THE FORMAL APPRAISAL PROCESS

Chapter 3

CHAPTER TERMS AND CONCEPTS

Appraisal process

Appraisal report

Assignment conditions

Client

Contractual conditions

Cost approach

Credible appraisal

Definition of the appraisal

problem

Effective date of value

Exposure time

Extraordinary assumption

Form report

Hypothetical condition

Income approach

Intended use

Intended users

Letter report

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CHAPTER TERMS AND CONCEPTS

Limiting conditions

Market data

Market exposure

Market value

Marketing time

Narrative report

Reconciliation

Restricted Use Appraisal Report

Sales comparison approach

Scope of work

Self-Contained Appraisal Report

Subject property

Summary Appraisal Report

Type of value

Value in exchange

Value in use

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LEARNING OUTCOMES

1. Explain the four steps in the appraisal process.

2. Name the six elements that define the appraisal problem.

3. Define the term scope of work.

4. Explain the difference between value in use and value in exchange.

5. Define the term market value, and explain how it differs from market price.

6. Outline the three approaches to value, and explain how they are used in appraisals.

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THE APPRAISAL PROCESS AND USPAP

The Appraisal Process

Is Defined by USPAP

USPAP must be followed byo Appraisers completing Federally Insured Transactionso Licensed or Certified Appraisers in Mandatory Stateso Most Professional Organizations require compliance with USPAP

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CONFORMITY WITH USPAP REQUIRMENTS

Standard 1

How an appraisal should be developed

Standard 2

How an appraisal should be reported

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FOUR STEPS IN APPRAISAL PROCESS

I. Identify the Appraisal ProblemII. Identify Appropriate Solutions –

The Scope of WorkIII. Execute the Appropriate Scope of WorkIV. Report Findings and Conclusions

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Step 1: Identify the Appraisal Problem

The elements to be identified1. The client and any other intended users

2. The intended use of the appraiser’s opinions and conclusions

3. The type and definition of value

4. The effective date of the appraiser’s opinions and conclusions

5. The Subject of the Assignment and its relevant characteristics

6. Any assignment conditions

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RELEVANT CHARACTERISTICS

Intended use of the appraisal and report What the appraiser finds out about the property, and What is important to the buyers of such property, as

reflected by the market data

Consider:

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1. IDENTIFICATION of the CLIENT

The client engages the appraisero The client defines the other intended users

The client’s name must be in the work fileo Client’s name does not have to be in report

Three key points for intended users:o Decision between client and appraiser at the engagemento Parties that are directly involved in appraisalo Only includes those to whom the appraiser must clearly

communicate the results.

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2. INTENDED USE

Different Users Have Different Needs

Federally Insured Institutions Require USPAP Compliance

Type of Report

Self Contained

Summary

Restricted Use Report

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3. TYPE & DEFINITION OF VALUE

Opinion of Market Value Most common type Must be agreed on at the beginning of

assignment Requires an estimate of Exposure Time.o time to sell prior to effective date

Client may wish to have a marketing timeo time to sell after the effective date

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4. EFFECTIVE DATE OF APPRAISAL

Must be Agreed on by the Appraiser and Client at the start.

Three Possible Dates 1. The effective date of value2. The date of inspection3. The date of the report

Date of Value May Be:o Retrospective – In pasto Prospective – In futureo Current

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5. THE SUBJECT’S RELEVANT CHARACTERISTICS

Identification of Subject Address Legal Description Tax I.D. Number Map reference Survey Property sketch Photographs Personal property identified Property rights appraisedo Fee simpleo Leased feeo Other Partial Interests

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6. ASSIGNMENT CONDITIONS

1.USPAP2.Supplemental Standards3.Jurisdictional Exceptions4.Extraordinary Assumptions5.Hypothetical Conditions6.Regular Assumptions and Conditions7.Contractual Conditions

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STEP 2: IDENTIFY APPROPRIATE SOLUTIONS

1.Defining the Scope of Work The extent of identification of the property The extent of property inspection The type and extent of data researched, and The type and extent of analysis employed to

reach a conclusion.

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EXTENT OF IDENTIFICATION

How much Identification of a Property is Necessary?

Legal Descriptions

Address

Tax ID numbers

Ground and Aerial Photographs

Property Rights?

Fee Simple

Leased Fee

Leasehold

Other

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EXTENT OF PROPERTY INSPECTION

How Extensive the Viewing of the Subject Property?

Interior and exterior viewing? Drive-by appraisal? Desktop appraisal?

Appraisal must be Credible Appraiser must have adequate information from

other sources for a drive by or desktop appraisal Appraisers view a property Home Inspectors Inspect

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TYPE & EXTENT OF DATA RESEARCHED

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STEP 3. EXECUTE SCOPE OF WORK

1.The Sales Comparison Approach to Value2.The Cost Approach to Value3.The Income Approach to Value

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STEP 4. REPORT FINDINGS & CONCLUSIONS

1.Three Types of Written Reports

a.Self-Contained Appraisal Report• The report describes the material and analyzes to

solve the problem

b.The Summary Appraisal Report• The report summarizes the material and analyzes to

solve the problem

c.The Restricted Use Report• States the answer to the problem

d.With the Minimum required content

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FORMATS OF APPRAISAL REPORTS

1. Letter Report• Word Processed

2. The Form Report• Generated by appraisal software

3. The Narrative Report• Generated on narrative report generating

software and/or word processed

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TYPES OF VALUE

• Assessed value

• Book Value

• Capitalized value

• Cash value

• Depreciated value

• Economic value

• Exchange value

• Face value

• Fair value

• Going concern value

• Inheritance tax value

• Insurance value

Leased value

Liquidation value

Listing value

Loan value

Market value

Nuisance value

Potential value

Rental value

Salvage value

Use Value

Value in foreclosure

Value in place

Each type of value needs its own definition

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VALUE IN USE VS. VALUE IN EXCHANGE

Value in Use• Value of an item or object to a particular

user

• Value in Exchange• Value of a thing to people in general

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DEFINING MARKET VALUE

Market Value What a property should normally sell for, assuming

a willing buyer and a willing seller.

Market Value for Federally-Related R.E. Transactions

….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, knowledgeably, and assuming the price is not affected by undue stimulus.

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CRITERIA FOR MARKET VALUE

Conditions

1.Typical Motivation2. Informed Parties3.Market Exposure4.Terms of Sale5.No Sales Concessions

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PRICE VS. VALUE

1.Factors Influencing Price as Distinguished from Value:

a.Unusual financingb.Distress salec.Forced purchased.Uninformed partiese.Misrepresentation of facts

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CLASSICAL APPROACHES TO VALUE

1.The Sales Comparison Approach to Value

2.The Cost Approach to Value

3.The Income Approach to Value

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STEPS for SALES COMPARISON APPROACH

1. Investigate Comparable Sales2.Compare Sales to Subject Property3.Adjust for Differences4.Arrive at Value for Subject

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STEPS IN THE COST APPROACH

1.Estimate Land Value as if Vacant2.Estimate the Cost to Build the Existing

Structure3.Estimate the Amount of Accrued

Depreciation, or Loss in Value4.Subtract Accrued Depreciation5.Add Land Value to the Depreciated Cost of

Improvements

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Example of Cost Approach

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Steps in the Income Approach

1.Estimate Market Rent and Potential Gross Income

2.Estimate Annual Vacancy and Collection Loss

3.Subtract to Arrive at Effective Gross income

4.Subtract Annual Operating Expenses from Effective Gross to Arrive at the Net Operating Income

5.Decide on Capitalization Method and Rate

6.Capitalize Net Income into an Estimate (Opinion) of Value

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EXAMPLE OF INCOME APPROACH

The appraiser selected the direct capitalization method and a 10% capitalization rate, based on the market rate analyzed.

SUMMARY

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The steps in the appraisal process are to:

1. Identify the appraisal problem to be solved2. Identify appropriate solutions3. Execute the appropriate scope of work4. Report the findings and conclusions reached

SUMMARY

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The six elements of defining the appraisal problem are:

1. The client and any other intended users2. The intended use of the appraisal and report3. The type and definition of value4. The effective date of the appraiser’s opinions and

conclusions5. The subject of the assignment and its characteristics6. Any assignment conditions

SUMMARY

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The scope of work includes four issues:

1. The extent of property identification2. The extent of property inspection3. The type of data researched and the extent of research4. The types and extent of data analyses used

SUMMARY

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Three approaches are used for valuing real estate: Sales Comparison / Cost / Income

1. The sales comparison approach is often the most reliable.2. The cost approach estimates the value of a property by adding

its land value to the estimated cost to replace the existing structures less depreciation.

3. The income approach compares the income-producing capability of the property with that of properties that have been sold.