1. Appraisal Process Reading Material
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2. Reading and Resources
The Appraisal of Real Estate, 13th Edition, Appraisal Institute, 2008 (on reserve)
Chapter 7, The Valuation Process
Chapter 12, Highest and Best Use Analysis, pp
Appraisal Terms handout
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3. Outline What drives property value? Why appraisals?
The economics behind real estate value
Why appraisals?
Estimating the value when it’s not readily apparent
The Appraisal Process
Forensic investigation and analysis of market evidence
Value Opinion
Appraisal Process – Step by Step
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4. Economics of Real Estate Value
Economic Entities (Firms) in an Economic System
Cash flow cycle based on production function of activities
Economic inputs: land, capital, labor and knowledge
Real estate: land and capital (i.e. buildings)
Inputs have economic productivity/utility within the entity’s production function (unique to entity and production function/use)
Assume firms and households seek to maximize utility/profit
Urban economics
Physical geography and locational issues impact the firm’s production function
Locational attributes of property impact productivity/utility of land and buildings specific to a firm’s production function
Example: Bottling Plant
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5. Transactions vs. Appraisals
Markets (buyers and sellers) set value/prices through competitive bidding
Appraisers estimate value through forensic investigation and analysis of data
Results of the bidding process are not observable
Unique Properties
Infrequent Transactions
(Stocks vs. Real Estate)
Appraisal is forensic investigation of market evidence in the absence of direct observation of values
Requires thorough understanding of the “process” by which buyers and sellers establish values
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6. Appraisal Process Standardized methodology for estimating value
Rigorous, exhaustive approach to gathering and analyzing data
Applicable to all property types
Not formulaic, requires judgment, adaptation
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7. Appraisal Process Step 1: Identification of the Problem
Step 2: Scope of Work Definition
Step 3: Data Collection and Property Description
Market Area Data
Subject Property Data
Comparable Property Data
Step 4: Data Analysis
Market Analysis
Highest and Best Use Analysis
Step 5: Site Value Opinion
Step 6: Application of Approaches to Value
Sales Comparison
Cost
Income Approach
Step 7: Reconciliation of Value Indications and Final Opinion of Value
Step 8: Report of Defined Value (See Appraisal of Real Estate, Figure 7.1, page 131)
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8. Step 1: Identification of the Problem
Identify client and intended users
Disclosure and identification to avoid misunderstandings and misuse of the analysis
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9. Step 1: Identification of the Problem
Identify the intended use
Helps determine necessary scope of work
Common Uses of Appraisals
Financing
Determine Listing Price
Supporting a Sales Price
Property Taxation
Condemnation Appraisal
Lease vs. Buy Decisions
New Project Feasibility
Litigation of Property Rights and Interests
Project Performance Measuring (Capital Appreciation)
Fire and Casualty Insurance
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10. Step 1: Identification of the Problem
Value Definition and Purpose of the Assignment
Common Types of Value
Market Value
Investment value
Value in Use
Assessed value
Insurable value
Going – Concern value
Salvage Value
Book Value
Mortgage Loan Value (no definition in handout)
Liquidation Value
Business Enterprise Value (added definition)
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11. Market Value*
The most probable price which a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently and knowledgeably, and assuming the price is not affected by undue stimulus. Implicit in this definition is the consummation of a sale as of a specified date and the passing of title from seller to buyer under conditions whereby:
Buyer and seller are typically motivated;
Both parties are well informed or well advised and acting in what they consider their own best interests;
A reasonable time is allowed for exposure in the open market;
Payment made in terms of cash in US dollars or in terms of financial arrangements comparable thereto; and
Price represents the normal consideration for the property sold unaffected by special or creative financing or sales concessions granted by anyone associated with the sale.
* Definition of “market value” used by agencies that regulate federally insured financial institutions in the United States. The Dictionary of Real Estate Appraisal, Fourth Edition, Appraisal Institute, 2002.
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12. Step 1: Identification of the Problem
Identify the Effective Date of Value
Current date – most typical
As of completion of construction
As of stabilization
As of historic date – perhaps for litigation appraisal
As of effective date of taking – eminent domain appraisal
Why does the date matter?
Value changes with time
Appraisal is snapshot of value at single point in time
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13. Step 1: Identification of the Problem
Identification of Property Characteristics
Legal description
Identification of Property Rights
Fee simple
Leased fee interest
Leasehold interest
Sub-leasehold interest
Sandwich interest
Easement
Life estate
Condominium ownership
Cooperative ownership
Timeshare
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14. Step 1: Identification of the Problem
Assignment Conditions – Extraordinary Assumptions
An assumption which, if found to be false, could alter the appraisers opinion or conclusions (See definitions)
For example, in appraising new construction, the appraisal assignment may require estimating the value of the property upon completion. The appraiser would assume that construction will be completed as planned at a specific date.
Assignment Conditions – Hypothetical Conditions
An assumption contrary to what actually exists but is supposed for the purpose of analysis. (See definitions)
For example, for litigation purposes, the appraisal assignment may require estimating the value of a property if an adjacent property had been built.
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15. Step 1: Identification of the Problem
Limiting Conditions and Assumptions
Assumptions made by the appraiser beyond their level of expertise or scope that may have an impact on the value of property is different than assumed
Limitations on the use or reliance of the report
In effect, they are “extraordinary assumptions” to limit appraisers liability
Typical assumptions include
Legal description is accurate
Property title is free and clear of liens and encumbrances
Competent management
Engineering studies are correct
No hidden or other unapparent conditions
Property is in compliance with applicable laws
Property conforms to zoning
Licenses, certificates of occupancy, consents and other permits in place
No hazardous materials or environmental contamination
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16. Step 1: Identification of the Problem
Typical limiting conditions include;
Reliance limited to client and purpose
Reliance on allocation of value to components
Limited rights regarding publication
Opinion of value applied to entire property valued, with no reliance on pro ration or division of interests
Forecast based on current market conditions
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17. Step 2: Scope of Work Definition
Description of Scope of Appraisal
A brief description of the amount and type of information research and analysis applied in an assignment
Includes information regarding
Property inspection date and details of inspection
Area search to gather data
Degree of completeness of analysis
Names and experience of personnel performing appraisal
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18. Step 3: Data Collection and Property Description
Market analysis
General regional economic trends
Demand trends for property types
Supply trend for property types
Market rents and vacancy for various property uses
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19. Step 3: Data Collection and Property Description
Site data
Definition of site boundaries – legal description
Zoning and land-use information
Physical characteristics of site
Utilities and infrastructure
Characteristics of adjacent property and neighborhood
Improvement data
Structural description
Spatial layout
Equipment and mechanical systems
Architectural style
Functional utility
Quality and condition
Deferred maintenance
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20. Step 3: Data Collection and Property Description
Comparable property data
Income approach
Rent/Lease comparables
Operating expense comparables
Capitalization rate comparables
Sales comparison approach
Sale comparables
Cost approach
Land sales comparables
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21. Step 4: Data Analysis Market Analysis
Supply, Demand and Marketability Studies
Conclusions, specific to subject property:
Market Rent
Vacancy and absorption expectations
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22. Step 4: Data Analysis Highest and Best Use Analysis
Economics
Firms are profit maximizing – Landlords/Sellers seek highest price
Competitive bidding of alternative uses establishes prices
“Winning” use reflects the use having greatest productivity/utility of property
Subject to physical and legal constraints
Filtering Process
Physically possible
Legally permissible
Financially feasible
Maximally productive (i.e. highest price)
Two fundamentally different Options/Scenarios
HBU is continued use of property as built (as improved), or
HBU is to demolish improvement and build something else (as if vacant)
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23. Step 4: Data Analysis Highest and Best Use Analysis
As if the vacant
Physically possible uses
Legally permitted uses
Financially feasible uses
Maximally productive uses
As improved
Highest and best use
Identify most probable use
Identify “as improved” or “demolition and redevelopment” or other scenario
HBU conclusion drives data to be used in valuation – data must reflect the same use (i.e. if HBU is office, use only office comparables)
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24. Step 5: Site Value Opinion
Purpose
Necessary for HBU analysis
Necessary for cost approach
Approaches
Sales comparison
Extraction
Allocation
Subdivision development
Land residual
Ground rent capitalization
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25. Step 6: Apply Approaches Income Capitalization Approach
Principle
Investment perspective
Value = Present value of expected future cash flows
Two primary approaches
Discounted cash flow approach
Direct capitalization of current cash flow
Most applicable when
Reflects buyers and sellers analysis
Income producing property
Least applicable win
Not income producing
Typically acquired for owner occupancy
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26. Step 6: Apply Approaches Sales Comparison Approach
Principle
Substitution principle
One price rule – equivalent goods tend to sell for equivalent prices
Approach
Identify sales of similar properties
Adjust sale prices to reflect differences from the subject property
Typical adjustments include sales date, size, age, condition, location, amenities and key features
Most applicable when
Reflects buyers and sellers analysis
Plentiful sales data of similar properties
Least applicable win
Not used by buyers and sellers
Valuing a unique property
Few comparable sales
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27. Step 6: Apply Approaches Cost Approach
principle
Substitution principle – wouldn’t pay more than the cost to reproduce or replace the property
Value = Cost to replace/reproduce improvements – depreciation + land value
Most applicable when
Unique property (church or landmark)
Insurable value appraisal
No income, no sales
New construction (i.e. little depreciation)
Least applicable win
Any other approach provides reliable results
Old property, difficult to estimate depreciation
Comment
Rarely used by buyers and sellers
Useful benchmark in identifying bubble markets and depressed markets
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28. Step 6: Apply Approaches Cost Approach
Property Value = Cost New - Accrued Depreciation + Land Value
Accrued Depreciation = Cost New + Land Value – Property Value
Categories of depreciation
Physical deterioration
Curable, deferred maintenance
In-curable
Short-lived items
Long-lived items
Functional obsolescence
Curable
Deficiencies
Defects (no longer part of appraisal terminology)
Super adequacy’s
Defects
External obsolescence
Locational
Economic
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29. Step 7: Reconciliation and Final Opinion of Value
Three approaches => Potentially three different value indications
Distribution curve, value range, or single value estimate?
Economic reality => competitive bidding process that sets price in an imperfect market suggests a probabilistic range of values
Normal or other distribution curve
Business Reality => most appraisal assignments require a single value estimate
Most probable price – single value estimate
Appraiser’s Judgment
“Direct Results” vs. “Process”
Methodology used by buyers and sellers in the market
Quantity, quality and reliability of data used in each approach
Understanding of economic drivers of value in the market
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30. Step 7: Reconciliation and Final Opinion of Value
“Direct Results”
What was the direct “result” from the market?
Use direct evidence from the market (e.g. the last 3 buildings warehouses sold at prices ranging from $41.50 to $43.00psf)
Given good direct “results” data, a more reliable approach
Ex. Litigation work
“Process”
What methodology do buyers and sellers use in determining prices?
Duplicate their “process” (e.g. DCF results in a value of $X) to estimate value
Prone to errors in the estimates
Ex. Rent spikes
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31. Step 8: Appraisal Report
Written* presentation of data analysis and results
Report standards conform to scope and purpose of the appraisal
USPAP – Uniform Standards of Professional Appraisal Practice
* Appraisals can be presented orally, but, as with legal contracts, generally not a good idea
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