Last week we outlined how home appraisers gather and measure the qualities of a house based on its neighborhood, site, and home improvements. Now we will try to explain how they use visual impressions and hard information to determine the market value of a home.

As was stated earlier, the appraiser reaches a value through three methods. The first is the cost approach - what would it cost to replicate the house in its current location? The second is the Sales Comparison Analysis. The third, the income method, is typically used only if the home is in an area with a lot of rental properties.

The cost approach is a best estimate of what it would take to replace the existing structure at current market rates. Appraisers first assign a value to the lot or site on which the home is situated. In the case of our $145,000 example, the 19,780 square foot site is valued at $30,500 based on current sales of both vacant and improved land. Our example reflects the abundance of local land available. In the more congested Northeast and in California it is not unusual to find a desirable site valued far higher than the house itself.

With the value of the site established, the appraiser uses data compiled by publishers such as Marshall & Swift and information from local builders to arrive at a reproduction cost on a per square foot (psf) basis. This is done separately for the heated and (if relevant) air conditioned portion of the house (1,845 square feet in our example) and, for any garages, porches, or patios. The psf value is a figure reflecting local labor and material costs and the quality of the structure being reproduced. Our example is slightly above average in terms of construction and material; the porch is a pre-fab on a concrete slab, and the garage is pretty typical of most garages. The appraiser calculated a replacement cost of $70.50 psf for the house and 25.50 for the porch and garage. This results in a replacement cost of $130,073 (1845 x 70.50) for the house and $18,550 for the enclosed porch and a couple of small unenclosed porch/patio areas and $13,158 for the 516 sq. ft garage for a total value (excluding site) of 161,781.

Next the appraiser depreciates the value of the existing house - in our example this is done using the Age/Life Method. Our house was given a 60 year life expectancy and a remaining life was determined. The appraiser considers age and condition (as well as a little "gut instinct" according to an appraiser we interviewed.) Our subject is 38 years old and was assigned a remaining usable life of 40 years. Based on this, the improvements were depreciated 33% or $53,388 leaving a depreciated value of $108,393. Add back in the value of the lot and $7,500 "as is" value of site improvements (landscaping, fencing, outbuildings) and the cost approach yields a value of $146,393.

The second and more important method used by appraisers is the comparison analysis.

Appraisers identify homes that have sold recently in the "neighborhood." Lenders generally expect appraisals that analyze three comparables, although unusual properties might require more. Proximity is the key to good comparables, proximity in both timing and location. The ideal is to use sales that have concluded within six months of the appraisal and within one mile of the subject property.

In rural areas or in those with a slow moving market, meeting both of these goals, maybe even one, can be difficult. The use of comparables is also problematic when dealing with a very unique property. Fortunately, our example was very straight-forward.

The appraiser identified four very similar properties, all within .07 mile of our subject. Two of them had sold outside of the six month parameter (exactly eight months in both cases), one had closed only a few days before the appraisal, and one two months earlier. Average time on market in the subject area is four to six months so eight-month old comparables are reasonable. In a fast moving and rapidly appreciating market like Boston or Las Vegas, an appraiser would find it tough to justify comparables that were more than two or three months old and, were they used, would have to adjust values to reflect appreciation.

Properties are then evaluated on a list of criteria. Those that are not instantly familiar are:

Sales or financing concessions: did the seller agree to perform repairs on the property or offer inducements like paying closing costs or carrying first or second mortgage financing?.

Leaseholds (this identifies properties that may have a legal basis different from the subject.)

Functional utility: Is the property inhabitable? Might it have a higher and better use?

In each of these categories our four properties were identical; there were no sales or financing concessions or premiums, all were sold on a fee simple basis and had good functional utility. There were other criteria that we eliminated from the chart below because of space: basement, none of our homes had one; heating or cooling (all had central heat and air), quality of construction (good) and quality of construction ("good" in each case.) Also because of space, we included only two of the four comparables, the two that differed the most from the subject property.

Description Subject Comp #1 Adj Comp #2 Adj
Sales Price N/A 156,000 151,850
Price psf N/A 85.57 63.38
Location Good Good Good
Site (size) 19,780 sf. 13,650 18,295
View Residential Residential Residential
Design Ranch Ranch Ranch
Age: 38 32 29
Condition Ave. Superior / Remodeled -5,000 Equal 0
Above Grade Room Tot / BR / BA
7 3 2
Tot / BR / BA
8 3 2
Tot / BR / BA
9 4 2
Gross Living Area 1,845 1,823 +440 2,395 11,000
Garage / Carport 2 Car 2 car carport +1,000 2 car 0
Porch, patio, deck, FP Enc. Porch, Patio, FP Scr. Porch, FP +500 Patio, 2 Porches, FP +500
Fence, pool, etc. Fenced Yard Fenced Yard Fenced Yard
Net (total) adjustment -3,060 -9,500
Adjusted Sales Price 152,940 142,305

For each of the criteria above, the appraiser can make adjustments but note that the adjustments are made to the comparable, not to the subject. At first glance this is very confusing. Understand that the appraiser's goal is to make the properties as equal as possible. He does this by determining what the comparable might have sold for had it had an enclosed porch or lacked a garage; had it been 500 sq. ft smaller or had a better view. This is an exercise to take one property without a sales history and make it equal to two or more properties which have proven their value on the open market.

In our home appraisal example, Comparable #2 had been remodeled while the subject was in pretty much pristine 1966 condition. Therefore the appraiser subtracted $5,000 from the comparable, effectively removing the remodeling from the equation. There was substantial variation in the square footage of the house so comparables were adjusted up or down at the rate of $20 per foot. Comparable #2 slightly smaller than the subject so $440 was added (thus tacking on another 22 square feet) while Comp #3 was debited $11,000 to negate the value of its substantially larger footprint.

Remember, the cost approach had yielded a psf replacement value of $70.50 and the comparables had sold at a psf price ranging from $63 to $86. Our appraiser said that the $20 has nothing to do with either of the other calculations. It is more a measure of impact. Buyers do not attach that much value to actual measurements, assuming the size meets their needs.

There was also no adjustment for number of rooms and bedrooms even though the houses ranged from six to nine rooms and had either two or three bedrooms. All had two baths. If one of the houses had only two bedrooms or one bath, there probably would have been a substantial adjustment.

Note also that there was no adjustment for the much larger lot that the subject property sits on. Again, each lot was a reasonable size for the area, no subdividing is possible, and land in the area is not a particularly valuable commodity.

These homes are in a coastal area and in a subdivision with some spectacular water and marsh views. Each of the comps, however, was on an interior lot with a view only of other houses. If a marsh front lot was in the mix, there would be a substantial adjustment for "view".

After all adjustments are made, the net adjustment is added or subtracted from the comparable sales price. In this case Comp #1 was adjusted to a sales price of $152,940 and Comp #2 to $142,305. The other two comps not included in our chart were adjusted to $139,500 and $145,440. The appraiser then averages the four adjusted prices to arrive at a value of $145,046, rounded to $145,000. This is very close to the slightly higher cost approach which provided substantiation and, since the sales approach is considered the more reliable, the appraiser concluded the value was $145,000. If there had been a wide discrepancy between the two numbers, the appraiser would probably have done further reconciliation to factor in the cost figure.