Appraisal

What Is a Real Estate Appraisal?

An appraisal is a professional assessment of a property's market value conducted by a licensed appraiser. Lenders require appraisals before issuing mortgages to ensure the property is worth at least the loan amount. For investors, understanding how appraisals work is critical because appraisal values directly impact your ability to finance, refinance, and exit properties. The appraisal can make or break a deal, particularly in the BRRRR strategy.

Three Appraisal Approaches

Appraisers use three primary methods to determine value. The sales comparison approach examines recent sales of similar properties in the area and adjusts for differences in size, condition, features, and location. This is the most common approach for residential properties. The income approach calculates value based on the property's income-producing capability, using net operating income and market cap rates. This is the most relevant approach for investment properties, particularly commercial and multi-family.

The cost approach estimates the value by calculating the cost to rebuild the structure from scratch plus the land value, minus depreciation. This approach is used primarily for unique properties, new construction, and special-purpose buildings where comparable sales are limited.

The Income Approach for Investors

For rental property investors, the income approach is the most important valuation method to understand. This approach values a property based on the income it generates, making it particularly relevant for multi-family and commercial properties. The appraiser examines the property's actual and market rents, vacancy rates, operating expenses, and net operating income to derive a value using market cap rates. If your property's income exceeds the market average, it should appraise higher. If it underperforms, it will appraise lower.

Appraisal Gap Risk

An appraisal gap occurs when the appraised value comes in below the contracted purchase price. This is a common risk in competitive markets where bidding wars push prices above market value. When this happens, the lender will only loan based on the appraised value, leaving the buyer to cover the gap with additional cash or renegotiate the purchase price. Including an appraisal contingency in your purchase contract protects you by allowing you to walk away or renegotiate if the appraisal comes in low.

Challenging an Appraisal

If you believe an appraisal is inaccurate, you can challenge it through a reconsideration of value (ROV) process. Provide the appraiser or lender with additional comparable sales that support a higher value, evidence of property improvements not captured in the appraisal, or corrections to factual errors. Challenges are most effective when you can present concrete data the appraiser may have missed, such as recently sold comparables or documented renovation costs.

Impact on BRRRR Refinance

In the BRRRR strategy, the refinance appraisal is the most critical step. After buying a distressed property, renovating it, and renting it, you refinance based on the new appraised value to pull out your invested capital. If the property appraises at your target, you recover your capital and move to the next deal. If it appraises below your target, your capital remains trapped in the property. Before starting a BRRRR deal, research comparable sales thoroughly to ensure the after-repair value supports your refinance plan.