The Key Elements of a Rental Property Appraisal

An appraisal is an accurate, unbiased report of a home value. When you apply for a mortgage loan, typically, the lender is going to need to know the property value to determine if the home is appropriate collateral and if the amount the borrower is requesting makes sense. For an investment property, appraisals additionally help identify the expected monthly income and potential ROI. In this post, let's take a closer look at the appraisal process and key elements for both an owner-occupied residential property and an investment property.

What does a traditional appraisal look like?

In this section, we'll take a closer look at the necessity of appraisals for all mortgage loans and how they are the most trustworthy method for assessing property value. Appraisals are always ordered by a lender to maintain fairness and conducted by licensed third-party appraisers. Here is what you can expect to see in a traditional appraisal:

Property Condition

The appraiser examines the overall condition of the property, both the interior and exterior. They assess the quality of construction, any visible damages or defects, risk factors, and the general upkeep of the given property.

Size and Layout

The appraiser considers the square foot measurements of the property and its layout. They measure the rooms, including bedrooms, bathrooms, living areas, and any additional spaces. The layout's functionality and flow are also taken into account.

Location

The appraisal considers the location of the property and its proximity to amenities such as schools, parks, shopping centers, transportation hubs, and other local conveniences. Factors like the neighborhood's desirability and property values in the area are also considered.

Recent Sales Comparison

Appraisers compare the property to similar properties in the same area to gauge recent market values. The sales comparison approach looks at the subject property with other properties in terms of size, condition, age, location, and other relevant factors to establish a fair market value.

Functional Systems

The functionality and condition of essential systems in the home are assessed. This includes evaluating the electrical, plumbing, heating, and cooling systems to ensure they are in good working order and there are no safety precautions.

An Opinion of Value

Appraisers use all the data they have collected on the subject property and researched data including listings of other properties, sales, and square foot measurements, to draw a fair, reasonable opinion of value.

What does an appraisal for a rental property look like?

An appraisal for an investment property will have all the same components as one for an owner-occupied property, yet with a different angle and some added factors. Here are some key differences:

Inclusion of Rental Income Potential

As we previously stated, standard appraisals concentrate on the recent sales of comparable properties to determine the fair market value. The goal is to assess how the given property stacks up against recently sold properties in the same neighborhood or area. Factors like property condition, size, location, and amenities are taken into account to establish a reasonable market value.

Investment property appraisals, however, pay more attention to market conditions and rental trends. The appraiser considers factors such as vacancy rates, rental demand, gross rent, and market fluctuations to estimate the potential income and value of the property. Additionally, they may analyze the rental history of the investment to assess its performance and potential ROI.

Different Valuation Methods

Standard appraisals typically employ the sales comparison approach, which involves comparing the subject property to similar properties recently sold in the area. The appraiser considers factors such as size, location, amenities, and condition to determine a fair market value. They may also employ the cost approach, which estimates the value by considering the replacement cost of the property minus depreciation.

Rental property appraisals, on the other hand, focus primarily on the income approach. The income approach evaluates the property's value based on the potential rental income it can generate. The appraiser considers factors such as market rental rates, occupancy rates, operating expenses, and capitalization rates to estimate the property's value from a gross rent perspective.

Inclusions of Landlords and Property Managers

Standard appraisals primarily cater to the needs of buyers, sellers, and lenders involved in a real estate transaction. It helps both buyers and sellers understand the fair market value of the property, ensuring they are making informed decisions. Lenders also rely on standard appraisals to determine the loan amount they can offer based on the property's value.

In contrast, appraisals for rental properties primarily serve the interests of landlords, property investors, and lenders involved in investment property transactions. The appraisal assists landlords in understanding the gross rent of the property, enabling them to set appropriate rental rates. Property investors and lenders rely on investment property appraisals to evaluate the potential ROI and determine the viability of investment property ventures.

Summary

Appraisals for rental properties not only give the lender and buyers and sellers an idea of fair market value, but they also help investors and property managers. They use an income approach to gauge the gross rent of the investment.