An appraisal is a thought process leading to an opinion of value. This opinion or estimate is arrived at through a formal process that typically uses the three “common approaches to value”. They are the Cost Approach – which is what it would cost to replace the improvements, less physical deterioration and other factors, plus the land value. There is the Sales Comparison Approach – which involves making a comparison to other similar, nearby properties which have recently sold. The Sales Comparison Approach is normally the most accurate and best indicator of value for a residential property. The third approach is the Income Approach, which is of most importance in appraising income producing properties – it involves estimating what an investor would pay based on the income produced by the property.
Market Value is the estimated amount for which a property should exchange on the date of valuation between a willing buyer and a willing seller in arms-length transaction after proper marketing wherein the parties had each acted knowledgeably, prudently, and without compulsion.
Because much private, corporate, and public wealth lies in real estate, the determination of its value is essential to the economic well-being of society. It is the job of the professional appraiser to determine these values by gathering, analyzing, and applying information pertinent to a property.
Unquestionably, the professional opinion of the appraiser, backed by extensive training and knowledge, influences the decisions of people who own, manage, sell, purchase, invest in, and lend money on the security of real estate. And because the appraiser is trained to be an impartial third party in the lending process, this professional serves as a vital “check in the system,” protecting real estate buyers from overpaying for property as well as lenders from over lending to buyers.
What rules must appraisers follow? – Uniform Standards of Profesional Appraisal Practice
Appraisal Standards Board (ASB)
The ASB sets forth the rules for developing an appraisal and reporting its results. In addition, it promotes the use, understanding and enforcement of the Uniform Standards of Professional Appraisal Practice (USPAP).
FIRREA requires that real estate appraisals used in conjunction with federally-related transactions be performed in accordance with USPAP. More than 80,000 state certified and licensed appraisers are currently required to adhere to USPAP. USPAP contains the recognized standards of practice for real estate, personal property and business appraisal.
The authority of USPAP extends beyond FIRREA. Since 1992, the Office of Management and Budget (OMB) has required federal land acquisition and direct lending agencies to use appraisals in conformance with USPAP.
The cost approach combines an estimate of land value with an estimate of depreciated reproduction or replacement cost of the improvements. The principle of substitution is the basis of the cost approach, in that no rational person will pay more for a property than the amount for which he can obtain, by purchase of a site and construction of a building, with undue delay, a property of equal desirability and utility.
Market value or fair market value is the most probable price that a property should bring (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 market or direct sales comparison approach to an estimate of value is a process of comparing market data, that is, prices paid for similar properties, prices asked by owners, and offers made by prospective purchasers or tenants willing to buy or lease. Typically a comparison grid is used and adjustments are made to each of the comparable sales used for major differences between the comparable and the subject property for such items as location, gross living or building area, lot size, condition/effective age, market conditions, degree of remodeling, construction quality and significant amenities, ie: fireplace, jacuzzi, in ground pool, garage, deck, patio, porch and central air conditioning etc. In the market approach, the appraiser attempts to both gauge and reflect the anticipated reaction by a typical purchaser to the subject property.
The appraisal process is an orderly and concise method of reaching an estimate of value. The process has six major steps which include: definition of the problem, preliminary survey and appraisal plan, data collection and analysis, application of the three approaches to value, reconciliations of value indications, final estimate of defined value. This process assists the appraiser in reaching a sound conclusion. The major phase of this process involves the application of the three approaches to value which include the Market Data Approach, the Cost Approach and Income Approach. The three approaches are reconciled and the value via most applicable approach, in the opinion of the appraiser, is selected as the final estimate of value. In most residential appraisals, particulary those of single or two family dwellings, the direct sales comparison or market approach best reflects the actions of buyers and sellers and is the most convincing and defendable approach to value.
Typically, an appraiser needs to document the condition of the property, both inside and out, from the layout and features to degree of modernization including any updates as well as the overall quality of construction. This information will help to assist the appraiser throughout the valuation and comparison process.
The appraiser estimates the square footage (GLA – gross living area), by measuring the exterior of the home. Non-living areas, such as garages or covered porches, aren’t included in GLA, but are accounted for and considered in value seperately. Finished basements are also calculated separately from the above-ground GLA. The local market will dictate the contributory value of the finished basement, which can be influenced by governmental regulations, the degree of modernization, the quality of the finish, and other factors.
The appraiser will generally consider only permanent fixtures and real property. Because many above-ground swimming pools and small sheds are not permanent structures, they typically usually aren’t included in the valuation. Depending on the specific installation process and local custom, however, an above ground pool or small shed might be considered part of the real property.
The physical inspection of the real property being appraised can take from approximately fifteen minutes to several hours, depending upon the size and comlexity involved.
After the initial inspection of the property the appraiser spends time touring through the neighborhood or area. The purpose of this tour is to search for comparable sales (other properties that are similar to the property being appraised) that have sold within the last six months to a year or so. When the field work is finished, the appraiser completes the report at his office. The report can consist of a short form report (typically under ten pages) to a long narrative report which can sometimes exceed a hundred pages. A short form report usually takes between three to six hours to complete. A narrative report can take weeks or sometimes even months, depending upon the complexity of the assignment.