Differentiating between appraisal value and inspection strength is a difficult scenario in the real estate industry. It is especially difficult for new investors and even experienced investors who buy passive investments. Each will offer some distinction as to the strength of the property, with the appraisal giving you an estimate of the property value and the inspection give you its deficiencies.
However, the reality for real estate investors is that neither will give you the full picture, and neither area is all that good as stand alone data on the strength of an investment property. There is so much that goes into each, and the strength and weakness of each needs to be weighed by an investor before purchasing.
What the Appraised Value Tells You
Where real estate investors go wrong is in thinking that the appraised value is the absolute number your property is worth. An investor makes an error when they think they could buy or sell the property for the appraised value from an appraiser. While the appraisal can be a pretty good estimate, it is just that. It is a snapshot of where the property is at the time the appraisal is done. As an investor, you could hire five different appraisers, and all five could give you a different appraisal value — and they could vary wildly!
Most appraisers will tell you that they operate in a difficult environment today. Whether real or implied, the appraisers that I network with all describe a regulatory environment that is overbearing, a hiring system that makes them look over their shoulder for the next appraiser to be hired and quite possibly feel pressured to either perform and bring in properties at value, or lose their spot in the rotation. They are literally being pulled from both directions.
So, how much can you trust an appraisal today in this environment? Understand, that is not a question about the appraisers themselves, but rather about the arduous process that they are working under. Their communication has been cut. They are feeling pressure to bring appraisals in at value, while also feeling pressure to hold values down to prevent having their values questioned later.
The more discretion they use in a value — such as considering the level to which a property is renovated, the distance comparison properties are from the subject property and even the varying elements that they have to make adjustments for — leads to more scrutiny and the possibility of issues and questions arising about their work. At the very least, this is a tough environment in which to work and an extremely difficult set of circumstances for an investor to accept an appraisal as the last word in value.
To get a better idea of what the property value really is, an investor can match an inspection report with an appraisal and find out a clearer picture of their future with this property.
How Home Inspections Fit into Your Pre-Closing Process
The home inspection on an investment property is done by a licensed inspector for your benefit. It is done under the idea that the inspector will give you an unbiased opinion of what is wrong with the property and what needs to be repaired, replaced and updated. The appraiser’s job is to look at surrounding properties and nearby properties that match the features of the property you are buying to give you an idea of its value. They have to take into consideration the condition of your property, but they also can make assumptions on how the property is currently finished as opposed to how it will be finished in the future.
The inspector comes in and gives it to you down and dirty. Their job is to say, here are the issues and here are the fixes. They could not care less about comparables or how other houses are finished out. Their job is to tell you what works, what does not work, and what you have to address. Many investors will get involved with a property and refuse to hear what the inspector has to say. Nothing can get you in trouble quicker on a given property.
The inspector has no skin in the game and no reason to exaggerate the issues on a property. They are essentially working to protect the buyer (you) and will get paid whether there is mold in the basement or not. There is some fear within the real estate community about inspectors and whether they make a list simply to show they are doing their job! I think that is pretty short sighted and borderline conspiracy theorist. However, worrying about an inspector simply making lists for the sake of “looking busy” or “justifying their payment” is a waste of time. Hire a quality inspector, be clear on what you expect and then let them do their work.
The appraisal process has gotten much more reliable, but it is still far from perfect. Because the appraisal is a snapshot at any given time, what the value is today oftentimes will not be the same in 90 days. Plus, the number could be skewed in the favor of whoever is ordering the report. If the seller is selling for $200,000, the appraiser will start with comps in that price range and go from there.
Since no two houses are exactly alike, much of what the subject property is compared to is open for interpretation — much like if you are trying to find lower comps for an REO or a foreclosed property. If you look hard enough and stretch your imagination, you could find ones to fit what you are looking to do. The same could be said with any online valuation sites you may find. Those values should be used only as a starting point and never a final estimation of value. In many cases, the information they receive on a property may not tell the whole story of a previous sale.
The inspection process and report may be long and sometimes boring, but the information inside is invaluable. If the inspection comes back with mold or with a decaying roof, use that for your benefit. Never go into a property with a set opinion on the condition or any other aspect of the property. If you fall in love with a property, you are sure to ignore the warts that will end up costing you money. At the same time, no matter how many houses we look at or how long we have been investing, ordering an inspection and getting a second set of eyes can be a very positive action that protects our investment decisions and process.
When making a decision on a property, use all of the possible information available to you. This includes the inspection, the appraisal and anything else you can find. These items are in place to help you get the best deal possible. If you don’t utilize them, you may end up regretting your purchase!
What has your experience with property inspections been? Do you agree with my assessment?
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