In 2014, The Wall Street Journal estimated that as many as one in seven residential appraisals conducted from 2011 to 2014 was inflated by 20 percent or more. As property values in the Denver metro area continue to rise, it’s important to know how to evaluate appraisals and identify those that are poorly done or intentionally deceiving, regardless of whether the property is residential or commercial. 

Even in a rising real estate market, property value should not be solely determined by what buyers are willing to pay. This is especially important to keep in mind if you’re considering purchasing an income-producing property as a more long-term investment strategy. 

Why You Need An Accurate Appraisal 

An accurate appraisal is essential for several reasons. They are crucial for protecting the interests of buyers, sellers, and lenders, facilitating fair transactions, and ensuring market stability. Whether you are a homeowner or looking for an investment property, an accurate appraisal value can include the following benefits: 

1. Fair Market Value: It ensures the value of a property reflects its true worth, preventing buyers from overpaying and sellers from undervaluing their property.
2. Loan Approval and Terms: Lenders rely on accurate appraisals to determine how much to lend. This protects both the lender and the borrower by aligning the loan amount with the property’s actual value.
3. Protects the Buyer: Buyers are protected from overpaying for a property and making a poor investment that could lead to financial loss.
4. Protects the Lender: It minimizes the risk of lending more than the property is worth, reducing potential financial losses if the borrower defaults.
5. Property Taxes: Accurate real estate appraisals help determine fair property taxes, ensuring homeowners do not overpay or underpay.
6. Avoids Legal Issues: Minimizes the risk of potential legal disputes and accusations of fraud that could arise from inflated or deflated property values.
7. Insurance Coverage: Ensures appropriate insurance coverage by reflecting the true replacement cost of the property.
8. Refinancing and Home Equity Loans: Provides a basis for determining how much equity is available for refinancing or home equity loans.
9. Facilitates Smooth Transactions: Establishes a fair value for real estate transactions, reducing disputes and ensuring both buyers and sellers operate with a clear understanding of the property’s value.
10. Market Stability: Helps maintain stability in the real estate market by preventing overinflated values and promoting sustainable growth.

4 Ways to Spot an Inflated Property Appraisal

An inflated appraisal is when a property’s value is assessed higher than its actual market worth, often to secure a larger loan amount or justify a higher sale price. An over-inflated appraised value of a property can be an attempt to deceive the buyer to get a higher price. 

Here are four important aspects to examine on the appraisal to identify any potential red flags.

1. Look at Photos of the Comparables Used in the Appraisal Report 

When you consider the property you are interested in and the comparable sales used in the appraisal process, consider if the properties are actually alike. Are the structures similarly constructed? If a comparable building is decidedly better constructed than the building on your property, then the appraisal value might be a bit optimistic.

2. Note the Locations of the Comparables 

Are they in the same neighborhood or are they across town from each other? When you’re looking at properties in a dense metropolitan area such as Denver, even two miles can make a huge difference in property values. If none of the comparables used for the appraisal are actually close to the appraised property, then you should look into why that is. It’s quite possible that all of the neighboring properties are valued far lower and even if the appraised property is superior to its neighbors, a significantly higher value is unlikely to bear out.

3. Examine the Adjustments Made to the Comparables 

While making adjustments to comps to account for small differences is standard practice (for example, adjusting a comparison of property with a basement to one without), typically such adjustments should not exceed 25 percent. Larger adjustments (such as 40 to 50 percent) should be viewed skeptically as they indicate that the comparables were not actually significantly similar and the appraiser probably should have chosen ones that were a better match to the property being appraised.

4. Review the History of the Property 

Any sales within the last three years should be disclosed in the appraisal; you can double-check with the county assessor to make sure none were overlooked. If the property was recently sold, then you can calculate the appreciation in the value and determine whether it’s typical for the area and the property type. Significant appreciation without substantial renovations or rehabilitation is another sign of an optimistic appraiser. If you’re evaluating a commercial property, you should also consider the history of the property’s finances, especially if it is income-producing. If the property is underperforming or has a high vacancy rate, that should be reflected in the appraisal.

While inflated appraisals might seem appealing in the short term, they pose significant risks for both borrowers and lenders, potentially leading to legal complications. If you’re considering a hard money loan and want a lender who values transparency and security, apply online for a loan or contact us today to learn how we can help you help you with your investment properties.