Is it an art form or a science?

The definition of appraisal—”an opinion of value”—appears straightforward and simple. In fact, the appraisal is likely the most misunderstood aspect of a typical real estate transaction. When it goes well, the appraisal is an afterthought. When it does not go well, it has the potential to delay or even spoil your closing.

Within the appraisal community, there has been an ongoing debate: Is real estate appraising an art form or a science?

Critics may argue whether it can be science if two appraisers view the same home yet arrive at differing opinions of value. The reality is that real estate valuation requires a process to develop an opinion of value, and two appraisers may use different processes or view the data differently.

Appraised Value vs. Sales Price

According to a 2017 National Association of Realtors’ study, owners rarely shop for realtors, and only 26% interview multiple realtors. In most cases, sellers count on the realtor to establish not only a marketing strategy but also an asking price. The borrower only sees homes the realtor preselects, so they are generally within an agreed-upon value bank.

Like appraisers, realtors will tell you that establishing the right approach to a listing price is an art form because there is no single list price. Different agents, employing varying techniques, will suggest different prices.

Often realtors arrive at a price per square foot to establish value. Price per square foot is an acceptable approach if homes are identical. However, except in new developments, they never are. Price per square foot never factors in characteristics that account for value differences (e.g., size, location, condition, quality, etc.) Realtors rate these differences by relative comparison; one home might be in a better location, and another may have a larger lot. These are the factors sold to a particular buyer.

In general, realtors arrive at an overall listing price using qualitative techniques.

Agents also factor marketing strategy into the list price. Some agents may suggest listing a home for sale around the market value or just below. They hope to create momentum and stress anxious buyers into a bidding war.

Other realtors will set a higher price point and allow buyers room to negotiate.

In either case, the listing price plays an integral part in the process. “Anchoring bias” is a cognitive bias that causes us to rely too heavily on the first piece of information we’re given about something. And it works. When given a number (the sales price), you unknowingly tether your opinion of worth to the asking price. The listing price sets the standard for the rest of the negotiations. Prices negotiated lower than the listing makes the home seem more reasonable than the initial list price, even if they are still higher than what the data says a home is really worth.

This approach is particularly effective if online sources also skew high. Most buyers will use an online valuation tool to get an idea of value. These tools validate the price they negotiated. However, online tools cannot factor in the location, quality, and utility of the home or the condition. In reality, the online tools may provide a positive bias toward inferior homes and a negative bias against homes that deserve to be at the top of any given market but judged as if they are typical.

If the transaction is financed, then an appraiser will be used. The realtors should be able to support the contract price with closed sales data, which most appraisers welcome. Once the appraisal is complete, if the appraiser arrived at a value lower than the contract, the realtor should be able to provide similar closed sales that support the contract.

Buyers should be prudent and ask their realtor for these sales before making an offer.

Appraising During COVID-19

We are witnessing how COVID-19 is changing how we will live. Homeowners’ needs are changing. Some areas are going to benefit, while others, in time, will have an oversupply of inventory. Appraisal analysis should include looking at inventory, days on market, and identifying homes with extended marketing times or with huge price reductions. These homes may or may not be signs of distress.

Investors’ expectations are for appraisers to base trend analysis on quantitative analysis, most prominently, closed sales. This technique is effective in determining present trends. However, it’s not as effective in identifying what is coming because, in effect, we are looking through a rearview mirror.

If the sale is a flip, how much was spent on updating? A good appraiser will review MLS, including the subject prior sale MLS. The appraiser will contact the selling agents to understand the condition, quality, and any unknown sales factors.

A comparable choice should illustrate the subject market and its place within that market. The ideal comparable selection would be in the same market and, if the subject is a condominium, in the same development. They should be similar in physical characteristics, as well as be relevant to the current market.

When markets are shifting, the more recent sales and listings reflect current market conditions.

A good appraiser will reconcile their opinions of market value to the pending sale price of the subject property. Often, this tends to make sense if the pending sale price of the property falls within the range of the market data collected (after being adjusted for variances to the subject property) because appraisers are essentially trying to “mirror the marketplace.”

While much of the appraisal process requires quantitative techniques, making adjustments is often a combination of quantitative and qualitative. Although appraisers would love every comparable to be perfect, they are not. There are always value-influencing differences between two homes. In these cases, appraisers make adjustments. Some home features add value but are hard to quantify.

Regardless, the most common reason for the difference of opinion between the contract and the appraisal is the adjustments. Which just happens to be the most qualitative part of the appraisal process.

After all, it is not science, nor art. It is a little of both.