What is an appraisal?

It is an analysis, opinion, and/or conclusion relating to the nature, quality, value, or utility of specified interests in, or aspects of, identified real estate. In developing an appraisal the appraiser: (1) gathers data, (2) analyzes that data, and (3) draws logical conclusions there from. An appraisal is not a statement of fact but only an assemblage of facts from which an appraiser draws a conclusion or value estimate. Although ultimately only an opinion, it is certainly much more than that.

What methods do appraisers use to estimate value?

Appraisers use many methods to derive value. These can be classified into 3 main groups.

Cost Approach: This method is based on the idea that the value of a property is equal to the value of the land plus the cost of all the additions less depreciation from all causes. Gen­erally people will not pay more for a property than it would otherwise cost to buy a similar site and build a similar addi­tion upon it. Therefore, under stable market condi­tions, this approach tends to set an upper limit to value. In summary:

                                   +          cost new

                                    -          accumulated depreciation

                                   +          land value

                                   =          value by cost approach

 

Market Approach: This method is based on the idea that value can be derived from comparing the subject property to recently sold similar properties with allowances for differences. Comparables inferior to the subject property (i.e. those not as good as or offering fewer or lower quality amenities and features than the subject) likely suggest the bottom value range for the subject property and comparables superior, the upper. If adjustments are attempted, amenities or features inferior or not as good as the same subject amenities or features are adjusted upward and those superior adjusted downward. Inferior comparables may be adjusted upward based on individual amenity differences in order to indicate a value for a subject property. And superior comparables may be adjusted downward.

 

Income Approach: This method is based on the idea that a property’s ability to generate net income creates value. That is, a future net income stream commands a price in the market place for which there are buyers and sellers. This relationship can be expressed as follows:

V = I/R

where:   V  = value of the property or investment

I = net income generated over a given time period, usually per year

R = rate of return, aka capitalization rate, usually per year

So, in order to estimate value by way of the Income Approach, two components need to be established: annual net income and rate of return. Of course, since it is a simple equation, as long as any two components are known, the third can be calculated.

What is market value?

The most commonly used definition in the appraisal industry is:

“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 and 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:

• buyer and seller are typically motivated;
• both parties are well informed or well ad­vised, and acting in what they consider their best in­terests;
• a reasonable time is allowed for exposure in the open market;
• payment is made in terms of cash in United States dollars or in terms of financial ar­rangements comparable thereto; and
• 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.”

This definition focuses upon price and does not include such issues as: property taxes, mortgages, surveys, appraisals, buyer and seller financial situations, sales commissions, etc. Market value is not represented by one individual sale but instead it represents the central tendency of many similar sales taken together.

Continued on FAQ's page 2.

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