Extraordinary Assumptions and Hypothetical Conditions
Are you in the market to buy a house? Or maybe you are trying to tap into the equity that has built up in the house you already own? If purchasing or refinancing, the bank/lender will need to determine how much of a mortgage you qualify for, or how much your current house is worth. To do this they will order an appraisal. This mean that a professional appraiser will come and inspect your property. They will scribble notes, take pictures, and ask you some questions, then drive off to do the analysis and paperwork to determine that magic number.
A market appraisal report for your home has many parts. Several key analysis tools are used in combination together to come to the final estimate of value. Some of these include a thorough market analysis, determination of replacement cost, and a comparison of similar properties in your market area that have recently sold.
One particularly important, yet often misunderstood section is the extraordinary assumption and hypothetical conditions section. This section can be challenging to understand and may not be straightforward to the average homeowner.
So what are extraordinary assumptions and hypothetical conditions and what are they used for? In summary, both of these are used to limit liability, and even though they work to achieve the same goal, each is used differently. Let’s look at what they do.
The extraordinary assumptions section is used to state any assumptions used in the valuation process that assume specific conditions are correct, and that if found false could change the value of the property. For example, an extraordinary assumption can be made to assume the foundation walls of a property are in good condition and constructed in compliance with appropriate standards, even though they may not be able to be viewed during the inspection. The basement will be valued in the report as if this assumption is correct and will be reflected in the estimate of market value. If the foundation is later found to have been damaged or poorly constructed, it could change the market value that was stated in the initial report. The extraordinary assumption is added to let users of the appraisal report know what assumptions have been made and used in the valuation. In addition to this, most appraisers do not check the title of a property, especially for purchases and re-mortgages. Instead, the appraiser assumes that the property owner is legally on the title and that there are no liens or unforeseen encumbrances. Then they use an extraordinary assumption to limit the liability associated with making this assumption. In summary, an extraordinary assumption can be used anytime that something is assumed and can not be physically verified.
Hypothetical conditions refer to aspects of a house that either have not yet happened, or factors that are to be changed/omitted, usually at the request of the lender (bank). Hence the term ‘Hypothetical’. The most common use of this section is when appraising a new construction or renovation. In this situation, the appraiser is asked to value a house that has not been built yet, or value renovations that are not complete. The appraiser must place a value on the property as if the home has been constructed or renovated. To do this they add a hypothetical condition to the report. Another common scenario is in the case of purchased acreages, most banks will only allow 10 acres to be valued in the appraisal report. This means that if you purchase a property with 40 acres, only 10 acres may be valued, even though the remaining 30 acres might add more value, especially if sub-divided or used for production. A hypothetical condition is made to reflect this.
So, the next time you read through the report to understand the value of your home, this can help you understand the inclusion of any assumption or conditions that were used to determine your market value.