Have you done an appraisal for your self before? How was your experience' well that depends of course on the fact that you were doing a refinance or a purchase! in both cases you hoped for a high value right?

Well you are not alone. It seems that everyone wants the same thing, you want a high value because of the equity position, the seller doesn't mind a little higher value since it may lock you into to the deal for good, the lender also is happy about it.

But what drives this number' and why should we examine this process' because you will encounter it at some point in your life and the major part of your monthly expenses will be related to it! Yes, I am talking about either your rent or mortgage payment!

Before we start please keep in mind that the term "real estate" or "real property" is legally considered the land and anything on top of this land including the house it self is simply a "improvement" to the land.
What gives the real value in real estate is the land itself more than anything.

There are three main methods to appraise a property:

The cost approach, the sales comparison approach and the income approach.

The cost approach:

This value is estimated by adding the land value and the depreciated value of any improvements. Now please note that improvements here mean the actual house! this method is not much used anymore because it does not include the market condition in it.

The sales comparison approach:

This value is very simply derived from comparing the actual value of a similar piece of property sold in close proximity. Now this today is the most common method of evaluation, the website zilliow.com has a nice tool for finding this information.

The income approach:

This method is right now mostly used for investment and commercial real estate, it basically finds the net income of the property and value the property based on how much income it produces.

Now lets say people default on their mortgages and now they need to sell fast at a lower than usual price. This happened here in Colorado for example when not far from were I am in Littleton at Roxborough Park which is actually a very nice place because of the globally unique rock formations, here Lockheed Martin has a plant and it suddenly laid off many people. These homes were worth 500,000 to 2 Million dollars.

Suddenly without a job these people needed to sell their property fast. So they accepted the low offers they got! if they were lucky to have any!

This phenomena will cause the sale comparison to be horrible and the prices as a whole will suddenly come down, the equity in the properties will disappear and it will result in a local depression.

Now how can you make money in such a situation' financially speaking the picture is horrific!

However there is still both a long term and short term opportunity here!

In the long term scenario you would buy one property at a deep discount and hold it for a min of 1 year. Yes that is a long time but the bottom line number can actually work. Say for example you buy a 500k home for say 300k. You will of course have to find the seller that has close to that kind of equity! now your mortgage payment will be around say 3k a month with leveraged financing and a year payment will be 36K, now you can rent this place for about 2k because this place is a very nice piece of property, the views are extraordinary and the real nice wild state park is just next door! this will cause some people to get attached and stay! so here is an income of 24k. Leaving you with a 12k negative cash flow.

Now you do have to do some speculation here but Lockheed Martin is not going to go away! it will hire more people within the year and you can sell your place to them, also you can create a lease-option to buy deal with your current tenant to have incentive to buy this place and hopefully a good market condition will create equity for you to make up for the 12k. This is a very risky move and I am not by any means recommending it to any beginner investor that does not have enough liquid assets to play, however, I am suggesting that with the right move and a buy and hold strategy one "can" make money.

Now how about the short term' how can someone make money' well this requires a little bit of fundamental understanding of the term "value" in real estate and out the box thinking!

Now we discussed the three common methods of property valuation, in the above example we saw a direct impact to the real estate prices because of a local economic downturn resulting in lower than ever sales comparisons!

But we still have both the income and cost approach left. In a short term investment scenario for example when something like this happens you can still invest in the area real estate! that means that say for example someone moves into the area or someone wants to rent a place. So you would invest in the closest town or neighborhood to Roxborough Park in an income producing property! That way you will offer cheap housing to people that still want to stay in that nice area! and you can make good rental cash flows.

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