Divorce Appraisals: Calculating Equity & Estimating Market Value

Calculating Equity

Divorce, even in the best circumstances is typically not a pleasant experience. One thing common among divorce proceedings is the need to determine an equitable distribution of marital assets. For many couples the distribution of assets includes the amount of equity that has accumulated in their home or other real estate they may own. My job as an appraiser is to estimate the value of the real estate in order for the amount of equity to be determined.

What is equity…Most people know that equity is typically estimated to be the value of the home less the mortgage balance owed. But this short cut to estimated equity is wrong and can lead to property settlements that my not be equitable. The actual definition (my definition) of home equity is that amount of money that is left after the real estate is sold and all liens and expenses associated with the sale are subtracted. The estimate of home equity is therefore the same whether the house is sold outright or if one of the couple decides to keep it.

Typically I am asked to estimate the value of real estate in a divorce settlement when either the property is going to be kept by one of the parties or the sale so that property is to be concluded at some undetermined time in the future but a value is needed now.

Once the appraisal is completed the amount of equity is determined by subtracting all the costs that would be associated with sale of the property on a given date. Let’s go through most of these expenses.

First the biggest item will typically be the mortgage if there is one. Most people calculate the estimate of equity using the mortgage balance. However, the mortgage balance is always lower then the mortgage payoff. While I won’t go into details here the mortgage payoff will be as much as one month’s mortgage payment higher than the mortgage balance. So a payoff should be ordered from the mortgage company that coincides with the effective date of the property settlement agreement.

Another important factor that may be missed s the inclusion of any mortgage prepayment penalties. A mortgage balance does not include any prepayment penalties that may be charged under the terms of the mortgage. Prepayment penalties often are several thousand dollars. If we agree that equity is the amount of value left over after all obligations and expenses are subtracted from the sale price of the real estate, then the cost of a prepayment penalty must be included in the equity analysis determination of the real estate.

Real estate commissions should be calculated into all equity estimates since this is a major expense to over 90% of all real estate transactions. Full brokerage service fees should be used in the calculation. Typically it will be between 5 and 6 percent. In really hot markets it may drop to 4% and could be over 6% in slow markets or when dealing in lower priced real estate. So make sure you subtract your typical real estate brokerage fee from the current value of the real estate.

Other items may be overlooked and should be considered in estimating equity. If you were to sell a home today, there would be an adjustment for real estate taxes. You could owe tax which would be subtracted from equity. Since real estate taxes are paid in advance, then if payments are current, their may be a prorated balance that would add to the estimated equity. In high real estate tax areas, this can be substantial.

Other less significant expenses that would be adjusted for in estimating equity may include water and sewer bill, insurance, home service contracts etc….

The bottom line is that regardless of how amicable the negotiations of the property settlement are, it should be understood by all parties what the equity portion of what the real estate value is, and how it was determined and the equity is the equity regardless of whether one party will keep the real estate or it will be sold.

Estimating Market Value

Typically market value is the most probable price an informed buyer will pay for a piece of real estate that has exposure times (marketing times) that are consistent with the marketplace.

Appraisers are supposed to be objective and unbiased in their appraisal of real estate. Unfortunately, some are not and whether they admit it or not they may be actually acting as advocates for their client which is specifically prohibited in our standards of professional practice. While this as a general rule may not be true, the perception is common enough to motivate each party of the property settlement agreement to retain their own independent appraisal report.

It is a forgone conclusion that one of the parties benefits from a high value and the other from a low value. The question in my mind is “can a appraiser value a property knowingly high or low and still adhere to the standards of professional practice?” My conclusion is yes and let me explain.

A piece of real estate has many potential values. There is value in “as is” condition. There is value “subject to” some future action or event. There is distressed sale value. In other words value can be shaped to reflect specific circumstances. Thus an appraiser can provide high values or low values as long as the scope of the appraisal is properly explained and the conclusions made are logical.

Let me use an example. A couple owns a home that is estimated to be worth $300,000. That value may be based on the home being marketed by a realtor for as long as six months. Now if one of the parties is looking to buy out the other party would you use market value to determine the equity position? Maybe! Haven’t we all heard the story of a home being sold under market value because it was a distressed sale due to a divorce? Does a divorce create a more motivated seller? The answer is typically yes and the appraiser could argue that market value may not apply since the motivation of the sellers requires a shorter marketing exposure time. Could it be argued that a “quick sale” value should be used as opposed to a market value? I believe that the answer to this question is yes. It really comes down to the appraisers instructions. If it can be argued that the sale of the property would be distressed the appraiser can appraise as instructed. If it is not distressed then appraising for market value would apply.

There are other considerations when valuing a property. Some divorce situations can be downright nasty. One party may intentionally damage the property in order to lessen its value. While an appraiser could value such a property in “as is” condition which would result in a lower value, the appraiser could value the real estate “subject to” certain conditions with a value that may be substantially higher than an “as is” value.

The bottom line is that an appraiser should not be an advocate but when properly instructed and properly disclosed an appraiser can determine values within a fairly large range of values which may actually be more representative of the situation. It goes back the saying; “that if you only have a hammer, everything looks like a nail”.

All appraisers and all appraisals are not created equal. Appraisers have different levels of experience and different levels of analytical skills and abilities. Any appraiser may due when valuing a typical home in a residential subdivision, but there are certain times when you need an appraiser with greater skills and abilities.