The Appraisal Process
Introduction - A Real Estate Appraisal is the practice of developing an opinion of the value of real property, usually its Market Value.
A real estate appraisal is performed by a licensed or certified appraiser. The opinions and conclusions are based on an in-depth review of the economic climate in which the subject property exists in concert with the available (3) fundamental approaches to values; Direct Comparisons, Income and Cost.
Price Versus Value
It is important to distinguish between Market Value and Price. A price obtained for a specific property under a specific transaction may or may not represent that property's market value: special considerations may have been present, such as a special relationship between the buyer and the seller, or the transaction may have been part of a larger set of transactions in which the parties had engaged. Another possibility is that a special buyer may have been willing to pay a premium over and above the market value, if his/her subjective valuation of the property (its investment value for him/her) was higher than the Market Value. It is the task of the real estate appraiser/property valuer to judge whether a specific price obtained under a specific transaction is indicative of Market Value.
The definition of value used in an appraisal analysis and report is a set of assumptions about the market in which the subject property may transact. It becomes the basis for selecting comparable data for use in the analysis. These assumptions will vary from definition to definition but generally fall into three categories:
1. The relationship, knowledge, and motivation of the parties (i.e., seller and buyer);
2. The terms of sale (e.g., cash, cash equivalent, or other terms); and
3. The conditions of sale (e.g., exposure in a competitive market for a reasonable time prior to sale).
The Most Common Definition Of 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, 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: (1) buyer and seller are typically motivated; (2) both parties are well informed or well advised, and each acting in what he or she considers his or her own best interest; (3) a reasonable time is allowed for exposure in the open market; (4) payment is made in terms of cash or in terms of financial arrangements comparable thereto; and (5) the 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."
Three Approaches To Value
There are three general groups of methodologies for determining value. These are usually referred to as the "three approaches to value":
* The Cost Approach
* The Direct Comparison Approach, and
* The Income Approach
The appraiser using three approaches will determine which one or more of these approaches may be applicable, based on the scope of work determination, and from that develop an appraisal analysis. Costs, income, and sales vary widely from one situation to the next, and particular importance is given to the specific characteristics of the subject property.
Consideration is also given to the market for the property appraised. Appraisals of properties that are typically purchased by investors may give greater weight to the income approach, while small retail or office properties, often purchased by owner-users, may give greater weighting to the sales comparison approach. While this may seem simple, it is not always obvious. For example, apartment complexes of a given quality tend to sell at a price per apartment, and as such the sales comparison approach may be more applicable. Single family residences are most commonly valued with greatest weighting to the sales comparison approach.
If a single family dwelling is in a neighborhood where all or most of the dwellings are rental units, then some variant of the income approach may be more useful.
The Cost Approach
The theory is that the value of a property can be estimated by summing the land value and the depreciated value of any improvements. In practice, appraisers use replacement cost and then deduct a factor for any functional disutility associated with the age of the subject property.
In most instances when the cost approach is involved, the overall methodology is a hybrid of the cost and sales comparison approaches. For example, while the replacement cost to construct a building can be determined by adding the labor, material, and other costs, land values, and depreciation must be derived from an analysis of comparable data.
The cost approach is considered reliable when used on newer structures, but the method tends to become less reliable for older properties.
The Direct Comparison Approach
The direct comparison approach examines the price of similar properties being sold in the marketplace. Simply put, the sales of properties similar to the subject are analyzed and the sale prices adjusted to account for differences in the comparables to the subject to determine the value of the subject. This approach is generally considered the most reliable if adequate comparable sales exist. In any event, it is the only independent check on the reasonability of an appraisal opinion.
The Income Capitalization Approach
The income capitalization approach (often referred to simply as the "income approach") is used to value commercial and investment properties. Because it is intended to directly reflect or model the expectations and behaviors of typical market participants, this approach is generally considered the most applicable valuation technique for income-producing properties, where sufficient market data exists to supply the necessary inputs and parameters for this approach.
In Conclusion
At Boutilier and Associates, we undertake every assignment with the greatest of care and expertise. It is our responsibility to ensure that we provide a valuation that is proper, regardless of what that entails. We will meticulously inspect and investigate each property that we are asked to place a value on, and complete and exhaustive analysis of the marketplace, to arrive at a value that is truly reflective of the marketplace, as of the effective date of the appraisal.
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