Unit 16: Real Estate Appraisal
Real Estate Appraisal
Learning Objectives
Explain appraisal concepts and the process employed by the appraiser.
Differentiate between value and price.
Describe the three approaches to value.
Key Terms
Accrued Depreciation: Loss in property value due to deterioration or obsolescence.
Anticipation: Value is influenced by expectations of future events.
Appraisal: An opinion of value based on supportable evidence and approved methods.
Appraiser: An independent professional trained to provide an unbiased opinion of value.
Appraiser Independence Requirements (AIR): Standards to ensure appraiser impartiality and independence.
Assemblage: The process of combining two or more parcels of land.
Broker's Price Opinion (BPO): A less expensive alternative to appraisal for assessing property value.
Capitalization Rate: The rate used in the income approach to value, determined by analyzing net operating income relative to sales prices of similar properties.
Change: Principle that real estate is subject to physical and economic changes.
Competition: The interaction of supply and demand in the market.
Conformity: Property value is maximized when in harmony with surrounding properties.
Contribution: Value of part of a property based on its contribution to the whole.
Cost Approach: Estimation of property value based on replacement cost minus depreciation.
Depreciation: The reduction in value due to various factors.
Economic Life: The period an asset remains useful relative to its cost.
External Obsolescence: Depreciation due to outside factors not related to the property itself.
Functional Obsolescence: Loss in value from outmoded design or features.
Gross Income Multiplier (GIM): Ratio used to estimate property value based on income generated.
Gross Rent Multiplier (GRM): Ratio for estimating value of residential rental properties based on monthly rent.
Highest and Best Use: The most financially productive use of a property.
Income Approach: A method for estimating property value based on the revenue it generates.
Law of Diminishing Returns: Increases in property improvements lead to diminishing value returns after a certain point.
Law of Increasing Returns: Investment results in increasing value up to a certain limit.
Market Data Approach: Also known as the sales comparison approach, it uses comparable property sales to determine value.
Market Value: The most probable price a property should sell for under competitive market conditions.
Net Operating Income (NOI): The income generated from the property after operating expenses are deducted.
Physical Deterioration: Loss in value due to wear and tear.
Plottage: Increased value resulting from the assemblage of properties.
Progression: The principle that the value of a lesser property is raised by surrounding higher-value properties.
Regression: The opposite of progression; lower property values can reduce the value of a higher-quality property.
Reconciliation: The process of weighing all evidence from different valuation approaches.
Sales Comparison Approach: A valuation method comparing the subject property with similar properties.
Substitution: The principle that a buyer will not pay more for a property than an equally desirable substitute.
Supply and Demand: Economic principle affecting property values based on availability and buyer interest.
Uniform Standards of Professional Appraisal Practice (USPAP): Standards for appraisals established by the Appraisal Foundation.
Value: The monetary worth of a property based on desirability.
Overview of Appraisal
Appraisal is critical in real estate transactions; it determines the market response to a property.
Essential for brokers to perform accurate comparative market analyses (CMA).
Appraisals provide analyses of market conditions, the subject property details, comparable properties, and lender considerations.
Appraisal Process
An ** appraisal** is defined as an opinion of value that must be objective, impartial, and based on supported evidence.
Major components include:
Market conditions: Current economic trends affecting property value.
Features of subject and comparable properties.
Recent sales, listings, and overall construction costs.
Appraisers must comply with regulations such as the Dodd-Frank Act and AIR initiated by Fannie Mae to prevent appraisal coercion.
Regulation of Appraisal Activities
Under the FIRREA, federally related transactions must be appraised by licensed professionals.
Appraised values for residential properties valued at $400,000 or less do not require a certified appraiser. Nonresidential property above $500,000 must have this requirement.
Limited instances allow for not requiring new appraisals, such as in certain refinancing cases.
Appraiser Qualifications
Must adhere to state licensing and certification standards, which align with directives from the Appraisal Subcommittee and Appraisal Standards Board.
Compliance with USPAP is required to maintain professionalism in the practice.
Organizations and Resources for Appraisers
Various organizations offer educational resources and networking opportunities, including:
American Society of Appraisers
Appraisal Institute
International Association of Assessing Officers
Comparative Market Analysis (CMA)
Unlike formal appraisals, CMAs provide a quick analysis based on similar properties.
Focuses on:
Recently closed transactions
Current market competition
Expired listings
Broker's Price Opinion (BPO)
A BPO is an informal and less detailed estimate of value typically used in various real estate scenarios.
Cannot be used in federally related transactions requiring a formal appraisal.
The Appraisal Process
Define the Problem: Establish the purpose of the appraisal.
Determine Scope of Work: Define the extent of the appraisal needed.
Data Collection and Verification: Gather and analyze relevant data:
General Data: National, regional, and local economic factors.
Specific Data: Features of the subject property and comparable properties.
Formulate Opinion of Value: Analyze data using three different approaches (Sales Comparison, Cost, Income).
Reconcile and Report Final Opinion of Value: Combine insights from all approaches and provide a formal report.
Reporting Requirements
The appraisal report should include:
Real estate identification
Purpose and intended use of the appraisal
Statement of value and its effective date
Methods of data collection, assumptions, and limitations
Reasonings supporting chosen approaches and any departures from standard practice
Identification of highest and best use
Required signed certification
Uniform Residential Appraisal Report (URAR): A standardized form used by appraisers to report the market value of residential properties.
Market data analysis: Utilizes comparable sales, income potential, and cost estimates to determine property value effectively.
Reconciliation of value estimates: Appraisers must evaluate the final value conclusion based on the collected data and methods employed, ensuring accuracy in the appraisal report.
Understanding Value
Characteristics of Value (DUST)
Demand: the need or desire for possession or ownership backed by the financial needs to to satisfy that need.
Utility: the property’s usefulness for its intended purposes.
Scarcity: a finite supply.
Transferability: the relative ease with which ownership rights are transferred from one person to another.
Market Value : the most probable price that a property would bring in an open and competitive market.
A determination of market value thus requires that
the buyer and the seller are unrelated and acting with undue pressure;
both the buyer and the seller are well informed of the property's use and potential, including both its defects and its advantages;
a reasonable time is allowed for exposure of the property in the open market;
payment is made in cash or its equivalent; and
the price paid for the property is a normal market price, unaffected by special financing amounts or terms, services, fees, costs, or credits incurred in the market transaction.
Market Value vs. Market Price
Market Value: an opinion on a property’s worth.
Market Price: the sales price of a property.
Basic Principles of Value
Anticipation: Future events can raise or lower property value.
Change: Constantly evolving conditions and demand influence value.
Competition: Market forces determine the profitability and value of properties.
Conformity: Valuation is optimized when properties align with neighborhood standards.
Contribution: Each part's value consideration in relation to the entire property.
Highest and Best Use
Definition: The most profitable, legally permitted, physically possible, and financially feasible use of the property.
Can fluctuate with market trends and economic conditions.
Increasing and Diminishing Returns
Law of Increasing Returns: Additional investments improve property value.
Law of Diminishing Returns: Beyond a threshold, additional investments do not proportionally increase value.
Plottage and Assemblage
Plottage: Increased value from combining adjacent properties.
Assemblage: Merging separate lots to maximize property utility.
Regression and Progression
Regression: Lower-quality properties affect the value of a higher-quality property negatively.
Progression: More valuable properties increase the value of lower-quality properties.
Principle of Substitution
Maximum value determined by the cost of an equally desirable substitute property.
Supply and Demand
Prices rise when demand is high relative to supply and vice versa.
The Three Approaches to Value
Sales Comparison Approach
Definition: Compares subject property with recently sold comparable properties.
Adjustments consider:
Property rights
Financing concessions
Market conditions
Sale conditions
Location and area preferences
Physical features and amenities
Most reliable for single-family homes.
Adjustment methods:
CBS: Comp Better, Subtract.
CPA: Comp Poorer, Add.
Cost Approach
Definition: Based on replacement cost of improvements minus depreciation. Steps include:
Estimate land value as if vacant and usable.
Estimate construction cost of improvements.
Deduct accrued depreciation.
Add land value to depreciated improvement cost.
Useful for newer or specialized buildings but less effective for properties with numerous comparable sales.
Income Approach
Definition: Based on the net income an investment property generates, emphasizing:
Estimating annual gross income.
Deducting vacancy losses to find effective gross income.
Deducting operating expenses to determine net operating income (NOI).
Finding capitalization rate through comparable sales.
Applying cap rate to forecasted NOI to estimate value.
Utilizes GRM and GIM for quick estimates in regarding rental properties.
Reconciliation of Value Approaches
Involves analyzing values from the three approaches to reach final appraised value.
Not merely averaging values; emphasizes the most reliable method based on property type.
Greater emphasis on the sales comparison approach for residential properties.
Income approach values prioritized for rental or income properties.
Key Point Review
Appraisal provides an opinion of value, framed by USPAP standards.
CMA differs from formal appraisals and BPOs may be used in certain transactions, but not in federally required appraisals.
Value relies on principles of DUST. Market value assesses probable price during fair sale, while market price reflects the actual sale.
Understanding valuation methods ensures accurate and objective appraisals across various property types.
Final Thoughts
Appraising requires a detailed understanding of market dynamics and standards. Regular updates to principles and practices ensure ongoing relevance in the appraisal field.