1. The Appraisal of Real Estate

2. What is appraisal?
Simply put, appraisal is the act or process of estimating value.
More precisely:
“The term appraisal means a written statement independently and impartially prepared by a qualified appraiser setting forth an opinion of defined value of adequately described property as of a specific date, supported by the presentation and analysis of relevant market information”
- Real Estate Valuation, Lusht, 1997

3. What is value? Value is the worth of an item.
Human behavior determines value because no item has inherent value.
Value in exchange is the quantity of one thing that can be obtained in exchange for another good. This relationship is determined by the market.
Value is subjective due to personal preferences, but market value is objective due to market behavior.

4. Market Value
"The most probably selling price in terms of money which a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buy and seller each acting prudently and knowledgeably, and assuming the price is not affected by undue stimulus.”
- Appraising Real Property
Boyce & Kinnard, 1984

5. Market Price
“The amount actually paid, or to be paid, for a property in a particular transaction, which differs from market value in that it is an accomplished or historic fact, whereas market value is and remains an estimate……”
- Appraising Real Property
Boyce & Kinnard, 1984

6. Market Value vs. Market Price (the skinny)
Value and price are identical in a theoretical, perfectly competitive market.
We live in a real world! Market value is the “most probably selling price” under typical market conditions.
Price is an agreed upon amount or a historical figure.

7. Typical Market Conditions
It depends!
Open and competitive market
Prudent buyer and seller
Typical motivation for buyer and seller
Adequate marketing effort
Cash equivalency

8. Other Types Investment value Use value Book value Rental value
Salvage value
Assessed value

9. Fundament Theory of Appraisal
Supply and demand
Anticipation/Change
Competition reduces economic rents
Substitution
Opportunity cost
Contribution
Externalities/linkages

10. Value - Why do we care? Ownership transfer Financing Litigation Taxes
Consulting
Rents, feasibility, zoning board, insurers, etc.

11. The Appraisal Process Step 1: Problem Definition
Real estate identification
Property rights
Use of appraisal
Value definition
Date

12. The Appraisal Process Step 2: Preliminary Analysis & Data
Plan of attack
Information
General – trends
Specific – property and comparable
Supply & Demand – future changes

13. The Appraisal Process Step 3: Highest and Best Use Analysis
“the reasonably probable and legal use of vacant land or an improved property, which is physically possible, appropriately supported, financially feasible, and that results in the highest value”
Vacant vs. improved
Vacant may be highest and best use.
Identify use with highest overall return
Helps identify comparable properties

14. The Appraisal Process Step 4: Land Value Estimate Sales comparison
Allocation (ratio)
Extraction (less improvements)
Subdivision & development
Land residual technique (NOIland)

15. The Appraisal Process Step 5: Application of Three Approaches
Sales Comparison (VSC)
Cost (VC)
Income (VI)

16. The Appraisal Process Step 6: Reconciliation
Using various estimates of value under a number of methods determine one estimate of value.
How?

17. The Appraisal Process Step 7: Report of Defined Value
Conclusion communicating the final value estimate written.
It presents the data, assumptions, and analyses in a manner so that an intelligent reader should comprehend the logical process and come up with a similar answer to the problem.
It should also explain how and why particular steps were taken.

18. The Income Approach
Should look familiar!
GI=GO (DCF model)

19. The Income Approach Gross income multipliers
Potential or effective gross income

20. The Sales Comparison Approach
Underlying economic theory: Similar goods sell for similar prices.
Applicable to all property types but works best for property types with frequent transactions.
Data, data, data..

21. Sales Comparison Procedure: Research market/gather data
Verify information
Select units of comparison (ft^2, apt. unit, etc)
Develop comparable analysis
Compare comps to subject with respect to elements of comparison & make adjustments
Reconcile

22. Sales Comparison Sequence of adjustments: Financing terms
Conditions of sale
Market conditions
Location
Physical characteristics

23. Sales Comparison
A(n) _________ adjustment will be made to the comparable price when the comparable property is superior to the subject property.
Net adjustments lead to the adjusted sales price.

24. Sales Comparison Uses and limitations: Good data = good results
An easy “amateur” appraisal
Financing advantage
No data = no use

25. The Cost Approach
Underlying economic theory: No prudent buyer would pay more than it would cost to purchase the land and develop.
Applicable to all property types but does not have the ease of sales comparison.
Data, data, data..

26. Cost Approach Procedure: Estimate site value
Estimate hard and soft costs of improvements including reasonable profit
Estimate accrued depreciation in the structure
Add site value to improvement depreciated cost

27. Cost Approach Site Value (previously discussed)
Reproduction vs. replacement cost
Reproduction is exact replica
Replacement is a “newer” building of equal utility (modern materials, designs, and layout)

28. Cost Approach Direct (hard) costs Building permits Labor Materials
Equipment
Security
Contractors profit

29. Cost Approach Indirect (soft) costs: Consulting
Engineering and architecture
Cost of carry (fees, points, interest, lease-up)
Selling expenses
Leasing commissions

30. Cost Approach
Cost Data Collection
Marshall & Swift
MEANS

31. Cost Approach Comparative Unit Method:
Determine (find) estimate of cost per unit of area
Aggregate cost per unit
Size matters
Use of benchmark building
Adjust for size, finish quality, time, etc.

32. Cost Approach Unit in Place Method:
Each category (section) of the building’s cost is estimated.
Foundation, sprinkler, roof, framing, on a square foot cost basis

33. Cost Approach Quantity Survey Method Most complex and time consuming
No aggregation of data according to size
Number of labor hours, direct cost supplies are estimated and the cost of each is applied.
Rarely used.

34. Cost Approach Depreciation: Non-accounting sense Three major types:
Physical deterioration
Functional obsolescence
External obsolescence
Economic life, effective (actual) age, remaining economic life

35. Cost Approach Market Extraction Method (depreciation):
Transaction prices of similar properties with respect to age/depreciation
Sale price minus land = depreciable cost (1)
Estimate the replacement cost (2)
(2)-(1) = total depreciation

36. Cost Approach Age-Life Method (depreciation)
Estimate total economic life of similar properties
Estimate effective age
Compute ratio of effective age (subject) to total economic life
Apply ratio to development cost

37. Cost Approach Breakdown Method (depreciation):
Most complex and least used
Usually used with another method of estimating depreciation
Each form of depreciation is estimated separately

38. Cost Approach In summary:
Useful when there is not an active market for the subject property type

39. Reconciliation
We have 3 (or more) estimates of value.

40. Appraisal Method Summary
Comparable sales
Like goods sell for like prices
Requires transaction data on “similar” properties
Income approach
Value is PV(future benefits)
Most relevant for income producing real estate
Cost approach
Buyers will not pay more than the cost
Utilizes industry cost estimators

41. Conclusion
A real estate appraisal is a professional opinion of value as of a particular date based on systematic analysis and market data.