Real Estate Appraisal
An appraisal of real estate is the valuation of the rights of ownership. The appraiser must define the rights he intends to appraise.
The appraiser does not create value, the appraiser interprets the market to arrive at a value estimate. As the appraiser compiles data pertinent to a report, consideration must be given to the site and amenities as well as the physical condition of the property. An appraiser may spend only a short time inspecting the property, however, this is only the beginning.
Considerable research and collection of general and specific data must be accomplished before the appraiser can arrive at a final opinion of value.
Due to the many types of value, such as Fair Market Value, Insurance Value, Tax Value and Value In Use, the need to precisely define the purpose of the appraisal is essential.
An appraisal is an opinion of value or the act or process of estimating value. This opinion or estimate is derived by using three common approaches, all derived from the market. They are:
Cost Approach to value is what it would cost to replace or reproduce the improvements as of the date of the appraisal, less the Physical Deterioration, the Functional Obsolescence and the Economic Obsolescence. The remainder is added to the Land Value.
Comparison Approach to value makes use of other “bench mark” properties of similar size, quality and location that have been recently sold. A comparison is made to the subject property.
Income Approach to value is of primary importance in ascertaining the value of income producing properties and has little weight in residential type properties. This approach provides an objective estimate of what a prudent investor would pay based upon the net income the property produces.
Then, after thorough analysis of all general and specific data gathered from the market, a final estimate or opinion of value is correlated.
Reasons for an appraisal
To determine an offering or selling price: In the real world, very few individuals order appraisal reports to establish an offering price or to substantiate a purchase price. At the point that an offer to purchase (in a typical residential transaction) is made, the price has been set by other parties, not the purchaser. The price has been determined by the seller, who wishes to obtain the highest price possible, or the agent, who receives a percentage of the price as compensation and often represents the seller in the transaction.
To obtain a loan: Usually, individuals applying for a loan are only interested in obtaining the loan and unfortunately are not worried about the prudence of buying the property at the agreed price. In fact, many purchasers will try to encourage appraisers to increase the appraised value so that they can purchase the home regardless of its value. The majority of real estate appraisals are requested by mortgage companies to validate the property’s purchase price for loan purposes. Except for periods of very low interest rates when everyone is refinancing, most loans are for the purchase of real estate and ordered after a sale price is negotiated. Purchasers mistakenly assume that mortgage companies are looking after their interests in the purchase transaction.
To settle an estate: Taxing authorities such as the IRS often require appraisals to establish the value of an estate when a death occurs. Generally, the survivors want a conservative value estimate that limits their tax liability as much as possible. Most estate appraisals are ordered by attorneys, not by the survivors.
To establish the replacement cost for insurance: Appraisals obtained for establishing the loss risk in case of fire are often limited to providing an estimate of the replacement or reproduction cost of the improvements. The insurable value may not be representative of market value and usually does not include the value of the land. Insurance agents may order appraisals when their standard cost service manuals are not adaptable to an atypical home or structure. Or property owners may order appraisals to contest the annual appreciation increases mandated by some insurance companies, especially when the increase in the insurance coverage results in an unrealistic Premium.
To establish just compensation for condemnation: The appraiser may represent either the landowner or the condemning authority. Usually, the government entity that needs the land for public use orders an appraisal and offers to purchase the land for the value indicated by the appraisal. If the landowner feels that the amount offered by the condemning authority is not enough, then the landowner may also order an appraisal. If the parties cannot agree on a price, then the matter will be settled in court with each appraiser testifying on behalf of their respective value estimates. The appraisers are not advocates for their client; they are expert witnesses trying to support their value estimates. Often landowners do not consider ordering another appraisal from an appraiser of their choice. Usually, they try to settle with the authority by negotiation rather than incur the expense of an appraisal. It is obvious that the landowner’s negotiating position would be enhanced if a supporting professional appraisal report were available.
To contest high property taxes: If property owners feel that their property is assessed too high, then they may order an appraisal from a qualified appraiser to contest the assessment. In certain parts of the country this practice is common, but many property owners are not aware that this avenue of reducing their tax burden is available. The return on investment is easy to perceive when the cost of an appraisal is compared to several years of lower taxes. Sometimes these assignments include an appearance in front of the equalization board to argue the landowner’s case. The appraiser, however, must be careful not to base the appraisal fee on the dollar amount of the appraised value, which could be a violation of the USPAP.