Appraisal Information
Copyright © 2007 Accurate Real Estate Appraisals, 3884 Griffin Road, Syracuse, NY 13215
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Real estate appraisal is the practice of developing an opinion of the value of real property, usually its Market
Value. The need for appraisals arises from the heterogenous nature of property as an investment class: no two
properties are identical, and all properties differ from each other in their location - which is the most important
determinant of their value. So there cannot exist a centralised Walrasian auction setting for the trading of
property assets, as there exists for trade in corporate stock. The absence of a market-based pricing mechanism
determines the need for an expert appraisal/valuation of real estate/property.
A real estate appraisal is performed by a licensed or certified appraiser. 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. Appraisals of more complex property (e.g. -- income
producing, raw land) can be 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 – 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.
* Value-in-use – The net present value (NPV) of a cash flow that an asset generates for a specific owner under
a specific use. Value-in-use is the value to one particular user, and is usually below the market value of a
property.
* Investment value - is the value to one particular investor, and is usually higher than the market value of a
property.
* Insurable value - is the value of real property covered by an insurance policy. Generally it does not include
the site value.
* Liquidation value -- may be analyzed as either a forced liquidation or an orderly liquidation and is a
commonly sought standard of value in bankruptcy proceedings. It assumes a seller who is compelled to sell
after an exposure period which is less than the market-normal timeframe.
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.
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 sales comparison approach and
* The income approach
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
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.
The Income Capitalization 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 rates 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.
Value. The need for appraisals arises from the heterogenous nature of property as an investment class: no two
properties are identical, and all properties differ from each other in their location - which is the most important
determinant of their value. So there cannot exist a centralised Walrasian auction setting for the trading of
property assets, as there exists for trade in corporate stock. The absence of a market-based pricing mechanism
determines the need for an expert appraisal/valuation of real estate/property.
A real estate appraisal is performed by a licensed or certified appraiser. 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. Appraisals of more complex property (e.g. -- income
producing, raw land) can be 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 – 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.
* Value-in-use – The net present value (NPV) of a cash flow that an asset generates for a specific owner under
a specific use. Value-in-use is the value to one particular user, and is usually below the market value of a
property.
* Investment value - is the value to one particular investor, and is usually higher than the market value of a
property.
* Insurable value - is the value of real property covered by an insurance policy. Generally it does not include
the site value.
* Liquidation value -- may be analyzed as either a forced liquidation or an orderly liquidation and is a
commonly sought standard of value in bankruptcy proceedings. It assumes a seller who is compelled to sell
after an exposure period which is less than the market-normal timeframe.
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.
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 sales comparison approach and
* The income approach
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
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.
The Income Capitalization 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 rates 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.
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