What is a real estate appraisal and how does it work?

[ecis2016.org] Explained is the significance of real estate appraisal and its effects on a buyer’s home purchase plans

Banks apply various methods to gauze a borrowers’ creditworthiness, before they approve their home loan applications. Since a lot hinges on the property’s value in a home loan, they also carry out several checks on the unit in question, to arrive at its fair value. Based on these factors, the bank decides whether or not it will lend money to you, the amount of the loan, the repayment tenure, etc. Real estate appraisal or property appraisal is a key step in that direction.

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What is real estate appraisal?

Real estate appraisal is an unbiased process to arrive at the true value of a property in the existing circumstances. While a seller may invariably value his property with a lot of bias, the buyer may also value it lower, because of his preconceived notions. In such a situation it becomes extremely necessary to arrive at a contract price that is fair for everybody – the buyer, the seller and the bank. To achieve this, financial institutions adopt a systematic approach to gather information about the property’s actual worth, as they process home loan applications.

Home loans fall in the category of secured loans, because the property against which the loan is taken is secured by the asset in question. In case of a default by the borrower, the bank will be able to sell the property and recover its costs. This is why evaluating the property, for the purchase of which the bank is lending money, becomes extremely crucial for financial institutions. They have to know how much money they will be able to get for the property, if they were to sell it in the market. The process through which they arrive at the fair market value of the property, is known as real estate appraisal or property valuation.

Property appraisal methods

There are two prime methods applied by real estate valuers, to arrive at the market value of a property:

Sales comparison method: Through this method, the appraiser compares the quoted price of the property in question, with recent property transactions in the neighbourhood. This information could be gathered by examining the sales deed registration data available with the sub-registrar’s office, multiple listing service databases or third-party websites.

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Cost approach: In this method, the evaluator arrives at the property’s current value, by estimating the cost needed to rebuild the property from the scratch, in case the existing structure is destroyed. The worth of the land will then be added to this cost, to arrive at a final property value.

How home appraisals work

The bank sends technical and legal experts, to physically examine the property and prepare an appraisal report based on various factors, including its:

• Size
• Age
• Map
• Location
• Structural status and issues
• Construction quality
• Level of deterioration
• Property title
• Notes about the surrounding area
• Market trends
• Current value
• Prices of similar properties in the vicinity
• Value of improvements and their expected lifespans for depreciation
• Rental prices
• Predictable expenses of similar homes

While the general tidiness of the property is good to showcase your property, remember that it would not have a direct impact on the property valuation. How the property has been maintained over the years would reflect on its structure and the same will certainly have a bearing when the appraiser attaches a value to the property.

Who pays for property valuation?

While banks hire independent and recognised property appraisers to carry out property valuation, they make the borrower bear the cost. Typically, banks charge a flat fee for the same under the head ‘legal and technical valuation’. Charges for this, which have to be paid by the borrower while his home loan application is processed, might vary from bank to bank but would typically fall in the range of Rs 5,000 to Rs 10,000.

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How does property appraisal impact your home loan application?

Based on the value specified after the appraisal process, the bank will decide to lend you a certain percentage of this value, depending on the loan-to-value ratio and the borrower’s repayment capacity. Most banks in India offer 80% of the property value, as specified after property appraisal, as the home loan. For example, if the appraised value of the property is Rs 1 crore, a bank with a LTV ratio of 80% will provide you Rs 80 lakhs as home loan, while the remaining amount will have to be arranged from your own sources.

How does the property appraisal help home buyers?

A home purchase is often an extremely emotional decision, its immense monetary implication notwithstanding. Consequently, a buyer may agree to pay more than the property’s worth, if one likes the property very much. Financial institutions, on the other hand, use a ‘no-nonsense approach’ to evaluate a property. If the asking price for the property is much higher than its actual worth, as stated by the property appraiser, it is certainly not worth completing the transaction. The buyer should in this case re-negotiate the deal with the seller, to lower the prices to its fair value. If the seller is not willing to do so, it would be in your best interest to move away from the deal. Purchasing such a property using your own finances to increase the down payment may not be a good idea, because this would start a vicious circle of overvaluation. When you try to sell this property in future, it would again be evaluated less than the price you would quote.

What if you are not satisfied with the appraised value?

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If the seller feels that the previous appraisal had some errors and failed to capture the key points of the property while attaching a value to it, he might ask for another evaluation from the bank. For this, however, the seller will have to pay the bank. Till the time the second appraisal is done, the bank will also maintain a status quo on the borrower’s home loan application.

General tips for buyers and sellers

Both, the buyer and the seller, should analyse past property transactions in the area. This will help the seller to quote a reasonable price and the buyer will arm himself with knowledge of the property market in the area, leaving no scope for any misinformation on the part of the seller or the broker.

Both the parties have to be present when the bank sends its legal and technical valuation team to complete the property appraisal. The seller has to make available all property related documents at this time, for the appraiser’s convenience.

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Asking a price that is higher than the market rate, would reduce the chances for the seller to close the deal quickly. Paying the asking price for such a property will be bad for the buyer, as he would own an overpriced asset for which he may not be able to get the same worth.

What if the deal falls through?

An agreement to sell is already signed between the buyer and the seller before an application is given to a bank, to process the home loan request. Since the agreement to sell is a legal document and is legally binding on all parties involved in the transaction, the buyer may have to take a monetary hit if the deal falls apart. Since the buyer has little control over how the bank staff would evaluate the property, a clause must be inserted in the agreement to sell, stating that the buyer would only be able to close the deal, provided the bank agrees to lend him the loan as asked for. For further clarity, one could also mention the technical evaluation bit in the agreement.

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