Real Estate Investing Basics

Why Appraisals Don’t Necessarily Value Homes From an Investor’s Point of View

Expertise: Landlording & Rental Properties, Real Estate Investing Basics, Personal Development, Business Management
32 Articles Written

There was a forum question that caught my eye the other day. Basically, the question asked, “Should the useful life of a fully renovated house (little future cap ex) have a bigger influence on the property’s appraisal than recent sales in the area?”

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The post was in regard to turnkey properties in areas with low comps. The quick response he got was, “If the property doesn’t appraise out, you shouldn’t buy it.” Which I think in general is a good rule, but I want to address here that it isn’t just that simple. The value of something is all a matter of perspective. So you have to remember whose lens you are looking through.

How Are Single-Family Homes Valued?

Single-family homes are valued via a comparable sales approach. An appraiser will go out and take a look at the property and compare that property to other properties that have sold in the area. He will make various adjustments to try and create apples to apples comparisons.


Why is This?

Owner-occupants buy the vast majority of single-family homes. So the value of the property is reflected from the perspective of the owner-occupant. How much will someone pay to live in this house in this neighborhood? And when they’ll be going to sell, how much will another owner-occupant pay to be in this neighborhood? The owner-occupant sets the market because they are the consumer. So the comparable sales approach is a snapshot of the market. It shows the value of a house relative to other houses in that neighborhood. It is market value for owner-occupants.

Related: Why You MUST Buy Below Intrinsic Value for Solid Real Estate Returns

But who is really setting that value? Most would say other homebuyers, but I would argue that it isn't them. It is the banks. The banks have the final say on whether the price the homebuyer pays is appropriate because they are supplying the majority of the money. The bank is out to protect its interest. They will not lend on a property unless the amount they are lending is less than the appraised value. When you look at it from the bank's perspective, it makes sense. The bank is only looking at the value from the eyes of an owner-occupant.

What is the Value of a Property From an Investor’s Point of View?

An investor is going to value the property from an investment point of view. They treat it as though it was a commercial property. They look at the yield of the property. The amount of money invested versus the amount of money that gets returned. The value of the property is derived from the yield that someone is willing to accept, and this value can be very different from the appraised value.

Let’s try to understand this by using an example of a property in Beverly Hills. It shows the property sold for $1,950,000, and they are trying to rent it for $8,900 a month. This comes in at 0.45%. As a cash flow investor, depending on which rule you use — 1% or 2% — you wouldn’t buy this house.  As a 1% investor, you would pay $890,000 and as a 2 percenter, you would be down at $487,500 for that property.

A cash flow investor would value that property very differently. There is a big gap between what the appraised value may be and what the investor's value is. In this instance, it wouldn't be a problem for an investor to get a loan on this property if he were able to hit its numbers.


Related: Multifamily Myths: Why You Don’t Control The Value Like Everyone Says You Do

On the other end of the spectrum, when you look at low priced homes in C or D-class neighborhoods, sometimes the appraised value will come in below what an investor may be willing to pay based off of the return. This doesn’t mean their value is wrong; it just isn’t in line with how the banks value single-family homes.

Appraisals are there to protect banks from overzealous homebuyers, which in turn protects homebuyers from overpaying for a property. I personally don’t think an investor should necessarily pay over the appraised value, but there may be some instances where a sophisticated investor may see more value in a property than what the appraiser may.

Do you invest in single-family homes? How do you calculate their value?

Let me know with a comment!

Mark Ainley is an investor, managing broker, and property manager with almost two decades of experience in real estate. Mark found his way into real estate by purchasing and flipping condominiums p...
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    Randy E. Rental Property Investor from Durham, NC
    Replied over 4 years ago
    Hi Mark, Just when the article was getting interesting, it ended before you revealed why an investor should spend more than appraised value for a house in a C/D neighborhood. I really wanted to see your reasoning, as my philosophy is to purchase homes in C neighborhoods below appraised value. I want to see if there is something I’m missing.
    Mark Ainley Developer from Roselle, IL (Chicago Suburb)
    Replied over 4 years ago
    Thanks Randy for commenting! My point is that there are many ways to look at “value” and appraised value is just one of those ways. As a professional real estate investor, I look at other things besides just appraisal. For instance, I bought an attached home in a C+ area. There is no comps for these attached single family homes and everything on the market is distressed. I bought the property, rehabbed it and rented it out. I got an appraisal on it because I wanted to see where it would come in at. The appraisal came in almost 20k BELOW what I had into it. I didn’t do anything extravagant. I replaced all of the plumbing, electrical, new roof and new bathroom and new kitchen. Not high end and the cost of the renovation was cheap relative to what others could do it for because I deal in scale and have some crews in house. I rented the house out and my “cap rate” on the property is 16%. I will keep buying these even though the appraisal came in where it did. Why? Because I think the market is mispriced. As a professional one of my goals is to find discrepancies between fair value and market value. As I said in the post, I think it is fine to work off of appraised value and most investors should work from appraised value. I am just pointing out there is more to it than what the house next door sold for.
    Jade S. Investor from Evans, Georgia
    Replied over 4 years ago
    Seems like several of the local appraisers in the area used by my lending bank have a solid conservative streak in them. Even on a few buy & holds I’ve acquired at 10-15% below market comps, they seem to come in juuuuuuuust above my agreed purchase price on two of those SFH. Oy…..
    Jonathan Webster
    Replied over 4 years ago
    That is referred to as the fourth approach to value (sales, income, cost), the sales contract approach. Even if you have underwritten the investment at 10-15% below market, as long as the transaction you are involved in is an arm’s length market transaction it is still a “market sale”. If it was an origination appraisal for the bank, they are going to base the LTV on the lower of the two numbers anyway, so it is not worth to the appraiser to stick their neck out.
    Jade S. Investor from Evans, Georgia
    Replied over 4 years ago
    Jonathan, those two were indeed origination appraisals. One was a purchase off the MLS which I negotiated down, the other was a FSBO with no real estate agency involved. My mortgage officer commented about the same thing recently and how “conservative” many recent appraisals had been on new loans. So you are probably quite right about appraisers not sticking their necks out.
    Susan Maneck Investor from Jackson, Mississippi
    Replied over 4 years ago
    I bought a house a couple of years ago from a colleague of mine. It was a 3 bdrm 2ba house with a two car garage on a quarter of an acre lot. She had bought it a few years earlier from HUD at 55K, put a privacy fence around it, a new roof and gutters and a very expense AC unit. I bought the house from her for 35K cash and then rented it promptly for $800 a month. I was stunned last fall when I got a HELOC on the house that it only appraised for 35K. Of course, they only did a drive-by appraisal. I make more profit on this house and do less repairs than any of my other ones! And I have always been able to find good tenants.
    John C. Carlson Appraiser from Victorville, California
    Replied over 4 years ago
    When I first read the title to this article I thought it was going to be another “appraisers-don’t-know-what-they-are-doing” article. However, it was very well written and right on point – thank you Mark. I’ve been an appraiser for 38-years & I am embarrassed to say that appraisal is no longer a “profession”, it is, at best, an “industry”. You investors have to be VERY proactive if you are getting a loan & the appraiser is coming out to tell the lender what the value is. Investors have to know more about the comps in an area than the appraiser. This is a numbers game. Appraisers are no longer chosen based upon their expertise in a market area or their proximity. Most lenders, thru their Appraisal Management Companies (AMCs) send an e-mail blast out to every appraiser on a list and the appraiser who gets the assignment is the one who hits the “accept” button the fastest. Lenders/AMCs only care about which appraiser is the cheapest and fastest. When you meet an appraiser, be prepared and hand the appraiser Comps that are available – not just an address & sales price. If you are an Agent, provide the appraiser with an Agent Copy of the listing. If you’re not an Agent, get a copy of the listing. Don’t listen to them if they say: “I can’t use comps provided by the borrower/agent”. That’s bunk, the thing they have to do is independently verify each comp given to them. I wish I could say that working with appraisers & lenders is going to get better, but it’s not. I changed my practice several years ago when I saw the writing on the wall & only deal with a few of the best lenders, and mostly do appraisals for CPAs & Attorneys
    John C. Carlson Appraiser from Victorville, California
    Replied over 4 years ago
    I got a few phone calls when I was writing this & missed some things. Hopefully, you know that while you may pay $450 to $650 for an appraisal, the appraiser is only being paid from $275 to $350. The AMCs are taking the rest. This is what I was getting paid in the 1980s. This is why it is a numbers game – the appraiser cannot afford the time to REALLY scrub a market area & prepare a competent report. They have to complete each appraisal FAST – & then get on to the next one
    Andrew Syrios Residential Real Estate Investor from Kansas City, MO
    Replied over 4 years ago
    We have this problem where appraisers will value a split only on the part of the property that is “above grade”. Anything “below grade” is a finished basement. That makes sense on an actual finished basement, but when the “finished basement” is only two feet under grade, has a walkout on the back or side and windows at eye level that see out side, that is not a basement my friend. But then they value a 1400 sq. ft. 4 bed, 2 bath house as a 1000 sq. ft., 3 bed, 1 bath house with a finished basement even though homeowners don’t view these houses that way. It’s infuriating.
    John C. Carlson Appraiser from Victorville, California
    Replied over 4 years ago
    Andrew, You can thank FNMA & FHA for this conundrum – they are the ones who provided this regulation. In my area, numerous homes are built down a hill with the entry to the upper level at street grade & stairs access the lower levels. I fight with Underwriters & reviewers all the time who apply FNMA’s regulation and say I have value the lower levels as basements. My argument is that the market area values them as actual living area. I usually win my argument. I’ve run into your situation also. As long as I can document that Buyers consider the slightly below ground area as total gross living area, that’s the way I value it.
    John C. Carlson Appraiser from Victorville, California
    Replied over 4 years ago
    Posting again because I keep forgetting to check the boxes so I get notified of follow up comments & new posts
    Bob E. from Queen Creek, Arizona
    Replied over 4 years ago
    As a seller, in low price band neighborhoods, all the investors and cash buyers drag down the comps. These same homes can be sold to buyers that are comparing their monthly payment to rent. If financing is not available then seller financing works well.
    Bob Taylor
    Replied over 4 years ago
    Another thing that kills me about appraisals is the whole “style” question, you can have two homes (and I’m not personally coming at this from the cash flow/landlord angle as much as for selling renovated homes) but two homes, three, four or thirty of them within a small radius that if you go “by the numbers” are all nearly the exact same home for a comp, yet what if say 3 out of the 5 are VERY MUCH not “in style”, whether that means painted ridiculous colors, or an out of style type of home (the Brady Bunch tri-level comes to mind, must’ve been HUGE back then, try selling one now for same $$ as the “identical by the numbers” 2 story right next door-good luck!!!) Or, in the same metro area, you always have various parts of town that draw different groups of people with often like minded tastes. We’ve got some burbs where the “McMansion” is the dream home for most buyers and other areas where chances are very good that “McMansion” is a vile insult to most residents! Lastly, John C Carlson made many excellent points, one being does this randomly picked appraiser have a clue about THAT specific area? I can think of a few areas here where literally 2 blocks makes a MASSIVE $$$ difference for the EXACT SAME HOME!! Sounds like AS USUAL, gov’t involvement is helping to really screw things up yet again!!!!
    Fernando Jones Flipper/Rehabber from Fort Lauderdale FL
    Replied over 4 years ago
    It’s funny because i’m running into this situation as i type. The seller wont agree to settle for anything less than the appraised value and thats including seller concessions. So I’m thinking about negotiating a lesser purchase price and then agreeing to sign a 6 month interest free note for the difference. Any thoughts?