Basic Concepts and Understanding
Professional real estate appraisers perform a useful function in society and offer various services to their clients. They develop opinions of several types of property value and assist in multiple decisions about real estate.
An appraisal is an opinion of a professional appraiser.
Market Value / Open Market Value
The most probable selling price in an open market with an arm’s length transaction.
The future worth.
The actual selling price.
Intended Use of an Appraisal
Transfer of Property
- To facilitate the transfer of ownership of real property
- To help prospective sellers determine acceptable selling prices or prospective buyers decide on offering prices
- To establish a basis for the exchange or reorganization of real property or for merging the ownership of multiple properties
Appraisals for the Lending Industry
- Many appraisals are performed for lending purposes.
- Property owners should be aware that current federal lending regulations* require the lender to “initiate” the appraisal.
- The lender must have the first contact with the appraiser and oversee the appraisal process.
- According to these regulations, the lender must be the client and the appraiser must be engaged by the lending institution.
- Any property owner who wants to use the appraisal for lending purposes should communicate this need to the lender and have the lender engage the appraiser.
- This avoids the possibility of the lender rejecting the appraisal or requiring a new appraisal because the appraisal was not initiated by the bank.
- According to federal lending laws, any bank can use an appraisal prepared for another bank, as long as the initiating bank reviews the appraisal and finds it to be acceptable.
Financing and credit
- To assist the underwriter in establishing a value of security for a mortgage loan
- To provide an investor with a sound basis for the purchase of real estate mortgages, bonds, or other types of securities
Help resolve legal or tax issues
- To estimate the market value of a property in eminent domain proceedings
- To estimate the market value of a property in contract disputes or as part of a portfolio
- To estimate the market value of partnership interests
- To estimate damages created by environmental contamination
- To estimate the assessed value
- To determine gift or inheritance taxes
- To estimate the value of the real property component of an estate
Investment counseling and decision-making
- To set rent schedules and lease provisions
- To determine the feasibility of a construction or renovation program
- To aid in corporate mergers, issuance of stock, or revision of book value
- To estimate liquidation value for forced-sale or auction proceedings
- To counsel a client on investment matters, including goals, alternatives, resources, constraints, and timing
- To advise zoning boards, courts, and planners, among others, regarding the probable effects of proposed actions
- To arbitrate between adversaries
The Valuation Process
Although characteristics of properties differ widely, all appraisal problems can be solved through the valuation process’s systematic application.
In the valuation process, the problem is identified. The work necessary to solve the problem is planned, and relevant data is collected, verified, and analyzed to form an opinion of value.
The valuation process is accomplished by following specific steps, which depends on the nature of the appraisal assignment and the data available to complete it.
Identification of the Problem
Scope of Work Determination
Data Collection and Property Description
Site Value Opinion
Application of the Approaches to Value
Reconciliation of Value Indications and
Final Opinion of Value
Report of Defined Value
The most common type of appraisal assignment is the development of an opinion of market value.
1, Identification of the Problem
The first step in the valuation process is to identify the problem.
This sets the parameters of the assignment and eliminates any ambiguity about the nature of the assignment.
In this step, the appraiser identifies the client and intended users of the appraisal, the appraisal’s intended use, the purpose of the assignment, the effective date of the opinion, the relevant property characteristics, and the assignment conditions (extraordinary assumptions or hypothetical conditions).
2. Scope of Work Determination
The scope of work is the amount and type of information researched and the analyses applied in an assignment.
After the problem to be solved is clearly identified, the appraiser must determine the appropriate scope of work to solve the problem.
The scope of work must be clearly disclosed in the appraisal report.
3. Data Collection and Property Description
The appraiser gathers general data on the market area and specific data on the subject and comparable properties in this step.
The appraiser collects general data related to property values in an area to understand the economic climate in which properties compete and the interacting forces that cause values to increase, decrease, or remain stable.
Specific data are details about the property being appraised (the subject property) and comparable properties that have been sold or leased in the local market.
Land and building descriptions are specific data that help an appraiser to select comparable sales and rentals.
4. Data Analysis
In the analysis of general data, national, regional, and local trends are emphasized.
Supply and demand data
are studied to understand the competitive position of the property in its market. In an analysis of specific data, a set of properties most like the subject property is studied.
The analysis of comparable properties helps an appraiser extract specific sale prices, rental terms, incomes and expenses, rates of return on investments, construction costs, economic life estimates, and rates of depreciation. These figures are used in the calculations that result in indications of value for the subject property.
The highest and best use
is a critical step in the development of a market value opinion. In the highest and best use analysis, the appraiser considers the use of the land as though it were vacant and the use of the property as it is improved. To qualify as the highest and best use, a use must satisfy four criteria: it must be legally permissible, physically possible, financially feasible, and maximally productive. The highest and best use is selected from various alternative uses.
Market analysis provides the basis for an appraiser’s conclusions about the highest and best use of a subject property, and the remainder of the valuation process follows from these conclusions.
5. Site Value Opinion
A land value opinion is formed by applying a variety of methods derived in varying degrees from the three approaches to value.
The most reliable procedure for arriving at a land value estimate is sales comparison.
Sales of similar vacant parcels are analyzed, compared, and related to the land being appraised.
If sufficient sales are not available for comparison or the value opinion indicated by sales comparison needs substantiation, the appraiser may use another procedure such as extraction, allocation, the residual land technique, ground rent capitalization, or subdivision development analysis.
6. Application of the Approaches to Value
The appraiser begins to derive an opinion of property value using one or more of the three approaches to value.
The approaches employed depend on the type of property, the appraisal, and the quality and quantity of the data available for analysis.
7. Reconciliation of Value Indications and Final Opinion of Value
In reconciliation, the appraiser analyzes alternative conclusions and selects a final opinion of value from among two or more indications of value. A thorough review of the entire valuation process may precede reconciliation.
In reconciliation, an appraiser draws upon his or her experience, expertise, and professional judgment to resolve differences among the value indications derived from applying the approaches.
The appraiser weighs the relative significance, applicability, and defensibility of each approach and relies most heavily on those most appropriate to the appraisal’s intended use. The conclusion drawn is based on the appropriateness, accuracy, and quantity of all the evidence in the appraisal.
8. Final Opinion of Value
When a final opinion of value has been derived, the immediate objective of the valuation process has been accomplished. However, an appraisal assignment is not completed until the conclusions and findings have been stated in a report and communicated to the client.
9. Report of Defined Value
The type, format, length, and contents of a written appraisal report may vary depending on the client’s requirements and the scope of work criteria.
Appraisal reports will specify
The identity of the client and any other intended users
The intended use of the report
The purpose of the assignment (the type of value)
The effective date of the opinion
The real estate being appraised
The real property interest being valued.
Any assignment conditions (extraordinary assumptions and hypothetical conditions) affecting the appraisal
The scope of work—i.e., the extent of the process of collecting, confirming, and reporting data.
Any usual valuation approaches that may have been excluded
The highest and best use of real estate when such an opinion is necessary and appropriate
The information was considered, appraisal procedures followed, and reasoning applied.
Signed certification in accordance with USPAP Standards Rule 2-3
Uniform Standards of Professional Appraisal Practice (USPAP)
Appraisal Standards Board of The Appraisal Foundation.
Standards for the appraisal profession are outlined in the Uniform Standards of Professional Appraisal Practice (USPAP) developed by the Appraisal Standards Board of The Appraisal Foundation.
USPAP specifies the procedures to be followed in developing and communicating an appraisal and the ethical rules for appraisal practice.
Opinion of Value
As defined in USPAP, an appraisal is the act or process of developing an opinion of value. The valuation process is a systematic procedure the appraiser follows to answer a client’s question about real property value.
Three written formats
The Uniform Standards of Professional Appraisal Practice
set forth the requirements for appraisal reports, which may be presented in one of three written formats:
- self-contained reports,
- summary reports, and
- restricted-use reports.
A self-contained appraisal report
provides comprehensive coverage of appropriate information contained within the report itself with minimal reference to files outside the report. In general, a self-contained report fully describes the data and analyses used in the assignment.
A summary appraisal report
summarizes the data and analyses used in the assignment.
A restricted-use appraisal report
simply states the appraisal’s conclusions; this type of report may be provided only when the client is the sole user of the report.
The appraisal file for a summary or restricted-use appraisal report contains backup data and analyses that would be presented in a self-contained appraisal report.
Types of Real Property Reports
1, Uniform Residential Appraisal Report
This report form is designed to report an appraisal of a one-unit property or a one-unit property with an accessory unit, including a unit in a planned unit development (PUD).
2. Individual Condominium Unit Appraisal Report
This report form is designed to report an appraisal of a unit in a condominium project or a condominium unit in a planned unit development (PUD). This report form is not designed to report an appraisal of a manufactured home or a unit in a cooperative project.
3. Individual Cooperative Interest Appraisal Report
This report form is designed to report an appraisal of the cooperative interest (the cooperative shares or other evidence of an ownership interest in the cooperative corporation and the accompanying occupancy rights) in a cooperative project or the cooperative interest in a planned unit development (PUD). This form is not designed to report an appraisal of a manufactured home or a unit in a condominium project.
4. Land Appraisal Report
Appraisal License Levels
1, Appraiser Trainee
Someone qualified to appraise those properties, which the supervising certified appraiser is qualified to appraise.
2. Licensed Real Property Appraiser
Someone qualified to appraise non-complex one to four units with a transaction value of less than $1,000,000 and a complex one to four residential units having a transaction value less than $250,000. This classification does not include the appraisal of subdivisions.
3. Certified Residential Real Property Appraiser
Someone qualified to appraise one to four residential units without regard to value or complexity. This classification does not include the appraisal of subdivisions. To be a state-certified residential appraiser qualified to do appraisals for federally related transactions, a state must have requirements that meet or exceed this minimum standard.
4. Certified General Real Property Appraiser
Someone qualified to appraise all types of real property. To be a state-certified general appraiser qualified to do appraisals for federally related transactions, a state must have requirements that meet or exceed this minimum standard.
The Economic Principles Affecting Valuation
A woman decided not to sell her property because she found out about a large shopping center built nearby. She believes that the value of her property will increase due to the new development.
She plans to sell when the construction is complete, and the stores are open. She is basing her decision on anticipation.
Buyers buy properties for future benefits. The principle says that value rises using anticipated benefits (money or amenities) to be gained from a property in the future, for example. You purchase a home with a pool for $190,000. A similar house without a pool sells for $140,000. Effectively you pay $30,000 for anticipated benefits of the pool, not its cost.
Change and Anticipation
Change and anticipation
are fundamental, and appraisers apply these principles and related concepts that influence value in their analyses.
Changes in social and economic conditions have a constant impact on property value and must be considered in an appraisal.
Supply and Demand
The scarcity of a commodity influences its value by creating a greater demand for the item. For example, as the supply of ocean-facing property diminishes, its value increases to meet the demand. Demand is also affected by desire. If there is an oversupply of apartments in a given area, the demand will reduce. The values and rents will go down.
Factors Affecting Supply
Government controls at all levels
Government fiscal and monetary policies
Factors Affecting Demand
Demographics—the make-up of the population, including mobility, financial stability, and the size and nature of the family unit
Employment and wage levels
where and how money is spent; perceived job security
The value of a property tends to be set at the cost of equally desirable substitute property. In theory, no one should pay more for a property than what it would cost to obtain a site by purchase and sale and construct a building of equal appeal and utility.
This principle refers to the relationship between cost, added cost, and the value it returns. For each dollar invested, the value should increase by more than one dollar.
The smallest house in the neighborhood benefits from PROGRESSION.
The idea behind this principle is, the price of a property escalates with an increased perceived value of a location. For example, if you are selling an old house, but surrounding homes in the area are renovated and thereby have increased value, the price of your property will also be pulled up because of its location.
The largest house in a neighborhood suffers from REGRESSION.
This is the opposite of progression principle. The price of a property decreases with a reduced perceived value of a site. For example, even if you have the best house in a neighborhood of storm- hit homes, your property’s value will go down.
Increasing & Diminishing Returns Principle
The cost of improving a property increases its value (law of increasing returns) only to a certain point; over-improving an obsolete property or improvements that do not add to value are examples of the law of decreasing returns.
An improvement that extends the life of a property, as opposed to maintenance. Capital improvements are not included in computing the operating expenses of a property. Example: New siding or roofing, but not painting or ceiling fans.
Four independent economic factors
Transferability – effective purchasing power
must be present to create value in a particular item or collection of items.
A property that conforms to its surrounding properties in style, age, size, appearance tends to maximize value.
A principle of value stating that Competition drives down profit, whereas excess.
Profit generates Competition.
Economies of Scale (The more you make, the less it costs)
Incremental increases in production require relatively less increase in resources, resulting in overall increased earning potential.
Similarity; Neighborhoods that have homogeneity of houses and people are generally stable in value.
No two are alike. Opposite of homogeneity
Highest and Best Use Principle
That use is determined by an appraiser of a commercial property that would bring the highest net return on investment to the owner. Highest and Best Use may not the same as the present use, depending on development in the surrounding area.
Consolidating two or more parcels to create a larger building site to create a greater return. The resultant increase in value is known as plottage.
The increased value resulting from assemblage (the combining of adjacent lots into one more considerable lot)
Determining the value of the vacant land alone.
Preference for one location over another without basis in objective fact or knowledge. It is said that the most essential consideration in buying real estate is location, location, location.
A specific person might be willing to pay for a property because of a perceived direct benefit not shared with others. Contrasts with objective value. For example, the property is next to a friend or relative.
The value of a specific owner is also known as subjective value.
The price an informed buyer might be willing to pay for a property absent a specific personal interest in the property. Contrasts with subjective value.
A term indicating parties to a transaction are acting independently and with full bargaining knowledge and position.
Less than Arm’s Length
A sale to a family member is not “arm’s length” and may impact market value or have tax consequences. They are not used for appraisals.
Straight Line Method of Depreciation (Taxes)
A method of depreciation computed by dividing the adjusted basis of a property by the number of years of estimated remaining useful life. The cost of the property is thus deducted in equal annual installments.
is the simplest and most often used method.
The value of the property is depreciated over a number of years.
Economic life (Taxes)
The period during which the structure is expected to remain useful in its original use.
The approximate length of time a building can be used profitably.
Book Value (Taxes)
The value, including accumulated depreciation as reflected in the financial records of the owner. Typically lower than market value.
Charts intended to standardize lot values based on an increase in lot depth, based on the front of a lot having greater value than the rear. Used by county assessors to assist in applying uniform assessments.
A value principle holding that an amenity or improvement is worth the value it adds, not what it costs.