What is the worth of a given property? It may seem as though a sales price would be the best index of value. Yet, this is not always the case as far as lenders are concerned.

To lenders, property is security; the ultimate recourse in the event a borrower fails to repay a mortgage. In this sense, lenders must know real estate values to limit their risk.

Consider what might happen if a lender incorrectly valued a real estate parcel and made a mortgage based on that misjudgment. If the mortgage were not repaid, the lender would sell the property at foreclosure, a costly and time-comsuming process. And if the property can only be sold for less than the mortgage balance and the cost of foreclosure, the lender would take a loss.

To limit such risks, lenders want a precise but conservative estimate of value before making a loan.

The value of a particular property is represented by more than bricks and mortar. Appraisers must be alert to many factors, including:

Occupancy: It is generally agreed that owner-occupants have a clear interest in maintaining property values. Tenant-occupied properties are seen as representing more risk to a lender, and therefore investment loans are likely to have both a higher rate of interest and a larger down payment requirement.

Transition: Property values may fluctuate as a result of zoning changes, growth patterns and other factors. Most transitions are evolutionary, but in some cases there can be dramatic value fluctuations. In one situation, an appraisal was changed from $15,000 to nearly $500,000 because the property was rezoned and incorporated into a rapidly developing urban area.

Predominate value: Housing patterns tend to be homogeneous. For appraisers, it is important for properties to be within the general pricing patterns of their neighborhoods. Buyers, it is said in the real estate industry, seek the least expensive property they can find in the most expensive neighborhood they can afford. This means that a home with a pool and five bedrooms in a neighborhood of conservative three-bedroom homes will be difficult to market at full economic value, and therefore a lender will want to limit the size of loans made against it.

Siting: Community improvements, such as sewers and sidewalks, also influence property values.

Improvements: Houses, apartment buildings, garages, pools, etc. are regarded as "improvements." An appraiser will evaluate each improvement in terms of its age, condition and modernization, and will estimate its remaining economic life. Consideration will also be given to items that reduce energy usage.

Once all the variables have been considered, an appraiser may calculate a property value using one of three systems.

With the "market data" approach an appraiser will compare the subject propety with other neighborhood sales. This is the most common form of appraisal for residential property.

The "income" system can be used to determine values for investment properties. Here the analysis is based on revenues and rates of return.

A third type of approach, "cost" valuation, estimates the value of materials and labor needed to erect a similar improvement on comparable property. This form of appraisal is valuable for specialized structures, such as churches and synagogues.

Using one or more forms of analysis, an appraiser will provide an estimate of value to the lender, who may then elect to make a loan.

However, since the lender views the property as economic security, a conventional, uninsured loan for the full value of the property will not be granted. Instead, the lender will provide a loan for a portion of the property's value, say 80 percent, and the purchaser will put up the balance in cash, as a second trust, or both. For the lender, a limited loan commitment and the equity contribution from the buyer both have the effect of reducing risk.

Not everyone can put up sufficient cash or secondary financing for a property purchase. In such situations a lender may provide more than 80 percent financing when there are assurances of repayment by a third party, such as the VA or FHA, or where the purchaser agrees to buy private mortgage insurance.

Next Week: The Nature of Yield.