| Real Estate Appraisal |
Article Index for Real Estate |
Website Links For Real Estate |
Information AboutReal Estate Appraisal |
| CATEGORIES ABOUT REAL ESTATE APPRAISAL | |
| real estate | |
| valuation | |
| mortgage | |
|
A real estate appraisal is performed by a licensed or certified appraiser (in many countries known as a ''property valuer'' or ''land valuer''). If the appraiser's opinion is based on Market Value, then it must also be based on the Highest And Best Use of the Real Property . For mortgage valuations of improved residential property in the US, the appraisal is most often reported on a standardized form, such as the Uniform Residential Appraisal Report .https://www.efanniemae.com/sf/formsdocs/forms/pdf/sellingtrans/1004.pdf Appraisals of more complex property (e.g. -- income producing, raw land) are usually reported in a narrative appraisal report. TYPES OF VALUE There are several types and definitions of value sought by a real estate appraisal. Some of the most common are:
::''Market Value is the estimated amount for which a property should exchange on the date of valuation between a willing buyer and a willing seller in an arms-length transaction after proper marketing wherein the parties had each acted knowledgably, prudently, and without compulsion.''IVS 1 - Market Value Basis of Valuation, Seventh Edition
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 else 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 subjective valuation of the property (its ''investment value'' for him) was higher than the Market Value. An example of this would be the owner of a neighbouring property who, by combining his own property with the subject property, could thereby obtain economies-of-scale. Such situations often arise in corporate finance, as for example when a merger or acquisition is concluded at a price which is higher than the value represented by the price of the underlying stock. The usual rationale for these valuations would be that the 'sum is greater than its parts', since full ownership of a company entails special privileges for which a potential purchaser would be willing to pay. Such situations arise in real estate/property markets as well. 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. Market value definitions in the US In the US, appraisals are performed to a certain standard of value (e.g. -- foreclosure value, fair market value, distressed sale value, investment value). The most commonly used definition of value is Market Value . While USPAP does not define Market Value, it provides general guidance for how Market Value should be defined: ...a type of value, stated as an opinion, that presumes the transfer of a property (i.e., a right of ownership or a bundle of such rights), as of a certain date, under specific conditions set forth in the definition of the term identified by the appraiser as applicable in an appraisal. Thus, 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: # The relationship, knowledge, and motivation of the parties (i.e., seller and buyer); # The terms of sale (e.g., cash, cash equivalent, or other terms); and # The conditions of sale (e.g., exposure in a competitive market for a reasonable time prior to sale). In the US, the most common definition of Market Value is the one promulgated for use in Federally regulated residential mortgage financing: : ''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 in U. S. dollars 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.''''The Appraisal of Real Estate'', 12th Ed. (Chicago: The Appraisal Institute) For example, adjustments must be made to the Comparables sales prices for special or creative financing or sales concessions. No adjustments are necessary for those costs which are normally paid by sellers as a result of tradition or law in a market area; these costs are readily identifiable since the seller pays these costs in virtually all sales transactions. Special or creative financing adjustments can be made to the comparable property by comparisons to financing terms offered by a third party institutional lender that is not already involved in the property or transaction. Any adjustment should not be calculated on a mechanical dollar for dollar cost of the financing or concession but the dollar amount of any adjustment should approximate the market’s reaction to the financing or concessions based on the appraiser’s judgment.FNMA form 1025, March 2005 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 appraiser 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. Consideration is also given to the market for the property appraised. Appraisals of properties that are typically purchased by investors (e.g. - skyscrapers) 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, but 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 cost approach was formerly called the summation 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. The value of the improvements is often referred to by the abbreviation RCNLD (reproduction cost new less depreciation or replacement cost new less deprecation). Reproduction refers to reproducing an exact replica. Replacement cost refers to the cost of building a house or other improvement which has the same utility, but using modern design, workmanship and materials. 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 cost approach is often the only reliable approach when dealing with special use properties (e.g. -- public assembly, marinas). The sales comparison approach See Also: Sales comparison approach The sales comparison approach examines the price or price per unit area 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. Note that this approach develops value from a purely pricing scheme, and as such is an example of a revealed preference model. An interesting perspective on the relationship between relatively subjective human estimation as compared with that obtained by purely mathematic modeling is contained in "Simple Heuristics That Make Us Smart" by Gerd Gigerenzer. Dr. Gigerenzer, a psychologist, asked people to estimate some real world facts based simply on their knowledge, experience and impressions. Common knowledge and some simple rules created models which were close to those produced by multiple regression analysis (MRA) and neural networks. The predictive value of the human models applied to a new sample was a bit better than the mathematical models, suggesting that the mathematical models may have described the data better but missed the predictive relationships. Similarly automated valuation models frequently find building size (square feet or meters) predictive of value, even when that information is not explicitly advertised. This is similar to the example in "The Wisdom of Crowds", Surowiecki, in which the scientist Francis Galton observed a crowd at a fair to, on average, accurately estimate the size of an ox. The income capitalization approach See Also: Income approach The income capitalization approach is used to value commercial and investment properties. In a commercial income producing property this approach capitalizes an income stream into a Present Value . This can be done using revenue multipliers or single-year Capitalization Rate s of the Net Operating Income. The Net Operating Income (NOI) is gross potential income (GPI), less vacancy (= Effective Gross Income) less operating expenses (but excluding debt service or depreciation charges applied by accountants). Alternatively, multiple years of net operating income can be valued by a Discounted Cash Flow analysis (DCF) model. The DCF model is widely used to value larger and more expensive income-producing properties, such as large office towers. UK valuation methods In the UK, valuation methodology has traditionally been classified into five methods: :1. Comparable method. Used for most types of property where there is good evidence of previous sales. This is analogous to the sales comparison approach outlined above. :2. Investment/income method. Used for most commercial (and residential) property that is producing future cash flows through the letting of the property. If the current Estimated Rental Value (ERV) and the passing income are known, as well as the market-determined Equivalent Yield , then the property value can be determined by means of a simple model. Note that this method is really a comparison method, since the main variables are determined in the market. In standard US practice, however, the closely related capitalising of NOI is confounded with the DCF method under the general classification of the income capitalization approach (see above). :3. Accounts/profits method. Used for trading properties where evidence of rates is slight, such as hotels, restaurants and old-age homes. A three-year average of operating income (derived from the profit and loss or Income Statement ) is capitalised using an appropriate yield. Note that since the variables used are inherent to the property and are not market-derived, therefore unless appropriate adjustments are made, the resulting value will be Value-in-Use or Investment Value, not Market Value . :4. Development/residual method. Used for properties ripe for development or redevelopment or for bare land only. :5. Contractor's/cost method. Used for only those properties not bought and sold on the market. Both the development/residual method and the contractor's/cost method would be grouped in the US under the Cost Approach (see above). FURTHER CONSIDERATIONS Highest and best use See Also: Highest and best use Highest and Best Use (HABU) is a term of art in the appraisal process. It is a process to determine the use of the property which produces the highest value for the land, as if vacant. There are four steps to the process. First, the appraiser determines all uses which are legally permissible for the property. Second, of the uses which are legally permissible, which ones are physically possible. Of those, which ones are financially feasible (sometimes referred to as ''economically supported'') Of those uses which are feasible, which one and only use is maximally productive for the site. In a simple context, the appraiser must do this twice, comparing the results -- as if the land is vacant and in the as-is-improved state, taking into account the costs of demolishing any existing improvements. The outcome of this process is the highest and best use for the site. An appraisal of market value must explicitly assume that the owner or buyer would employ the property in its highest and best use, and therefore value the site accordingly. In more complex appraisal assignments (e.g. -- contract disputes, litigation, brownfield or contaminated property valuation), the determination of highest and best use may be much more complex, and may need to take into account the various intermediate or temporary uses of the site, the contamination remediation process, and the timing of various legal issues.See, for example, John A. Kilpatrick , Valuation of Brownfield Properties, Chapter 29 in LexisNexis Matthew Bender's Brownfield Law and Practice, 2007 Types of ownership interest Implicit in the analysis of the subject property is a determination of the interest in the property being appraised. For most common situations (e.g. -- mortgage finance) the Fee Simple interest is explicitly assumed since it is the most complete bundle of rights available. However, in many situations, and in many societies which do not follow English Common Law or the Napoleanic Code, some other interest may be more common. While there are many different possible interests in real estate, the three most common are:
Scope of work While USPAP has always required appraisers to identify the scope of work needed to produce credible results, it became clear in recent years that appraisers did not fully understand the process for developing this adequately. In formulating the scope of work for a credible appraisal, the concept of a ''limited'' versus ''complete'' appraisal and the use of the Departure Rule caused confusion to clients, appraisers, and appraisal reviewers. In order to deal with this, USPAP was updated in 2006 with what came to be known as the Scope of Work project. In short, USPAP eliminated the Departure Rule and the concept of a limited appraisal and created a new Scope of Work rule. In this, appraisers were to identify six key parts of the appraisal problem at the beginning of each assignment:
Based on these factors, the appraiser must identify the scope of work needed, including the methodologies to be used, the extent of investigation, and the applicable approaches to value. The rule provided the explicit requirement that the minimum standards for scope of work were:
MASS APPRAISAL AND AUTOMATED VALUATION MODELS Automated valuation models (AVMs) are growing in acceptance. These rely on statistical models such as multiple regression analysis or geographic information systems (GIS). "Valuation" , RICS Organization While AVMs can be quite accurate, particularly when used in a very homogeneous area, there is also evidence that AVMs are not accurate in other instances such as when they are used in rural areas, or when the appraised property does not conform well to the neighborhood. AVM's have also gained favor in class action litigation, and have been substantiated in numerous cases, both in Federal and state courts, as the appropriate method for dealing with large-scale real estate litigation problems, such as contaminated neighborhoods. GOVERNING AUTHORITIES AND PROFESSIONAL ORGANIZATIONS United States Appraisal practice in the US is regulated by the various states. Prior to the 1990's, there were no commonly accepted standards either for appraisal quality or for appraiser licensure. In the 1980s, an ad-hoc committee representing various appraisal professional organizations in the U.S. and Canada met to codify the best practices into what became known as the Uniform Standards Of Professional Appraisal Practice , or USPAP. The Savings And Loan Crisis in the U.S. resulted in increased Federal regulation of the mortgage lending process via the Financial Institutions Reform, Recovery and Enforcement Act of 1991. A portion of this act required federal lending regulators to adopt appraisal standards. A not-for-profit organization, the Appraisal Foundation (TAF), was formed by the same organizations which had developed USPAP, and the copyright for USPAP was signed over to TAF. Federal oversight of TAF is provided by the Appraisal Subcommittee, made up of representatives of various Federal lending regulators. TAF carries out its work through two boards: the Appraisal Standards Board promulgates and updates USPAP; the Appraisal Qualifications Board (AQB) promulgates minimum recommended standards for appraiser certification and licensure. During the 1990s, all of the states adopted USPAP as the governing standards within their states and developed licensure standards which met or exceeded the recommendations of TAF. Also, the various state and federal courts have adopted USPAP for real estate litigation and all of the federally lending regulators adopt USPAP for mortgage finance appraisal. {Link without Title} The Appraisal Foundation In addition, there are professional appraisal organizations, organized as private not-for-profits, which date to the Great Depression of the 1930s. One of the oldest in the U.S. is the American Society of Farm Managers and Rural Appraisers (ASFMRA), founded in 1929.http://www.asfmra.org/ Others were founded as needed and opportunity arose in specialized fields, such as the Appraisal Institute (AI) and the American Society of Appraisers (ASA) founded in the 1930s, the International Right of Way Association and the National Association of Realtors which were founded after World War II. These organizations all existed to establish and enforce standards, but their influence has waned as the government increases appraisal regulation. In March 2007, three of these organizations (ASFMRA, ASA, and AI) announced an agreement in principle to merge. NAIFA (National Association of Independent Fee Appraisers), a charter member of The Appraisal Foundation, helped to write Title XI, the Real Estate Appraisal Reform Amendments. It was founded in 1961. The best known professional organization of real estate appraisers in America is the Appraisal Institute . It was formed in from the merger of the American Institute of Real Estate Appraisers and the Society of Real Estate Appraisers. Founded along with others in the 1930's, the two organizations merged in the 1990's to form the Appraisal Institute (AI). This group awards two professional designations: ''SRA'', to residential appraisers, and ''MAI'', to commercial appraisers. Other leading appraisal organizations include the ) has become highly regarded in the US, and has formed a collaboration with the Counselors of Real Estate, a division of the National Association Of Realtors . RICS, which is headquartered in London, operates on a global scale and awards the designations ''MRICS'' and ''FRICS'' to Members and Fellows of RICS. The Real Estate Counseling Group Of America is a small group of the top appraisers and real estate analysts in the US who collectively have authored a disproportionately large body of appraisal methodology. United Kingdom In the UK , real estate appraisal is known as ''property valuation'' and a real estate appraiser is a ''land valuer'' or ''property valuer'' (usually a qualified Chartered Surveyor who specialises in property valuation). Property valuation in the UK is regulated by the Royal Institution Of Chartered Surveyors (RICS), a professional body encompassing all of the building and property-related professions. The RICS professional guidelines for valuers are published in the ''RICS Appraisal and Valuation Standards'', commonly known as the ''Red Book''. While based in the UK, RICS is a global organization and has become very active in the US in recent years through its affiliation with the Counselors of Real Estate, a division of the National Association of Realtors. International The various US and international professional organizations have started collaborating in recent years toward the development of international valuation standards which will facilitate global real estate appraisal, a much-needed adjunct to real estate investment portfolios which transcend national boundaries. FURTHER READING
REFERENCES EXTERNAL LINKS
|
|
|