If you’re out to purchase a property, you’ll want to know how much it’s worth before you make an offer on it. After all, signing a purchase agreement or going under contract isn’t something to take lightly. It means you’ll have to put down an earnest money deposit—a sum you risk forfeiting if you decide to back out.
Fortunately, real estate appraisals can help you determine the right price to pay—allowing you to make a strong offer without overbidding. To conduct an appraisal, a licensed real estate appraiser uses a systematic process to determine the value of a property. However, appraisals aren’t always objective—especially given that “value” is often in the eye of the beholder.
Nonetheless, appraisals are an informative and necessary part of the due diligence process. Here’s the lowdown on how appraisals work—and why they can sometimes come across as subjective.
How do property appraisals work?
Though requirements vary by state, most appraisers will generally need some form of higher education and several thousand hours of approved training before qualifying for licensure.
In Alabama, for example, candidates who wish to attain a Certified General Appraiser license—the highest and most unrestricted professional license in the industry—must have at least a Bachelor’s degree and 3,000 hours of experience over a minimum of 18 months.
Licensed appraisers will assess properties using the Uniform Standards of Professional Appraisal Practice (USPAP)—a set of generally accepted quality-control standards that provide guidance on how to conduct appraisals.
Specifically, USPAP requires appraisers to value real estate by first defining a Scope of Work. This is a broad framework that takes into account client expectations, the valuation method that will be used (i.e. sales comparison, cost approach, or income approach), and the type of ownership interest in question.
After laying out a Scope of Work, the appraiser will conduct the appraisal by examining the property’s inspection report, its interior and exterior features, and its location or neighborhood. Depending on the valuation method laid out in the Scope of Work, an appraiser may also take into account the cost of land and improvements, the price of comparable sales, or the rental income earned by the property.
The end product is an appraisal report—a document that contains the appraiser’s opinion on the value of the property, along with information about the property and factors that have influenced its value.
Property appraisals can be subjective
Despite using a rigorous approach to valuation, an appraiser’s opinion of a property’s value isn’t entirely objective. For instance, two appraisers valuing a single property may arrive at different opinions of value—which may depend heavily on the valuation method employed.
Even identical approaches to value don’t guarantee the same opinions. For example, two appraisers both using the sales comparison approach—where the value of a property is determined using at least three recent comparable sales—may come to different conclusions about the value of a property. Specifically, an appraiser’s opinion will be strongly influenced by the comparable properties used and the appraiser’s working definition of “comparable”, neither of which are truly objective.
There ultimately isn’t a clear-cut handbook for determining how much properties are worth, and an appraiser’s opinion of value may boil down to personal preference and other idiosyncratic factors. For example, how much more is a lot of land with city views worth in comparison to a lot without? How much value does a kitchen or bathroom remodel add? And what happens if the design doesn’t fit the appraiser’s personal tastes? Might they be unconsciously swayed to attribute less value to the renovation?
After all, appraisals are an art—not a science. As a result, buyers or sellers may find that a property’s actual sales price will be markedly higher or lower than its appraised value, regardless of what conclusions appraisers come to about a property’s worth. In other cases, like in rapidly appreciating markets, recent sales comparisons may systematically lead appraisers to provide opinions of values that are lower than the true value of a property.
Data from Fannie Mae supports this, suggesting that appraisals come in low roughly 8% of the time and high in about 4% of all cases. If this occurs, it’s not the end of the world, and parties to a transaction can simply appeal the appraisal, renegotiate the offer, or order a second appraisal.
Even computerized appraisal systems are subjective
In a bid to make appraisals more objective, the real estate industry has welcomed algorithmic appraisal systems in the hope that they can do away with the subjective human factor that underlies so many appraisals today. Unfortunately, there’s a wide gulf between this vision and reality. Algorithmic appraisers aren’t perfect decision-makers, and they often come imbued with the same subjective biases held by human appraisers.
For instance, computerized appraisal systems tend to stamp valuations on properties without understanding the fuller context of the markets they’re tasked with appraising. As a case in point, Zillow’s iBuyer division shut down after its algorithm overbid on homes, rendering its nascent home-flipping operation deeply unprofitable.
However, appraisal algorithms do offer a key advantage over their human counterparts: they can analyze massive quantities of data at once, easily taking into account thousands of recent comparable sales and millions of data points. This wider scope of analysis and richer view of the market landscape may equip robotic appraisal systems to provide more accurate valuations that better forecast a property’s true sales price.
That said, human appraisers aren’t likely to go away anytime soon. In the meantime, new technologies like remote desktop appraisals may help to reduce racial bias, discrimination, and subjectivity in the appraisal process. Other tools, like 3D visualizations of property and databases that provide a more comprehensive look at a home’s upgrades, fixtures, finishings, and more—can allow trained professionals to offer better-informed valuation opinions, in turn allowing both buyers and sellers to engage in more thorough price discovery.