how appraisers work

Let’s talk about adjustments. Last month I wrote about being a trigger-happy real estate adjustment giver, and I had some great feedback. One appraiser told me she is going to stop adjusting for some of the very minor stuff like fireplaces and covered patios, and an agent told me his list of adjustments was basically the one I shared as an example of what not to use. It’s great to hear of growth like this, and I love the honesty, yet I think anytime we start talking about adjustments, it can also make us feel insecure because we begin to question everything we are doing. So for the sake of growth and conversation, let’s kick around the topic a bit more. I’d love to hear your take in the comments (or send me an email).

giving real estate adjustments - by sacramento appraisal blog - image purchased and used with permission from 123rf dot com

4 questions to ask when giving real estate value adjustments

Does the adjustment represent how buyers behave? When valuing a property, we adjust the comps when there are value-related differences compared to the subject property. The adjustments are not about what one buyer would pay, but rather what a representative buyer in the market might pay. In other words, if you lined up a group of 100 interested and qualified buyers, and they would pay a difference for that certain feature, we then adjust by that difference. Remember, there is always going to be one buyer who is going to love a feature, and pay way more because of it, but we have to ask, “How much is the market going to pay for this?” Example: House shaped like Darth Vader’s light saber.

Does the adjustment seem reasonable? Take a step back from the adjustment you are giving and just ask, “Is this reasonable?” If you’re giving a $500 fireplace adjustment, does that really seem like a reasonable adjustment, or is it purely made up? Does a $10,000 location adjustment for the busy street really represent what the market is willing to pay? Or does a $25,000 condition adjustment between the fixer and remodeled home make reasonable sense? This is a big question to filter our adjustments through, and I recommend getting into the habit of asking it. By the way, I find sometimes when it comes to condition, the adjustment might be more like 20% instead of $20,000.

Is the adjustment supported? It’s easy in real estate to pull out a list of canned adjustments and start giving them whenever we see any difference between a comp and the subject property. So we see a built-in pool and automatically give a $10,000 adjustment for the difference. Yet we need to do some research in the neighborhood. Is there a price difference between similar homes with and without pools? At times our canned adjustment at $10,000 might actually make really good sense, so it’s perfect to use, but other times we might see a different story of value. It’s easy to get stuck giving that $10,000 adjustment in every case, but this is where we need to let the market speak to us. Research the sales and let them set the tone. This means the adjustment might look different in each valuation. Maybe you’ll have no adjustment at all for a pool if there really isn’t a discernible price difference, while other times you might adjust twice as much as you normally do because the pool is something special and it looks like buyers paid a premium for it. Remember, the goal ought to be to find other homes that actually don’t need any adjustments at all because they are truly comparable. I know that’s a fat chance, but keep that in mind.

Does the adjustment fall in the range of value? As much as we’d like to think there is one perfect and precise adjustment out there to give, it’s most likely we will see a range of value emerge. For example, if we surveyed a neighborhood and found homes with built-in pools were tending to sell between $8,000 to $15,000 higher in price, we have to make a decision. What should the adjustment be in the case of the subject property’s pool? If it’s an older pool, maybe we end up giving a value adjustment closer to $8,000. But if it is a higher quality newer pool we might reconcile the adjustment closer to the top of the range.

I hope this was helpful.

Questions: What is question #5? Anything else to add?

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Have you ever wondered how appraisers come up with square footage adjustments? Why is the adjustment sometimes so low? Is it just a guess or is there some sort of methodology? Let’s take a quick look at four options for determining how much extra square footage is really worth.

4 options for making adjustments for square footage:

Make up a Number: Not a good method. Any adjustment in an appraisal report is supposed to be based on the market instead of a guess.
Use one standard figure: Sometimes appraisers are known to use one cost adjustment figure for every single neighborhood. This is bad since some neighborhoods will pay far more for extra space. For instance, a lower-end neighborhood in the Sacramento area could easily see adjustments around $30 per sq ft for extra square footage, but a higher-end area might see adjustments beyond $100 per sq ft. Also, when the market is hot, the price gap between small and large homes tends to squeeze together a bit more, but when the market is declining, values tend to spread further apart.
Use cost figures: Cost plays a role in determining adjustments to a certain extent, but keep in mind appraisers are really looking at what the market is willing to pay for something rather than what it costs. For instance, an addition might cost $50,000, but that doesn’t necessarily mean the addition would actually add $50,000 in value. How much would a buyer pay for the extra space? That’s the question the appraiser has to answer by finding similar properties in the neighborhood or market area. What if the owner overbuilt for the neighborhood? Or what if the owner added a $50,000 Yoda-shaped room? Stars Wars fans might love it, but others would probably run. The same is true for a built-in pool. It might easily cost $35,000, but buyers are simply not willing to pay for the entire cost of the pool in the resale market. Can you see why cost might not necessarily translate into value?
Analyze sales in the neighborhood: This is the best method. Compare houses in a neighborhood to determine the adjustment. Or in other words, find matched paired sales to discover what buyers are willing to pay for a certain feature. For instance, if you find a house that sold at $230,000 at 1700 sq ft, but a very similar house sold at $220,000 at 1500 sq ft, that tells us the market paid an extra $10,000 for 200 extra square feet. In this case the adjustment for square footage would be $50 per sq ft since $10,000 divided by 200 equals $50 per sq ft. This is just one example though. It’s important to find several other matched pairs so you can make a reasonable judgement about what the market is willing to pay for extra square footage. See the example below. Can you see how the adjustment for square footage is a reflection of what the market is willing to pay?

What does the market say the extra square footage is worth?

square footage example in appraisal report - by sacramento appraiser blog

Keys to Remember:

Similar Size: Compare similar-sized properties to the one you are trying to value. The market might look at larger and smaller properties differently, so if you want the proper adjustment, you’ve got to stick with comparing apples to apples so to speak.
Condition: Remember to consider upgrades and condition in your analysis. An upgraded property might sell for substantially more than a fixer. This is why properties in the most similar condition will be your best comparisons when trying to extract a reasonable adjustment for square footage.
Know the Market: Sometimes smaller homes can sell for more than larger homes. It’s easy to assume a larger home will sell for more, but at times certain smaller models may carry a value premium for whatever reason, which causes them to sell for more. This is where knowing the neighborhood market comes in handy.
Data Sample: Use more than just one comparison to substantiate how much extra square footage is worth. More data helps build a stronger case.

When I get asked how much appraisers adjust for square footage, I think my answer sometimes disappoints real estate agents and home owners. It would be nice to share a very concrete number, but saying, “It depends on the neighborhood and the market” is really the best answer. Most of all, real estate is about location, so it makes sense that the numbers can be different depending on the location, right?

Questions: Any insight to add or questions to ask? Or do you have any stories to share? Comments are welcome below.

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