If you are a loan officer and have been in this business for more than five minutes, you have dealt with the frustrations of a soft housing market and homeowner's sometimes unrealistic valuation expectations. I am fortunate in that I live and originate loans in Texas. The housing market isn't exactly booming here, but I cannot imagine how tough it must be for homeowners desiring to refinance in the "sand" states, such as Nevada, Arizona, and Florida, where housing is still on life support.

So, how does an appraiser determine a home's value? And why do so many homeowners believe their home is worth more than the appraisal?

The bottom line for most residential appraisals is market value......simply the value the appraiser believes the "market" will pay for the property based on recent comparable sales, also known as the Sales Comparison Approach. There are other valuation methods, including Income Approach for rental properties and Cost Approach, but Sales Comparison is by far the most accurate and widely used valuation method.

On the surface, a residential appraisal is fairly simple and straightforward. Find 3 to 6 recently sold properties that are similar to the subject property, average their sales prices, and the resulting number is the value the market will pay for the subject. Easy, right? Yes, until the devil shows up in those pesky details. How often are two properties exactly alike? And what about location? Market trends? Drive up appeal? Features? Additions? Amenities? View? And, even if two properties are exactly the same, no two sellers and no two buyers are the same. For example, homeowner A may be retiring in a few years and thinking about moving to a beach condo. He has all the time in the world to sell his house and may be willing to hold out indefinitely for top dollar. And homeowner B, in his theoretically identical house, may have been transferred to another city and needs to enroll his kids in school before the start of the semester. He is the more motivated seller and doesn't have time to hold out for the best price. Since the price that a seller gets for his comparable home becomes the market valuation used for determining your home's value, the motivation of sellers and buyers become ingredients in your home's valuation soup.

Setting aside the differences between sellers and buyers for a moment, let's take a brief look at what makes up value in an appraisal. The appraiser first looks at all the pertinent information about the subject property - age, size, number of rooms, updates, location, features, etc. She then searches multiple listings and extracts between 3 and 6 sales that best compare to the subject. Sales must be recent, preferably within the past 6 months, and no more than one year. And they must be close, expecially in an urban or suburban setting. Eveyone knows neighborhoods have characterisitics,so comparabel sales from the same neighborhood have more meaning than from competing neighborhoods. Adjustments are then made for differences. For example, if the subject has a pool but Comp #1 that sold last month does not, the appraiser makes an objective, positive adjustment for the market value of a swimming pool. Likewise, if Comp #2 is on a larger lot, a negative adjustment is made. Once all adjustments are made, the adjusted values are averaged, resulting in the Sales Comparison Value of the subject.

So, why are so many homeowners disappointed or even in disagreement about the value the appraiser assigns? I believe there are three primary reasons:

1. Unwilling to face the facts. Last year a client approached me for a reverse mortgage loan, but they didn't agree with the value assigned by the appraiser. Deciding they would be better off selling the house for what they thought it was worth, about 20% more than the appraisal, they easily found a realtor that was willing to list the house for their desired price. I checked in with them in December. The house has been on the market for 9 months, and they've dropped the price twice, to it's current list price of about 10% over the appraised value. They have not had a serious offer. A buyer doesn't care what you paid for your home. The question you must ask is why would someone pay more for my house than the one listed down the street for less?

2. Bad information. Like the realtor in the above scenario, it is easy to find support for your theory of higher value. I cannot count the number of homeowners that tell me their house is worth x because the neighbor's house is listed for the same amount. But asking price and sales price are two entirely different things.

3. Conservative appraisers. During the run up in the housing market, some lenders and appraisers played loose with the rules. Because of the actions of some appraisers and lenders, new rules prevent loan originators from selecting or talking directly to appraisers. Furthermore, appraisers have more government oversight and greater penalties for errors. The result is that the pendulum has swung in the entirely opposite direction, and appraisers approach their jobs much more conservatively than before 2008.

Yes, the real estate market is efficient, and large deviations in sales prices don't exist for generally homogenous properties. But the housing market is not as efficient as say the stock market, and there is some subjectivity to home valuations. In this housing market, marked by never ending foreclosures, shadow inventories, and difficult to obtain financing, homeowners will save themselves much frustration and possibly some expense if they remove their rose colored glasses and prepare for the new reality of residential appraisals.