No two elements of real estate can cause quite so much anxiety or lead to so many questions as the appraisal and the assessment.
To say that they cause some confusion is a total understatement.
Buyers ask sellers all the time why the assessment is so high or why an appraisal didn’t come in as high as they wanted. Answers to these types of questions are countless. But to try and sum it up in one thought: each number is estimating a different value based on different data and the purpose of the valuation is different for each.
Market Value (or Fair Market Value)
If we’re going to talk about valuations, we should start by defining fair market value (FMV). FMV is the measurement that most closely reflects the value of the asset at any given point in time. Maybe the easiest way to state this is that it’s the price a buyer and seller would settle on if both were rational, had access to applicable information, and weren’t under any extreme pressure to execute the transaction.
Two key points to remember :
- FMV is established by the market.
- FMV measures a specific moment in time; it is not fixed and not necessarily predictable.
Put another way, no third party calculates FMV based on previous inputs. FMV is now. There are lots of parties interested in the FMV—lenders, title companies, assessors, and now real estate websites—but FMV is set by the market and all other valuations should be driven by this fact.
Unfortunately, this isn’t always the case. FMV is undermined by other parties in the transaction, each with its own intent. To make their best decision, buyers and sellers need to understand what’s in play for each party involved.
Below begins a discussion of the other common valuations and how they are established.
The Assessment (Tax Assessment)
Every year, property owners get a piece of mail from their local government. Very rarely is it good news. The tax bill asks for money, and that already lends it an air of gloominess. But included on that tax bill is the assessment, and it almost always triggers some kind of emotional reaction, ranging from a sigh to an angry growl. Sometimes, if it’s really bad, it will spur us to action: maybe a call to the assessor’s office, maybe a call to a lawyer.
But what I’m trying to drive home is that the assessment drives the tax bill.
Now how do the assessors calculate that value? Well, they bring in a whole bunch of factors: size, age, beds, baths and location, as well as sales price of other ‘similar’ properties. They throw all of it into a calculator (okay, that’s not true) and an assessment value comes out. What’s interesting is that the town, city, or county doesn’t have to be perfect. They just have to be decently close. Because their ultimate objective is to generate enough revenue without disturbing the collective peace. And they have to fund the budget. So it’s natural for tax assessors to prefer that tax rates rise to raise revenue—that responsibility falls on lawmakers—instead of increasing assessed value, in which the assessor is the bad buy.
So how accurate are assessments? The best way to describe it is “kind of.” Assessments tend to drag behind the current climate of real estate. A market might surge one year, and the assessments won’t catch up till the next—or even later. You see, assessors don’t see what’s in the MLS and they don’t go visit actual properties, so they don’t know about renovated kitchens or unfinished attics or all kinds of things. Likewise, they won’t know if a roof is shot or the mechanicals are vintage. All of these will play into the FMV but they very well may not affect the assessment.
Accuracy Level – 85% at best and generally below the FMV, unless the market is falling dramatically.
The Appraisal
If you’ve recently bought a piece of property and borrowed money to do so, you have been through an appraisal.
If not, you want to know what an appraisal is. Well, there’s a hint in the previous sentences. Lenders drive the need for appraisals. They want to understand the value of the thing that will soon be collateral on their loan.
How does it happen? There’s an army of professional appraisers out there. These people are licensed and required to stay educated about the discipline. Many of the better ones get even more education to earn additional designations. And there is a standardization to the process.
Anyway, a lender hires one to examine a property and render an evidence-based analysis on the value. That appraiser will have access to the most accurate information (otherwise known as MLS) and the most recent sales information. And appraisers will go and visit that property to confirm as many details as possible.
How do appraisers establish values? While the appraisal process notes the three primary methods of valuation (comparable sales, income approach, and replacement cost) the comparable sales method is the most common when establishing value of single family homes. The appraiser is responsible for identifying three of the most applicable recent sales that compare to the property being appraised. So an appraiser working on a four-bedroom home in the Fan is going to look for other four-beds as near to that property as possible. And they’re going to have a lot of other things in common as well. They are comparable, hence the term “comparable sales” or comps.
What do lenders do with the appraisal? They use that value to figure out the maximum amount of money they will lend against the property. The less debt there is against the value of the home, the more secure the bank will feel, and they tend to lower the interest rate. As an example, a bank might want 5 percent on a loan that is 90% of the value of the property. That rate might sink to 4% if the loan is only 80% of the value. An important thing to know: the bank uses the appraisal value and technically doesn’t care what the agreed-upon sales price is.
If the appraisal falls below the purchase price, the buyer will either have to make a bigger down payment or accept a higher interest rate. Bottom line: the appraisal is pretty darn important, especially if buyers are seeking to borrow the maximum loan amount. Some deals can fail when an appraisal comes in too low.
Then how do appraisals differ from FMV? In many minds (including appraisers, underwriters, AND many Realtors) an appraisal and FMV are one and the same. This is not true. An appraisal is measuring value at a past point of time to establish a value in the present under the assumption past and present market conditions are effectively constant. In many cases, especially in an active market, the appraisal should be pretty close to FMV. But if you’re in a market that is experiencing relatively precipitous changes in value, there could be a gap between the appraisal and the FMV.
And remember, the appraiser is technically unbiased. He/she did not see what might have really struck the buyer during the ‘for sale’ period. The appraiser doesn’t bring emotion to the process. The appraisal seeks to compare the subject decision to one made during a different time period and by different people who saw an entirely different set of homes. Far too little attention is paid to this hugely important fact.
Regardless of the arguments presented above, the appraisal is USUALLY accurate enough and while not perfect, is probably the most accurate of the measurements of Fair Market Value.
Accuracy Level – 95-98%
The Zestimate (or other Automated Valuation Models…sometimes called AVM’s)
Zillow has certainly become a force within the real estate world in a relatively short period of time. Some people go to their site, see a figure that looks precise and assume it must be accurate. This is absolutely not true.
In Hanover County, for example, Zillow offers the following disclaimer – a Zestimate of $400,000 means a computer in Palo Alto has estimated that the ultimate sales price be plus or minus 10% in 64% of the cases. The other 36% of the time, the value is less accurate than that.
Use the Zestimate at your own risk.
Summary
If I wanted you to take anything from this piece, it’s that each of these measurements are done differently, using different sources of information, and they are performed for very different purposes.
Neither the assessment nor the appraisal and of course the Zestimate can be taken to represent the FMV. You get there by working with your agent, doing your homework, and performing a good, structured search. Be really careful before you let a Zestimate or an assessment color your judgment when making a real estate decision. Rely on the most current info—that is dependable—and you will come up with a good estimate that will lead to the true FMV.
Sellers, in many cases, may still be working against all the debt that we collectively racked up in the race to 2007’s bubble.
If you have a good property in a mature neighborhood that perhaps is feeling the effects of a lack of inventory, you’re likely in a very good position. You can be a little aggressive in your pricing. But pay attention to the most recent comparables. Use the higher comps in your market and/or the pending properties as the best pricing guide.
