Chapter 16: Real Estate Appraisal Flashcards
Appraisal
An appraisal is an act or process of developing an opinion of value.
An appraisal is numerically expressed as a specific amount (e.g., $100,000), a range of values (e.g., $95,000 to $100,000), or as a relationship to a previous value opinion or benchmark (e.g., “Value is greater than the previous appraised value.” Or “The property is worth at least as much as the amount indicated to facilitate the loan.”).
Appraiser
An appraiser is one who is expected to perform valuation services competently and in a manner that is independent, impartial, and objective. An appraiser conducts an analysis and renders an opinion as to the value of real property specified in his or her employment contract. Real property includes the physical land and improvements together with legal rights to own or use the property.
An appraiser is expected to produce opinions and conclusions based on evidence by sufficient research, analysis of information, and data that supports the rational and logic of those opinions and conclusions.
Appraisers are typically paid a fee that is based on the amount of time and the anticipated degree of difficulty not on the basis of the value of the property. Whether performing an appraisal, appraisal review, or appraisal consulting assignment, all appraisers must adhere to the Uniform Standards of Professional Appraisal Practice (USPAP).
Cost
Cost is the actual or estimated amount required to create, produce, or obtain a property. It includes labor, materials, financing expense, land, management and overhead, and the contractor’s profit necessary to bring the finished product to the market. Cost may be more than, or less than, the market value of the property.
Price
Price is the amount that is actually paid in a real estate transaction. It is not necessarily the asking amount or amount offered, and may not represent the actual market value of the property. It may be more than, or less than, the market value. Nonetheless, it is the amount that the buyer is willing to pay and the amount the seller is willing to accept.
Value
Value is an opinion of the worth of a property at a given time in accordance with a specific definition of value. It is the monetary relationship between properties and those who buy, sell, or use those properties. There are many types of value, each of which has a different definition. In appraisal practice, value must always be qualified (e.g. market value, liquidation value, or investment value).
The purpose of an appraisal and its function are
distinct
Purpose of appraisal
The purpose of an appraisal is to estimate some type of defined value. There are many different types of value, each of which has a definition of its own. Purpose relates to the work the appraiser was retained to perform, that is, to estimate some type of value. Most appraisals are performed to estimate market value.
Intended Use of appraisal
The use or uses of an appraiser’s reported appraisal, opinions and conclusions, or other valuation services by the appraisal client is referred to as its intended use (previously referred to as function in USPAP). For example, the client may use the appraisal to decide whether to sell or not, to buy or not, and at what price. A lender may use the appraisal to decide whether a loan should be made or not by using that property as security.
What four elements interact to create or affect the value of real estate?
- Demand
- Utility
- Scarcity
- Transferability
Demand (value)
real estate, like any other product or service, has no value unless someone has a need or desire for it. From an economic viewpoint, demand has two components: the desire for the item or service, and the financial ability to pay for it.
Utility (value)
Real estate must serve a purpose or be useful in order to have value.
Scarcity (value)
Real estate that is in short supply relative to the demand for it has value.
Transferability (value)
the ability to convey a marketable title is paramount to the value of real estate. Although a property with a defective title can be conveyed, it is risky and a purchaser may substantially discount the price if they feel they would incur time and expense in curing the defect.
Types of Value
Assessed Value Insurable Value Investment Value Liquidation Value Market Value Salvage Value Plottage Value Value-in-use
Assessed Value
is the value assigned by the property appraiser for ad valorem tax purposes. Generally speaking, properties with a higher assessment should sell for more than properties with lower assessments.
Insurable Value
or insurance value, is the value used by insurance companies as the basis for insurance coverage. Insurable value is often considered to be the replacement or reproduction cost plus allowances for debris removal or demolition and non-insurable items. Insurable value is less than the property’s appraised market value, because it excludes the value of land on which the building stands.
Investment Value
is the value of a particular property to a particular investor. Potential purchasers of income-producing properties commonly request investment value appraisals. Investment value is the highest price an investor will pay for a property and the lowest price the seller will accept. Investment value is the value to a specific individual, while market value is the value in a typical transaction to a typical buyer.
Liquidation Value
is the amount that remains after all assets of a business have been sold in a hurried, but not forced, sale and all liabilities have been paid. It is the value of a failing business that is not expected to continue. It can also be used to estimate the minimum value of a profitable business.
Market Value
is the value to a typical buyer and a typical seller. This is the most common type of value that is estimated by appraisers. The market value of a property is the most probable price at which specified property rights should sell. However, several assumptions are inherent in this definition:
o The property has been exposed to the market for a reasonable time.
o Both buyer and seller are well informed and acting in their own self-interest.
o Neither party is acting under undue duress.
o The seller has the ability to convey a marketable title
o Payment is in cash in U.S. dollars, or terms equivalent to cash.
Salvage Value
is the amount that can be received from the sale of the parts from a demolished structure.
Plottage Value
is the increase in value resulting from an assemblage, or combining, of two or more adjacent parcels of land under one owner. Typically, the value of the whole parcel will be greater than the sum of the individual smaller parcels.
Value-in-use
of real property is the net present value (income) which is generated by the property in a certain use for a certain owner. The value-in-use of a property may be higher or lower than market value.
Principles of Values
Appraisal principles are the rules that govern the formation of value and help to explain how and why values change in the market. Appraisers use them to assist in arriving at their value conclusion.
- Anticipation
- Change
- Competition
- Conformity
- Contribution
- Highest & Best Use
- Progression
- Regression
- Substitution
Anticipation
states that the value of a property today is the sum of its future benefits. When a potential buyer considers the purchase of a property, the benefits it will provide during that owner’s period of ownership forms the basis for the decision to buy, and at what price. Value today is measured in terms of future benefits. This principle is particularly visible in the purchase of income-producing real estate where present dollars are paid in exchange for the right to receive future dollars.
Change
states that circumstances can cause changes to occur in the market, which in turn may affect the value of real estate. An appraisal is made as of a specific date in order to take into account the market forces that influence value at that point in time.
Competition
recognizes that sellers compete with other sellers, and buyers compete with other buyers. This principle focuses on the effect of changes in supply and demand.
Conformity
states that the value of a property is sustained when it is in conformity with other properties in the same area. Conformity refers to size, architectural style, and other features.
Contribution
states that the value of a component of the property is the amount it adds to the total value of the property; in other words, the amount by which the value of the property would decrease by its absence. This principle illustrates the difference between the cost of a component and the value added by the component. Example: a swimming pool may cost $20,000 to install, but it may add only $15,000 to the value of the property.
Highest & Best Use
states that the best use for the property, known as its highest, best, and most profitable use, is that which will most likely produce the greatest net return to the land over a given period-of-time. This net return is realized in terms of money or other amenities.
Progression
applies when a lower-priced property is built or an existing property is inadequate (under-improved) in an area that consists of property that is more expensive. The lower-priced property will progress (increase) in value toward the level of the more expensive properties in the area. This principle tends to create price conformity within an area.
Regression
applies when a higher-priced property is constructed or an existing property is over-improved in an area that consists of lower-priced properties. The higher-priced property will regress (decrease) in value toward the level of the less expensive properties in the area. This principle, like the principle of progression, tends to create price conformity within an area.
Substitution
recognizes that no one would pay more for a property than the amount necessary to acquire an acceptable substitute. This principle is the basis for all mathematical methods that are used by appraisers to estimate value. Example: a property owner states that their house is worth $95,000. Buyers in the market can obtain a substitute property with the same features and utility for $90,000. The seller’s house, therefore, has a value of approximately $90,000, not $95,000.
The Appraisal Process
Appraisers follow a defined appraisal process when developing and reporting their opinions and conclusions in an appraisal assignment. The appraisal process is accomplished by following specific steps, the number of which depends on the nature of the appraisal assignment and the data available to complete it. In all cases, however, the valuation process provides the model to be followed in performing market research and data analysis, in applying appraisal techniques and in integrating the results of these analytic activities into an opinion of value.
Maps, cost information, previous appraisals, and other useful data that an appraiser accumulates and updates were historically referred to as the appraisal data plant. Today, this information is usually stored electronically.
Step 1: Define the Problem
Define the problem. Before proceeding, the appraiser must have a clear understanding of the problem that needs to be solved in order to determine the appropriate scope of work to apply to the assignment. The following information is required to define the appraisal problem:
• Identify the client and other intended users
• Identify the client’s intended use (function)
• Identify the type and definition of value (purpose)
• Effective date of the opinion
• Identify the relevant characteristics of the property
• Identify any assignment conditions and assumptions, laws and regulations, or other conditions that affect the scope of work.
Step 2: Determine the Scope of Work
A preliminary analysis of the assignment is made to determine the type and extent of research and analyses required. The data is then collected and assembled for use. Communication with the client is necessary to obtain much of the information necessary of most elements of problem identification.
Data falls into two types:
• General Data- concerns the region, neighborhood, economy, and so on.
• Specific Data- is information about the subject property and potential comparable properties to be used in the analysis.
Step 3: Perform Data Collection & Analysis
This step includes a market analysis and a highest and best use analysis.
Market analysis- includes supply, demand, and marketability studies.
Highest and best use analysis- the property is analyzed to determine the highest and best use of the site as if vacant and the property as improved. The highest and best use as vacant is used to establish the value of the site based on how the site should be used rather than how it is being used. The property is analyzed again, thereby considering any improvements that are presently on the site. This assists in determining whether the present use is the best use, or if an alternative should be considered to maximize the value of the land and improvements of the property (property value). Alternatives include renovation or possible removal.
Step 4: Apply the Three Approaches to Value
Appraisers can utilize three mathematical methods to estimate the value of a subject property. All three are employed to the extent that they are applicable, unless the assignment does not require one or more of them to be used.
The three methods are:
• Sales comparison approach
• Cost-depreciation approach
• Income approach
All three approaches are used by the appraiser if the assignment, the available data, and the requirements of the client do not limit their application. Each yields slightly different results, and the differences must be reconciled into a final value conclusion.
Step 5: Estimate the Final Opinion of Value
After the three approaches have been applied and each has resulted in a value estimate, the three estimates are compared.
The appraiser’s confidence in the data and the appropriateness of the approaches to the assignment are weighed. Greater weight is given to the approach that the appraiser feels best reflects the value of the subject, and then a final value is estimated.
Weighing the evidence and arriving at a final value conclusion is based on the appraiser’s knowledge, experience, and training. It is not accomplished by averaging the values or using a mathematical process.
Step 6: Prepare the Final Report of Defined Value Opinions
The objective of the appraisal is to answer the client’s original question with regards to the value of the rights specified in the subject property. Once the final value estimate has been estimated the appraiser prepares a report that is to be delivered to the client. Although there are legal and technical aspects to the way in which appraisals are performed and appraisal reports are prepared, they can be categorized as a form, narrative, or an oral report.
Form Reports
are used in millions of appraisals each year. Most primary lenders and the secondary market require them. The use of a form standardizes the way in which information is reported and facilitates the underwriting process. This is the reporting preference for most residential appraisals.
Narrative Reports
are very comprehensive. They provide the client with the reasoning and conclusions of the appraiser in a detailed report that can contain as many as 50 to 300 or more pages. The length and content can vary depending on the nature of the assignment and the requirements of the client.
Oral Reports
are generally given only in connection with court testimony. Appraisers, who provide court testimony, must follow the same procedures used to prepare written reports and must maintain files that support their conclusions and testimony.
Sales Comparison Approach
The sales comparison approach, also referred to as the comparable sales approach, is used to estimate the value indicated by the recent sales of comparable properties in the market.
Principle of Substitution
This approach is a direct application of the principle of substitution. The principle of substitution states that if similar or comparable properties are available for sale, the one with the lowest price will attract the greatest demand. The price at which a property will most likely sell is closely related to the price at which similar properties in the same market have previously sold.
Requires an Active Market
The sales comparison approach requires an active market. If no sales have occurred, this method is not applicable. Conversely, this method is appropriate for any type of property where sales have occurred.
Used by Real Estate Licensees
This approach is usually the most applicable method for appraising residential properties and vacant land. It is the basis for the value estimates that are used by real estate brokers and sales associates in listing and selling real estate. A sales associate should focus much of their attention on this approach, as it will be used virtually every day in the practice of their profession.
Sales Comparison Approach Step 1: Locate Comparable Properties
A comparable property is a property that is competitive with the subject property (the property being appraised) and similar to it in terms of design, size, location, age, and condition.
To be comparable, the property should be a recent sale, preferably within the last six months. The sale must have been an arm’s – length transaction in which the seller and the buyer were unrelated and each was attempting to get the best price possible.
A minimum of three to five comparable properties is required, but eight to ten are preferable.
Sales Comparison Approach Step 2: Adjust Comparable Sales Prices
The comparable properties are not exactly the same as the subject property. Adjustments to the sales price of the comparable properties are made to allow for differences between the comparable and the subject property.
Adjustments are always made to the comparable property, but never to the subject property. The subject property sets the standard for comparison. The price of comparable properties must be adjusted to reflect the characteristics of the subject property. The price at which a comparable property was sold is a known fact. The value of the subject property is unknown and cannot be adjusted.
If the comparable property is superior to the subject property, the comparable sales price is adjusted downward by the value of the superior features. If the comparable property is inferior to the subject property, the comparable sales price is adjusted upward by the value of the inferior features.
Adjustments are made for differences in?
- Financing terms
- Conditions of sale
- Market conditions
- Location
- Physical characteristics
Adjustments can be made in either dollar amounts or percentages. Adjustments for market conditions and location are often derived based on percentages. Whenever percentages are used, these adjustments must be made in the order above.
Financing Terms
the manner in which a property is financed can influence the price a buyer is willing to pay. If favorable terms are offered, the price may have been increased; if prohibitive interest rates are required, the price may have been decreased.
