What Is a Home Inspection?

A home inspection is an examination of the condition of a real estate property. It usually takes place in connection with the property's sale. A qualified home inspector assesses the condition of a property, including its heating and cooling systems, plumbing, electrical work, water and sewage, as well as some fire and safety issues. In addition, the home inspector will look for evidence of insect, water, or fire damage or any other issue that may affect the value of the property.

Key Takeaways

  • A home inspection is an examination of a property's safety and current condition, from its foundation to its roof and including its various systems (electrical, plumbing, and more).
  • A buyer arranges and pays for a home inspection and—depending on its findings—may choose to move on to closing, renegotiate the sale price, request repairs, or cancel the sales contract.
  • A home inspection is not the same as a home appraisal, which is required and scheduled by a lender to determine the value of a property for which a buyer is seeking a mortgage.
  • When valuing real estate for investment purposes, a home inspection is one of a number of variables considered.

How a Home Inspection Works

Potential home buyers often hire home inspectors to research a property and provide them with a written report that details the property's condition, including an assessment of necessary or recommended repairs, maintenance concerns, and any other potentially costly issues. The home inspector will assess the physical structure of the home, from the foundation to the roof, as well as the home's systems, making sure that the home is up to code.

A home inspection can tell a homebuyer a lot about a newly constructed or existing house that can save them money and aggravation. It can identify needed repairs or builder oversights and upkeep requirements. For sellers, having an inspection done before putting their home on the market can afford them the chance to make structural repairs or upgrade/replace systems that may increase the likelihood of a sale.

The inspection contingency

Typically, a home inspection is done after a sales contract or purchase agreement between a buyer and a seller has been signed. For this reason, it's important that the contract include an inspection contingency (also known as a "due diligence" contingency), which allows a buyer time to find an inspector, schedule and attend (if so desired) an inspection, receive the inspector's report, and decide how to proceed based on the information it includes.

Depending on the report's assessment—which can include everything from material defects that may negatively impact a home's value to cosmetic defects, which don't affect safety or functionality—a buyer may decide to proceed with the sale, schedule additional inspections, renegotiate the sale price with the homeowner (if there are serious issues), ask that certain repairs be made, or cancel the contract. If the buyer requests major repairs, they may also ask for a reinspection with the original inspector to verify that the original problem identified has been remedied.

Additional inspections may be done for asbestos, mold/mildew, termites, pests, radon, or lead, for example, or to check sewer lines, a chimney, or other structural components.

Home Inspection vs. Appraisal

A home inspection, which focuses on the home's current condition, should not be confused with a home appraisal, which determines the value of the property. Both are important steps in the process that leads to a home sale/purchase, but they are done for different reasons.

The buyer sets up a home inspection and can attend it to become educated about the condition and safety of the home and its systems. An appraisal, performed by a certified or licensed appraiser, is required and scheduled by a lender when a buyer needs a mortgage in order to purchase a home; typically the buyer isn't present for it. An appraisal can impact the amount that a buyer can borrow, but a home inspection won't. The appraiser uses several valuation methods, including comparable home prices, the size and quality of the home, lot size, and more, while the inspector is only evaluating the condition of the home.

Home Inspection and Real Estate Valuation for Investment

Valuing real estate can be a challenging process. The result of a home inspection is just one variable in this process. Investing in real estate is similar to investing in stocks. Two basic methodologies exist: absolute value and relative value. Discounting the future net operating income (NOI) of a property by the appropriate discount rate is similar to discounted cash flow (DCF) valuations for stock. Integrating the gross income multiplier model in real estate is also comparable to relative value valuations with stocks.

In both methods of real estate valuation, it’s critical to choose an appropriate capitalization rate or the real estate’s required rate of return. This is net of value appreciation or depreciation.