What to Expect from an Appraisal
Appraisers use selective market research and various analytical techniques to determine the market value of a property. Three different types of appraisals each require different information and techniques.
- Sales data report. A sales data report is based solely on sales data and does not include a physical inspection of the property in question. Typically, a sales data appraisal report is used for residential properties located in low-risk, marketable areas.
- Limited-restricted appraisal. A limited-restricted appraisal is a “drive-by” appraisal. The appraiser bases the appraisal only on the exterior appearance of the property. Such an appraisal contains more details about the neighbourhood and exterior of the property than a sales data report.
- Full review. Also known as a full internal appraisal, a full review includes a detailed inspection of the interior and exterior of the property, as well as neighbourhood details. This type of appraisal may be required for:
- Private sales or for transactions not listed on a listing database
- High loan-to-value ratio
- Non-sales transactions, such as refinancing or renovation loans
What does an appraisal report include?
Regardless of the type of appraisal and its purpose, certain information must always be included in the appraisal report. RECA requires appraisers to disclose:
- The licensing classification of the real estate appraiser;
- The standards adhered to by the real estate appraiser;
- The scope of the work used to develop the appraisal report; and
- Any extraordinary assumptions used to perform the appraisal assignment.
RECA also requires that appraisal reports:
- Identify the client or intended users;
- State the intended use and purpose of the assignment; and
- Bear the name and signature of the appraiser who prepared the report.
Additionally, members of the Appraisal Institute of Canada (AIC) are required to include:
- The intended use of the appraiser’s opinions and conclusions;
- The purpose of the assignment, including a relevant definition of value;
- Whether the appraisal is current, retrospective, prospective or an update of an earlier appraisal;
- An analysis of reasonable exposure time linked to a market value opinion;
- The effective date of the appraisal and opinions contained within;
- The date of the report;
- Location and characteristics of the property and the interest appraised;
- A formal opinion of value;
- All assumptions and limited conditions;
- Any hypothetical conditions; and,
- Land use controls.
Other professional appraiser associations have similar requirements of their members.
An appraiser who signs a certification of value as part of an appraisal accepts responsibility for the appraisal and the contents of the report.
Approach to value
There are three ways for appraisers to arrive at a formal opinion of value.
1. The cost approach estimates the cost to build a new building identical to the subject being appraised, at current prices, subtracting accumulated depreciation and adding the estimated land value. This approach is most useful when there are few comparable properties to be used for a direct comparison approach, such as with luxury homes or recreation properties.
This approach cannot be used to estimate the value of high-rise or townhouse condominiums.
In order to use the cost approach, an appraiser must:
- estimate the value of the vacant site (land value)
- estimate the cost of replacing the current building and add this to the land value to get the total value of the new building
- estimate the depreciation of the existing building and subtract this from the cost of replacing the current building (the total value)
- the end result is the market value for the building
2. The direct comparison approach is based on the theory that an informed purchaser would pay no more for a property than the cost of acquiring another existing and equivalent property. The value estimate is based on the selling price and listings of comparable properties, and the appraiser makes adjustments, upwards or downwards, for elements that are different between the properties.
Suitable comparable properties should:
- have sold recently (preferably within 90 days);
- be from the same or a similar neighbourhood;
- have similar lot size; and,
- be of similar age/style/condition/size
Once an appraiser has determined which comparable properties will be used, adjustments are made to take into account features that differ between the subject property and the comparables. Positive adjustments are made to a comparable property in areas where the subject property is superior. Negative adjustments are made to a comparable property when the comparable is superior to the subject property. The final value of the subject property should fall within the range of values for the properties used in the comparison.
3. The income approach relates to and is most often used for income-producing property, such as commercial or industrial. This approach is based on the theory that value is the present worth of the income stream which the property is capable of producing when developed to its highest and best use. The rental income that a property generates annually is calculated and annual operating expenses associated with the property are subtracted. The result is the net income from the property. The annual net income is converted to a single dollar value, which represents what this annual income in the future is worth today. This is the value for the property.
Some appraisals will use a combination of different approaches to value. Most often the decision of which approach to use depends on the purpose of the appraisal and the type of property.