The question of what a home is actually worth is the driving force of every real estate transaction. The negotiations about price and repairs, the managing of multiple offers for the best outcome, the buyer’s ability to obtain financing, and even insurance quotes all come back to determining the true value of a property.

A common situation that comes up on most transactions is that the assessed value, appraised value, and the agreed upon sales price (“market value“) are not all in alignment with each other. Sometimes, this can cause headaches for both buyers and sellers alike.

So what causes these values to be different? First, let’s go through each one of these values so we know what they really mean.

Assessed Value

The assessed value is usually the lowest out of the three values. This is the value that the property taxes are based on. Every county has their own tax rate that is assessed on each parcel of land in the county. In Southern California this tax rate is usually 1.25% of the assessed value.

The assessed value is typically equal to the purchase price paid for the home, and can increase every year if local home values are going up. However, increases in assessed value are limited to the lower of either 2%, or the inflation rate. In most of California, home prices tend to increase faster than the assessed value of a home.

For example, my grandmother purchased her home in 1972 for about $30,000. She still owns that home today and over the last 45 years the assessed value has increased all the way up to almost $90,000. So her property taxes are currently 1.25% of about $90,000, about $1,000 annually. That’s a pretty good deal considering her new neighbors assessed value is equal to the price they just paid for the home, about $849,000, for an annual property tax of around $10,000.

Assessed value vs. sale price

As you can see, it’s pretty common that the assessed value will be different than the sale price (purchase price) of a home. In fact, the first year of ownership is likely the only time that these numbers will be the same in most cases.

There are exceptions of course. Seniors, for example, are sometimes allowed to keep their current property taxes when they move to a new home of equal value or less.

Appraised Value

This is the value that a professional licensed appraiser assigns to a home. Most buyer’s will want to get a professional opinion of value before going through with a real estate transaction. If the buyer needs to get a loan in order to buy the property, then the bank will require an appraisal in order to determine how much money they can lend on the property.

The appraiser’s goal is to determine what a bank can reasonably expect to sell a property for on the open market. He will collect data on comparable home sales (recent nearby sales of similar homes), do the necessary analysis, and come up with a value.

Is the appraised value accurate?

At the end of the day the appraised value is the educated opinion of a real estate professional, kind of like your Realtor’s opinion. There is one big difference though…

The appraisal is a backward-looking valuation. This is because the appraisal relies heavily on recent home sales that have already closed. By definition, all of this data is old because these sales occurred in the past. Most neighborhoods are not made up of identical homes, so it can actually be fairly difficult for an appraiser to find comps that are both similar and recent. They often resort to going back several months and using homes that are not all that similar and just making adjustments.

In a market where home prices are increasing, a backward-looking analysis for valuation can prove to be overly conservative. Past homes sales from 4-6 months ago may not be representative of what today’s buyers are willing to pay, and what a buyer is willing to pay is ultimately what determines the price/value of a home.

Full Market Value

The full market value is what every home seller is hoping to get for their home. If the home has been properly marketed, it should get enough exposure to attract multiple offers. With multiple offers, the true market value of the home will typically be the highest bid from a willing and able buyer.

The true value of a home, after all, is what a buyer is willing to pay for it. This is where the appraised value falls short. As a backward looking analysis, it can’t take into account the current state of the market. This affect can be higher in areas where there are fewer listings.

Appraised Value vs. Market Value

When there is a large disparity between what a buyer is willing to pay for a home and it’s appraised value, it can cause some problems. As I mentioned earlier, banks are only willing to lend on the appraised value of a home. This means that if the appraisal falls short of the purchase price, the buyer will need to have enough cash to make up the difference.

Dealing with a low appraisal is stressful for both buyers and sellers, as either one could start having seconds thoughts about the true value of the home. Typically a low appraisal leads to renegotiating the purchase price, getting a second appraisal from a different bank, or canceling the transaction altogether.