not be enough.
Square footage— Size definitely matters. For a home to be truly comparable, it should be within 20 square feet of the size of the subject property. Houses with more square footage are worth less per square foot than smaller houses. So the houses compared should be as close to the same square footage as possible, give or take 200-400 sq. ft.
CMAs are calculated using price per square foot.
A CMA approach considers a subject’s property’s price per square foot to be of the same value of the comparable property’s price per square foot.
Therefore, a subject property's comparative market value is calculated by finding the median price per square foot of the comparable properties.
Then, the subject property’s square footage is multiplied by the median price per square foot to determine its comparative market value.
Potential obstacles in finding comparable properties.
It’s ideal to have your CMA look back no more than three months when the market is in transition, and no more than six months in a more stable market. If the property is located in an area where the market is somewhat sluggish, we may have to reach out to other comparable areas for comps.
If the property is unique to its area, there may be issues finding comparable properties. In this case, we can take a couple approaches:
Look at recently sold properties within the same price range to determine what other buyers were willing to purchase at a similar cost.
Do a cost-approach analysis.
Example: Identify a property that is the most comparable in size and location. Add the value (not the cost) of the subject property’s unique amenities to the comparable property’s sales price.
CMAs differ from appraisals.
A CMA is different from an appraisal, which is a comprehensive evaluation of a property that’s performed by an appraiser and used to qualify the home for a mortgage. The appraisal report contains physical data on the subject property including gross living area, materials of construction, and a description of its condition as well as the size of the lot it is on. Photographs of the exterior and interior features are included as well as items that may need repair. Information about the immediate neighborhood and surrounding community is also analyzed because they have a direct bearing on a properties value.
An appraisal is an opinion of the likely sales price based on recent closed and pending sales, and taking into consideration the existing inventory of homes. The appraisal has to meet lender and underwriter guidelines, therefore the sales that are used have to meet certain criteria relating to time of sale, distance of the comparable from the subject, and percentage adjustment guidelines.
