What is an Appraisal?
A appraisal is n estimate and opinion of value, or the process of estimating value. Usually, it is a written statement of an appraiser’s opinion of value of an adequately described parcel of property as of specified date. It may also be called “valuation”.
What is “Market Value”?
As defined by USPAP (Uniform Standards Of Professional Appraisal Practice) Market value or fair market value is the most probable price that a property will sell for 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; (3) a reasonable time is allowed for exposure to 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 Process
The appraisal process is an orderly program in which the data utilized to estimate the market value of the subject property is acquired, classified, analyzed and presented. The first step in the appraisal process is defining the appraisal problem, also called the appraisal assignment; namely, the identification of the real estate to be appraised, the effective date of the value estimate, the property rights being appraised, the clients, the owners, the buyers, the sellers, the borrowers, the extraordinary assumptions and hypothetical conditions, the type of the appraisal report needed, and the type of value sought. This step is presented in detail in the Scope of the Appraisal section at the beginning of this appraisal report and repeated, as needed, in other sections of this appraisal report.
Next, once the identification process has been completed within the intended Scope of the Appraisal, the appraiser collects the data and information and analyzes the factors that affect the market value of the subject property under the conditions of the appraisal assignment. These include the area and the neighborhood analysis, the site and the site improvements analysis, the highest and best use analysis, and the appropriateness of application of the three approaches to estimating the subject property’s market value. The approaches to value commonly used by the real estate appraisers are: the Cost Approach, the Income or Economic Approach, and the Direct Comparable Sales (Market Data) Approach. The Direct Comparable Sales Approach is primarily used to estimate the value of the land.
In the Cost Approach to value, the appraiser considered the cost of new construction of improvements less accrued depreciation, and the addition of the value of the land, with the resultant figure indicating the value of the whole property.
The Direct Sales Comparison Approach, also commonly known as Market Data and Comparable Sales Approach, is used to estimate the value of the land as if vacant and/or the whole property as improved. The appraiser gathers data on sales of comparable properties and analyzes the nature and condition of each sale, making logical adjustments for dissimilar characteristics. Typically, a common denominator is found. For land value, this is usually either a price per square foot or price per acre. For improved properties, the common denominator may be the price per square foot of the building, the price per unit, or a gross rent multiplier. The Direct Sales Comparison Approach gives a good indication of value when sales of similar properties are available.
The Income (Economic) Approach to value is predicated on the assumption that there is a definite relationship between the amount of income that a property will earn and its market value. This approach is based on the principle of anticipation; namely; that value is created by the expectation of benefits to be derived in the future. The anticipated annual income of the subject property is processed to produce an indication of the market value. Net income is the income generated before payment of any debt service. The process of converting it into value is called capitalization in which a capitalization rate is utilized. Factors such as risk, time, interest on the capital investment, and the recapture of the depreciating asset are considered in the capitalization rate. The appropriateness of the capitalization rate is critical, and there are a number of techniques by which it may be developed. The final step in the appraisal process is the Reconciliation or the Correlation of the value indications. In the reconciliation or the correlation, the appraiser considers the relative applicability of each of the three approaches to value used, examines the range between the value indications, and places major emphasis on the approach that appears to produce the most reliable solution to the specific appraisal problem (appraisal assignment). The purpose of the appraisal, the type of property, and the adequacy and reliability of the data analyzed are the considerations which influence the weight given to each of the approaches to value.