For many people, appraisals are a mystery, from why and how they’re done to how the information gathered during the process is ultimately used. Truth is, the mystery is easily demystified. Appraisal is, for all intents and purposes, a straightforward and simple component in the process to complete financial transactions. As they relate to real estate in general, and co-ops and condos in particular, appraisals can be defined simply as an estimate of value for the purpose of sale, assessment, and/or taxation. Appraisals are required for all types of financing, including individual co-op and condo loans, underlying permanent mortgages on cooperative apartment buildings, and even partial-interest property rights, such as shared common areas in condominium properties.
Real estate appraisal is as much a science as it is an art. It employs established techniques and methods to arrive at consistent and reliable valuations. According to Ken Chitester, Director of Communications for the Appraisal Institute, a national umbrella organization for the appraisal industry based in Chicago, “Appraisal methodologies and techniques are consistent across the country. Each market is unique, but the methodology of appraisal stays the same, and applies across the board.”
What sets appraising apart from other sectors of the real estate transaction process, says Jonathan Miller, President and CEO of Miller Samuels, a national appraisal firm based in New York City, is that, “In a real estate transaction, everyone has some sort of connection to the transaction except the appraiser. The appraiser gets paid whether the transaction closes or not; the brokers don’t if the transaction doesn’t close. We are outside, neutral experts. There’s no skin in the game. Therefore, there’s a different perspective.” That keeps everything transparent and above-board.
The Three Approaches to Value
Appraisal methodology rests on three approaches to determining value for any given piece of property: the cost approach, the comparable sales or market approach, and the income approach.
The cost approach is the simplest – though frankly the least used – of the three. Using a cost approach, value is determined by estimating the reproduction cost of a property; in other words, accounting for every physical aspect of a property—bricks, mortar, concrete, glass, tile, etc.— adjusting those costs for age and obsolescence, then adding back the value of the land on which the property sits, to determine what the property would be worth today. This approach is rarely used, except for insurable values, which we will return to later.