Overview of Real Estate Valuation

Overview of Real Estate Valuation

Intended Learning Outcomes

· Know which appraisal assignments must be performed by state-certified or licensed appraisers and that real estate licensees must comply with the USPAP when conducting appraisals, but not CMAs
· Distinguish among value, price, and cost
· Distinguish among the various types of value
· Describe the elements of demand and supply and the factors that affect them
· Distinguish among the various principles of value and understand how each influences the value
· Distinguish between highest and best use as vacant and highest and best use as improved
· Describe the steps in the appraisal process
· Reconcile indicated values from different comparables or different approaches to value using weighted and simple averaging
· List the three general types of reporting formats and describe the three types of narrative Reports

Introduction to Appraisal
Definition:

An APPRAISAL is supported, defended estimate of the value of an item of real property as of a given date. Title XI of the Financial Institution Reform, Recovery, and Enforcement Act of 1989 (FIRREA) requires states to establish appraisal licensing and certification programs for appraisers who may be involved in performing appraisals that support a FEDERALLY RELATED TRANSACTION. In Florida, licensed and certified appraisers are regulated by the Florida Real Estate Appraisal Board which is outlined in Chapter 475 Florida Statutes, Part II.

Systematic procedures and logical analysis presented in the Uniform Standards of Professional Appraisal Practice (USPAP) must be followed. The USPAP is the essential rulebook for appraisers.

Usually, the purpose of an appraisal is to confirm the value of the property being bought or sold. The mortgage lender needs to independently establish the value of the property so that, if the property must be sold at foreclosure, enough money can be raised at the auction to pay off the loan balance. Also, sometimes a seller likes to have his or her property appraised before putting it on the market to get an independent, expert opinion of the property’s value.

In order to prepare an appraisal in Florida, a person must be a licensed or certified appraiser. Brokers and sales associates are not authorized to perform appraisals unless they also concurrently hold an appraiser’s license. Even so, the broker or sales associate should not perform an appraisal on a property he or she is listing or otherwise involved with its sale. The real estate licensee may, however, perform valuation services, more commonly referred to as a COMPARATIVE MARKET ANALYSIS, which can be considered an informal method of estimating a property’s value.

Comparative Market Analysis vs. Appraisal: Both appraisal and Comparative Market Analysis (CMA) are methods to estimate a property’s market value. When performing a CMA, the real estate licensee will research the sales data of similar properties (comparable properties known as “comps”) and review comps that have recently sold and comps currently for sale and identify listings that have recently expired. Once all the data has been accumulated and reviewed, the licensee can establish a range of values for the subject property and suggest an initial listing price. Due to the CMA’s less complex nature, it is not considered to be an appraisal and will not be relied upon by lending institutions. CMA’s are exempt from USPAP regulations. Although it is permissible to charge a fee for performing a CMA, licensees will typically provide the service as a free courtesy.

Licensed professionals compensated for performing appraisals are paid a flat fee based upon the difficulty of their tasks and the amount of time involved in the appraisals’ preparation. Pursuant to USPAP ethics rules, appraisers are not compensated on a percentage of the subject property’s value to avoid a conflict of interest situation

Although the CMA and the appraisal both review prior sales of similar properties, there are many differences:

1. The appraisal will only consider similar properties (“comps”) that have actually sold as reliable data. The person performing the CMA will consider comps that have sold, comps currently for sale, and expired listings because they may be evidence that their listing prices were too high.

2. Appraisers are to follow formal rules established under the USPAP. CMA’s do not have a standardized set of rules and are considered to be an informal method of estimating value.

3. An appraisal will establish a specific dollar amount estimate of value while the CMA will establish an estimated “range” of values” for the subject property.

4. A person must be a state licensed or certified appraiser to perform an appraisal. No formal license is required to perform a CMA.

5. The CMA only uses the sales comparison approach to valuation while the appraisal includes the sales comparison approach, the cost depreciation approach, and the income capitalization approach (discussed in Chapter 7).

Broker’s price opinion

A broker’s price opinion is the process used by licensees to determine the potential selling price or estimated value of a real estate property. A BPO is popularly used in situations where a financial institution believes the expense and delay of an appraisal is unnecessary. At a price of US$50–150 per BPO, the work can provide side income or steady income for the broker. If a valuation assignment involves a federally related transaction, an appraisal must be conducted by a licensed or certified appraiser.

Title XI of the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA)

Under the Federal Institutions Reform, Recovery and Enforcement Act of 1989, the Federal Government requires that federally related transactions be performed with appraisals in writing, in accordance with uniform standards, by individuals whose competency has been demonstrated and whose professional conduct will be subject to effective supervision. These rules shall require, at a minimum:

That real estate appraisals be performed in accordance with generally accepted appraisal standards as evidenced by the appraisal standards promulgated by the Appraisal Standards Board of the Appraisal Foundation; and
That such appraisals shall be written appraisals.
In determining whether an appraisal in connection with a federally related transaction must be performed by a State certified appraiser, an agency shall consider whether transactions are of

sufficient financial or public policy importance to the United States that an individual who performs an appraisal in connection with such transactions should be a State certified appraiser, except that:

A State certified appraiser shall be required for all federally related transactions having a value of $100,000 or more; and
1-to-4 unit, single-family residential appraisals may be performed by State-licensed appraisers unless the size and complexity require a State certified appraiser. All federally related transactions not requiring the services of a State certified appraiser shall be performed by either a State certified or licensed appraiser.
It is against the law:

For a financial institution to seek, obtain, or give money or any other thing of value in exchange for the performance of an appraisal by a person who the institution knows is not a State certified or licensed appraiser in connection with a federally related transaction; and
For the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, or the Resolution Trust Corporation to knowingly contract for the performance of any appraisal by a person who is not a State certified or licensed appraiser in connection with a real estate-related financial transaction defined in section 1121(5) to which such association or corporation is a party.
PENALTIES: A financial institution that violates this law is subject to civil penalties under section 8(i)(2) of the Federal Deposit Insurance Act or section 206(k)(2) of the Federal Credit Union Act, as appropriate.

USPAP Uniform Standards of Professional Appraisal Practice

Anyone who appraises real property must conform to USPAP. To find the actual standards, go to http://commerce.appraisalfoundation.org/html/2006%20USPAP/toc.htm.

The Preamble of USPAP says:

The purpose of these Standards is to establish requirements for professional appraisal practice, which includes appraisal, appraisal review, and appraisal consulting, as defined. The intent of these standards is to promote and maintain a high level of public trust in professional appraisal practice.

These standards are for appraisers and users of appraisal services. Individuals comply with these standards either by choice or by requirement placed upon them or upon the service they provide by law, regulation, or agreement with intended users.

The Ethics Rule states:

It is unethical for an appraiser to accept compensation for performing an assignment when it is contingent upon:

The reporting of a predetermined result (e.g. opinion of value);

A direction in assignment results favors the cause of the client;

The amount of value opinion;

The attainment of a stipulated result; or,

The occurrence of a subsequent event directly related to the appraiser’s opinions and specific to the assignment’s purpose.

In other words, an appraiser must be paid on a fee-per-job basis, not a percent of the value of the property.

State certification and licensure requirements
The AQB has established the following classifications of appraisers:

Trainee appraiser

This means a person who is registered with the department as qualified to perform appraisal services only under the direct supervision of a licensed or certified appraiser. A registered trainee appraiser may accept appraisal assignments only from her or his primary or secondary supervisory appraiser.

Licensed appraiser

This means a person who is licensed by the department as qualified to issue appraisal reports for residential real property of one to four residential units or on such real estate or real property as may be authorized by federal regulation. After July 1, 2003, the department shall not issue licenses for the category of licensed appraisers.

Certified residential appraiser

This means a person who is certified by the department as qualified to issue appraisal reports for residential real property of one to four residential units, without regard to transaction value or complexity, or real property as may be authorized by federal regulation.

Certified general appraiser

A person who is certified by the department as qualified to issue appraisal reports for any type of real property.

The Appraisal Foundation, a not-for-profit educational organization dedicated to the advancement of professional valuation, was established by the appraisal profession in the United States in 1987. Since its inception, the Foundation has worked to foster professionalism in appraising by:

Establishing, improving, and promoting the Uniform Standards of Professional Appraisal Practice (USPAP);
Establishing educational and experience qualification criteria for the licensing, certification and recertification of appraisers;
Disseminating information on USPAP and the Appraiser Qualification Criteria to the appraisal profession, state and federal government agencies, users of appraisal services, related industries, and industry groups, and the general public and;
Sponsoring appropriate activities relating to standards, qualifications, and issues of importance to appraisers and users of appraisal services.
A certified residential appraiser, or a certified general appraiser responsible for the direct supervision of one or more registered trainee appraisers and fully responsible for appraisals and appraisal reports prepared by those registered trainee appraisers. The board, by rule, shall determine the responsibilities of a supervisory appraiser, the geographic proximity required, and the maximum number of registered trainee appraisers to be supervised by an individual supervisory appraiser.

Difference between Cost, Price, and Value:

Cost of production is the expenditure of resources necessary to bring the property into existence. It is measured in monetary terms and includes compensation of all factors of production including, but not limited to, land, utilities, improvements, and carrying costs. Price is the amount of money that is actually paid for a property. Value is the amount of money for which an appraiser believes a property will sell. In appraisal, market value is a result of the interaction of supply and demand.

It should be remembered that in an active market, cost, price, and value may be similar, but one does not create the other. For example, a home may cost $200,000 to build, but that does not mean that the market will be willing to pay that price.

Types of Value:

By definition, an APPRAISAL is supported, defended estimate of the value of property rights as of a given date. The “function” of an appraisal is for what it is to be used, while the “purpose” (or objective) of an appraisal is to determine the type of value. The appraiser must always understand the purpose for which the appraisal shall be used. There are several types of value that an appraiser may be trying to ascertain:

1. Investment value is a value that is determined because of individual investor’s requirements.

2. Assessed value is determined by the local property appraiser to establish value for real estate tax purposes.

3. Liquidation value is the amount a property is most likely sell for at a forced or hurried sale (e.g. foreclosure).

4. Salvage value is the amount that part or all of a property’s improvements can be sold at the end of its economic life, taking into consideration the cost of removing those improvements from the land.

5. Insurable value is often estimated for insurance coverage purposes which is based on replacement cost.

PRINCIPALS OF VALUE: There are certain underlying beliefs and principles in which appraisers believe and respect. They include:

1. Principle of Supply and Demand:

Supply is the amount of product that is available. Demand is the number of people who want a particular product. The relationship between supply and demand creates economic value. Factors that affect demand include price, local population, income, mortgage interest rates, and consumer tastes and preferences. Factors that affect supply include the amount of available skilled labor, construction loan interest rates, availability of buildable land, and availability of construction materials.

2. Principle of Anticipation:

Expectation of future income and/or the belief that a property can be sold for a higher price in the future.

3. Principle of Substitution:

The basic premise of appraising is found in the PRINCIPLE OF SUBSTITUTION which states that an informed buyer will pay no more for a property than the cost of acquiring an equally desirable substitute property. This principle is the fundamental philosophy behind the sales comparison approach and cost depreciation methods of appraisals.

4. Principle of Increasing and Decreasing Returns:

Sometimes, an owner spends money to improve his or her property. In the early stages, these improvements can increase the property’s value more than the dollar amount of improvement. On the other hand, sometimes that cost of improvement does not add as much value to the property. Typically this occurs because the improvement is made without considering the economic consequences. A good example of an OVERIMPROVEMENTmight be a swimming pool or adding an extra bathroom.

5. Principle of Conformity:

This principle states that property values will be enhanced if properties in a neighborhood are uniform and consistent with one another. Developers can record restrictive covenants to ensure continued conformity throughout the neighborhood. Architectural review boards are empowered to review construction plans so that future construction is in conformity with the master plan.

6. External economies and diseconomies:

If factors exist outside the boundaries of the subject property that enhance value, those conditions are known as external economies. Conversely, outside factors that decrease the subject property’s value are called external diseconomies.

7. Highest and Best Use as though Vacant:

A property’s highest and best use refers to what type of structure should be on the property to maximize the value of the land. This principle allows an appraiser to value a property as if no structure currently exists and therefore establishes the site’s maximum value.

8. Highest and Best Use as Improved:

This evaluation allows an appraiser to value a property based on its potential best use without the need for substantial reconstruction. This evaluation will help an owner decide whether to continue the building’s current use, remodel the structure, or demolish and build again.

Types of Appraisal Reports

Complete vs. Limited:

Typically, an appraiser will prepare a Complete Report which displays the appraiser’s research, discusses and reviews the mathematical calculations involved in the process, and contains a reconciliation and explanation of how the appraised value was determined, all in accordance with USPAP guidelines. A Limited Report means that the appraiser has invoked the Departure Provision of the USPAP (see “Talk the Talk” page).

Formats:

The type of report provided by the appraiser will vary depending on the needs of the buyer and/or lender. A professional appraisal should be thorough and complete on its face so that referral to other documents or reports is not required. The types of appraisal reports include:

1. Oral Report: Occasionally, a client will request an oral report. Although rare, this type of report will orally provide the necessary data and analysis together with a final conclusion. An appraiser giving expert testimony in a court of law is an example of when an oral report might be requested.

2. Form Report: Mortgage lenders typically require a Form Report which is a standardized form with which most lenders are familiar. A lender can efficiently review the form report since he or she is familiar with its format. Another advantage of the Form Report is that secondary mortgage market entities (such as the Federal National Mortgage Association) usually require the standardized form report as part of the mortgage package to be sold. The form report is the most common type of appraisal format. It is used primarily for residential, vacant land, and small investment property appraisals.

3. Narrative Report: A Narrative Report is a complete explanation of the appraisal that describes in writing the processes used by the appraiser. A professional narrative report will contain all the necessary data and analysis performed so that the reader can follow the methods and reasoning implemented by the appraiser. There are three types of Narrative Reports:

a. The Self-Contained Report gives a complete and detailed report that reviews each issue in detail and fully describes the appraiser’s reasons and analysis. The self-contained report contains all the necessary information and data without the need to refer to other reports or research.

b. The Summary Report includes some, but not all, of the appraiser’s information and reasoning. Essentially, this report summarizes the appraiser’s data gathering and conclusions.

c. The Restricted Report only contains the appraiser’s conclusions without giving any specific details on the data analyzed. Restricted reports are only for the client’s use and review.

SUMMARY

Only licensed appraisers are authorized to appraise real property. Real estate licensees typically perform valuation services, also known as Comparative Market Analysis.
Cost is the actual dollars spent to create a property; Price is the dollars actually paid for the finished product, and Value is a perceived dollar amount that a property is thought to be worth.
The different types of value include investment value, assessed value, liquidation value, salvage value, insurable value, and market value.
The principle of substitution establishes the upper end of a property’s market value. The principle of highest and best use determines for what a property can be used that will cause it to have the largest residual land value. Principle of anticipation creates current value based on the expectation of future benefits.
Highest and best use as though vacant determines residual land value. Highest and best use as improved values a property according to the structure that actually exists. This analysis helps determine the most beneficial use of an existing structure or whether it should be altered in some way.

The steps in the appraisal process include:
1. Define the problem

2. Preliminary analysis

3. Highest and best use analysis

4. Land value estimate

5. Application of the three approaches to value

6. Reconciliation

7. Report of value

The reliability of comparable property sales is weighted differently based upon their similarity to the subject and how recently it sold. The more similar the comp is to the subject and the more recent its sale, the more weight should be given to that comp.
Appraisal reports can be complete or limited. The appraisal reporting formats include oral reports and form reports. The three types of narrative reports include a self-contained, summary, and restricted.

Vocabulary List: appraisal, assessed value, complete appraisal, conformity, demand, federally related transaction, FIRREA, going-concern value, highest and best use, investment value, insurable value, limited appraisal, liquidation value, market value, over improvement, reconciliation, salvage value, substitution, supply, The Appraisal Foundation, USPAP, value in use

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