Commonly Asked Questions
- Real Estate Appraisers and Appraisals
Who are real estate appraisers, and what
do they do? Here are some answers!
What is an appraisal?
An appraisal is a professional appraiser's opinion of value.
The preparation of an appraisal involves research into appropriate
market areas; the assembly and analysis of information pertinent
to a property; and the knowledge, experience and professional
judgment of the appraiser.
What is the role of the appraiser?
The role of the appraiser is to provide objective, impartial
and unbiased opinions about the value of real property—providing
assistance to those who own, manage, sell, invest in and/or
lend money on the security of real estate.
What qualifications must appraisers
have?
At minimum, all states require appraisers to be state licensed
or certified in order to provide appraisals to federally regulated
lenders. However, appraisers who become designated members
of the Appraisal Institute have gone beyond these minimum
requirements. They have fulfilled rigorous educational and
experience requirements and must adhere to strict standards
and a code of professional ethics. The Appraisal Institute
currently confers the MAI membership designation on those
who are experienced in the valuation of commercial, industrial,
residential and other types of properties. Alan L. Johns,
MAI, CPM® and Thomas P. Williams, MAI have both obtained
the MAI designation from the Appraisal Institute.
How do well-credentialed appraisers
add value to real estate transactions?
They bring knowledge, experience, impartiality and trust to
the transaction. In so doing, they help their clients make
sound decisions with regard to real property.
What are the components of an appraisal
report?
Most appraisals are reported in writing, although in certain
circumstances, an appraiser may provide an oral appraisal.
A written appraisal report generally consists of: a description
of the property and its locale; an analysis of the "highest
and best use" of the property; an analysis of sales of
comparable properties "as near the subject property as
possible"; and information regarding current real estate
activity and/or market area trends.
What are the most important considerations
in the valuation of real property?
The value indicated by recent sales of comparable properties,
the current cost of reproducing or replacing a building, and
the value that the property's net earning power will support
are the most important considerations in the valuation of
real property.
What is the
range of services appraisers provide?
The Appraisal Advisory Group staff can assist with the following:
- Estate planning and estate settlements
- Tax assessment review and advice
- Advice in eminent domain and condemnation
property transactions
- Dispute resolution—including divorce,
estate settlements, property partition suits, foreclosures,
and zoning issues
- Feasibility studies
- Expert witness testimony
- Market rent and trend studies
- Cost/benefit or investment analysis,
for example, what will be the financial return on remodeling
- Land utilization studies
- Supply and demand studies
When
in need of an appraiser, why should I hire a member of the
Appraisal Institute?
Appraisers who hold Appraisal Institute professional designations
have met stringent educational requirements, have considerable
professional experience and are required to adhere to strict
standards and ethics of professional practice that exceed
those required by state or federal law. Moreover, many Appraisal
Institute designated members participate in continuing education
programs—including those that emphasize the most-up-to-date
valuation techniques—making them the preferred source
for high-quality appraisal services.
Understanding the Appraisal
Much of the private, corporate and public
wealth of the world consists of real estate. The magnitude
of this fundamental resource creates a need for informed appraisals
to support decisions pertaining to the use and disposition
of real estate and the rights inherent in ownership. An appraisal
answers one or more specific questions about a real estate
parcel’s value, marketability, usefulness or suitability.
The Appraisal Defined
Professional real estate appraisers perform a useful function
in society and offer a variety of services to their clients.
They develop opinions of several types of property value and
assist in various decisions about real estate. Standards for
the appraisal profession are set forth 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. 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.
The most common type of appraisal assignment
is the development of an opinion of market value. However,
because of their specialized training and experience, appraisers
can provide a wide range of additional appraisal services—from
investment consultation to advice on various business as well
as personal financial decisions.
The Intended Use of an Appraisal
An appraisal may be requested or required for many reasons.
- 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
Many appraisal assignments relate to 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
Other appraisals are requested to 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 assessed value
- To determine gift or inheritance taxes
- To estimate the value of the real property
component of an estate
Appraisals are also used in 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
Appraisals
for the Lending Industry
Many appraisals are performed for lending purposes. Property
owners should be aware that current federal lending regulations
Interagency
Appraisal and Evaluation Guidelines, October 27, 1994,
and Independent
Appraisal and Evaluation Functions, October 27, 2003
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 the 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.
Value Influences
The analysis of social, economic, governmental and environmental
forces provides an understanding of the dynamics of change
and helps identify value trends. Against this background,
the appraiser investigates the characteristics of the subject
property that might impact the property’s value. The
appraiser also investigates the nature of the market for that
property, competitive properties, and the buyers and sellers
who constitute the market for that property type. The principles
of supply and demand, substitution, balance and externalities
help explain shifts in value.
Four independent economic factors—utility,
scarcity, desire, and effective purchasing power— must
be present to create value in a particular item or collection
of items. Professional appraisal standards specifically require
the study of all value influences. Change and anticipation
are fundamental in this analysis, and appraisers apply these
principles and related concepts that influence value in their
analysis.
Approaches to
Value
Participants in the real estate market commonly think of value
in three ways:
- The current cost of reproducing or replacing
a building, minus an estimate for depreciation, plus the
value of the land (and entrepreneurial incentive, if applicable)
- The value indicated by recent sales of
comparable properties in the market
- The value that the property's net earning
power will support
These different viewpoints form the basis
of the three approaches that appraisers use to value property—the
cost, sales comparison and income capitalization approaches.
One or more of these approaches may not be applicable to a
given assignment or may be less significant because of the
nature of the property, the appraisal problem or the data
available. The approaches to value are applied within the
context of the valuation process.
The Valuation Process
Although characteristics of properties differ widely, all
appraisal problems can be solved through the systematic application
of the valuation process. In the valuation process the problem
is defined, the work necessary to solve the problem is planned
and relevant data are collected, verified and analyzed to
form an opinion of value.
The valuation 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.
Definition of the Problem
The first step in the valuation process is to develop a concise
statement of 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 or intended user of the appraisal, the real estate
to be appraised, the intended use of the appraisal, the type
and definition of value, the date of the value opinion, the
property characteristics (including location and property
rights to be valued) and any extraordinary assumptions or
hypothetical conditions affecting the assignment.
Scope of Work
The scope of work is the amount and type of information researched
and the analysis applied in an assignment. After the problem
to be solved is clearly defined, the appraiser must next determine
the appropriate scope of work to solve the problem. The scope
of work must be clearly disclosed in the appraisal report.
Data Collection and Property Description
In this step the appraiser gathers general data on the market
area and specific data on the subject and comparable properties.
The appraiser collects general data related to property values
in an area to understand the economic climate in which property
competes 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.
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.
Highest and best use is a critical step
in the development of a market value opinion. In 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.
Land Value Opinion
A land value opinion is formed through the application of
a variety of methods that are 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 land residual technique,
ground rent capitalization, or subdivision development analysis.
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 use of the appraisal
and the quality and quantity of the data available for analysis.
Cost Approach
The cost approach is based on the understanding that market
participants relate value to cost. In the cost approach, the
value of a property is derived by adding the estimated value
of the land to the current cost of constructing a reproduction
or replacement for the improvements and then subtracting the
amount of depreciation in the structures from all causes.
Entrepreneurial profit and/or incentive may be included in
the value indication.
The current cost to construct the improvements
can be obtained from cost estimators, cost manuals, builders
and contractors. Depreciation is of three different types
(physical deterioration, functional obsolescence and external
obsolescence) and is measured through market research and
the application of specific procedures. Land value is estimated
separately in the cost approach.
This approach is particularly useful in
valuing new or nearly new improvements and properties that
are not frequently exchanged in the market. Cost approach
techniques can also be employed to derive information needed
in the sales comparison and income capitalization approaches
to value, such as an adjustment for the cost to cure items
of deferred maintenance.
Sales
Comparison Approach
The sales comparison approach is most useful when a number
of similar properties have recently been sold or are currently
for sale in the subject property’s market. Using this
approach, an appraiser develops a value indication by comparing
the subject property with similar properties, called comparable
sales. The sale prices of the properties that are judged to
be most comparable tend to indicate a range in which the value
indication for the subject property will fall.
The appraiser estimates the degree of similarity
or difference between the subject property and the comparable
sales by considering various elements of comparison:
- Real property rights conveyed
- Financing terms
- Conditions of sale
- Expenditures made immediately after purchase
- Market conditions
- Location
- Physical characteristics
- Economic characteristics
- Use/zoning
- Non-realty components of value
Dollar or percentage adjustments may be
applied to the known sale price of each comparable property
to derive a range of value indications for the subject property.
Through this comparative procedure, the appraiser ultimately
arrives at an opinion of value.
Income multipliers and capitalization rates
may also be extracted through analysis of comparable sales,
though these factors are not regarded as elements of comparison
in the sales comparison approach. Instead, they are usually
applied in the income capitalization approach.
Income Capitalization Approach
Income-producing real estate is typically purchased as an
investment, and from an investor’s point of view earning
power is the critical element affecting property value. In
the income capitalization approach, value is measured as the
present value of the future benefits of property ownership.
There are two methods of income capitalization: direct capitalization
and yield capitalization. In direct capitalization, the relationship
between one year’s income and value is reflected in
either a capitalization rate or an income multiplier. In yield
capitalization, the relationship between several years’
stabilized income and a reversionary value at the end of a
designated period is reflected in a yield rate. The most common
application of yield capitalization is discounted cash flow
analysis. Given the significant differences in how and when
properties generate income, there are many variations in both
direct and yield capitalization procedures.
The specific data that an appraiser investigates
in the income capitalization approach might include the property’s
gross income expectancy (assuming either market rent or contract
rent), the expected reduction in gross income caused by vacancy
and collection loss, the anticipated annual operating expenses,
the pattern and duration of the property’s income stream
and the anticipated reversionary value. After income and expenses
are estimated, the income streams are capitalized by applying
an appropriate rate or factor or converted into present value
through discounting. In discounted cash flow analysis, the
quantity, variability, timing and duration of a set of periodic
incomes and the quantity and timing of the reversion are specified
and discounted to a present value at a specified yield rate.
The rates used for capitalization or discounting are derived
from acceptable rates of return for similar properties.
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 the application of the approaches. The appraiser weighs
the relative significance, applicability and defensibility
of each approach and relies most heavily on those most appropriate
to the intended use of the appraisal. The conclusion drawn
is based on the appropriateness, accuracy and quantity of
all the evidence in the appraisal.
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.
Report of Defined Value
The type, format, length and contents of a written appraisal
report may vary depending on the requirements of the client
and the scope of work criteria. 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. In general, a self-contained report fully describes
the data and analyses used in the assignment.
It provides comprehensive coverage of appropriate
information contained within the report itself with minimal
reference to files outside the report. A summary appraisal
report summarizes the data and analyses used in the assignment.
A restricted-use appraisal report simply states the conclusions
of the appraisal; it 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/or
analyses that would be presented in a self-contained appraisal
report. A form report may be a summary or a restricted-use
report. An appraisal may also be communicated by means of
an oral report when circumstances do not permit or warrant
the preparation of a written report.
Certification
The certification states that the appraiser has personally
conducted the appraisal in an unbiased, objective manner in
accordance with USPAP. It may follow the final opinion of
value or be combined with it. The certification must be signed
by the appraiser. Certification is important because it clearly
states the role of the appraiser, thereby clarifying that
the assignment was performed by an individual who is impartial,
objective and unbiased.
- All appraisal reports will specify
the following items:
- the identity of the client and
any other intended users
- the intended use of the report
- the type and definition of the
value to be estimated
- the effective date of the appraisal
- the real estate being appraised
- the real property interest being
valued
- any 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 the
real estate when such an opinion in necessary and appropriate
- the information considered, appraisal
procedures followed and reasoning applied
- a signed certification in accordance
with USPAP Standards Rule 2-3.
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