What is a Real Estate Appraisal?
A Real Estate Appraisal, Property Valuation or Land Valuation is the process of valuing real property (usually market value). Real estate transactions require appraisals because they occur infrequently and every property is unique (especially their location, a key factor in valuation).
Appraisal reports generally form the basis for mortgage loans, settling estates and divorces, taxation, expropriation and awards in litigation.
For valuations of improved residential properties, appraisals are generally reported on a standardized form. Appraisals of more complex properties (e.g., income-producing, raw land) are usually reported in a formal narrative appraisal report.
There are several types and definitions of value that can be sought by a real estate appraisal. Some of the most common are:
Market Value – International Valuation Standards (IVS) define: the estimated amount for which an asset or liability should exchange on the valuation date between a willing buyer and a willing seller in an arm's length transaction, after proper marketing and where the parties had each acted knowledgeably, prudently and without compulsion.
Value-in-use, or use value – The net present value of a cash flow that an asset generates for a specific owner under a specific use. Value-in-use is the value to one particular user, and may be above or below the market value of a property.
Investment Value – is the value to one particular investor, and may or may not be higher than the market value of a property. Differences between the investment value of an asset and its market value provide the motivation for buyers or sellers to enter the marketplace.
Insurable value – is the value of real property covered by an insurance policy. Generally it does not include the site value.
Liquidation value – may be analyzed as either a forced liquidation or an orderly liquidation and is a commonly sought standard of value in bankruptcy or foreclosure proceedings. It assumes a seller who is compelled to sell after an exposure period which is less than the market-normal time-frame.
Appraisers utilize three traditional groups of methodologies for determining value. These are usually referred to as the "three approaches to value" which are generally independent of each other. One or two of these approaches will usually be most applicable, with the other approach or approaches usually being less useful. The appraiser has to think about the "scope of work", the type of value, the property itself, and the quality and quantity of data available for each approach. No overarching statement can be made that one approach or another is always better than one of the other approaches.
The Cost Approach:
The theory is that the value of a property can be estimated by summing the land value and the depreciated value of any improvements.
In practice, appraisers almost always use replacement cost (replacement cost refers to the cost of building a house or other improvement which has the same utility, but using modern design, workmanship and materials) and then deduct accrued depreciation from any form including physical, functional and external sources. An exception to the general rule of using the replacement cost, is for some insurance value appraisals. In those cases, reproduction of the exact asset after a destructive event like a fire is the goal.
The Sales Comparison Approach:
The sales comparison approach is based primarily on the principle of substitution. This approach assumes a prudent (or rational) individual will pay no more for a property than it would cost to purchase a comparable substitute property. The approach recognizes that a typical buyer will compare asking prices and seek to purchase the property that meets his or her wants and needs for the lowest cost. In developing the sales comparison approach, the appraiser attempts to interpret and measure the actions of parties involved in the marketplace, including buyers, sellers, and investors.
Steps in the sales comparison approach:
• Research the market to obtain information pertaining to sales, and pending sales that are similar to the subject property
• Investigate the market data to determine whether they are factually correct and accurate
• Determine relevant units of comparison (e.g., sales price per square foot), and develop a comparative analysis for each
• Compare the subject and comparable sales according to the elements of comparison and adjust as appropriate
• Reconcile the multiple value indications that result from the adjustment (upward or downward) of the comparable sales into a single value indication
The income capitalization approach:
The income capitalization approach (often referred to simply as the "income approach") is used to value commercial and investment properties. Because it is intended to directly reflect or model the expectations and behaviors of typical market participants, this approach is generally considered the most applicable valuation technique for income-producing properties, where sufficient market data exists.
In a commercial income-producing property this approach capitalizes an income stream into a value indication. This can be done using revenue multipliers or capitalization rates applied to a Net Operating Income (NOI). Usually, an NOI has been stabilized so as not to place too much weight on a very recent event. An example of this is an unleased building which, technically, has no NOI. A stabilized NOI would assume that the building is leased at a normal rate, and to usual occupancy levels. The Net Operating Income (NOI) is gross potential income (GPI), less vacancy and collection loss (= Effective Gross Income) less operating expenses (but excluding debt service, income taxes, and/or depreciation charges applied by accountants).
In order to provide a higher level of professionalism, the Canadian National Association of Real Estate Appraisers (CNAREA) maintains an active role with the Appraisal Foundation located in Washington DC, USA, and sits on the Appraisal Foundation Advisory Council (TAFAC). All members of the Canadian National Association of Real Estate Appraisers must abide by the Uniform Standards of Professional Appraisal Practice (USPAP) as promulgated by the Appraisal Standards Board of the Appraisal Foundation. These standards are the international benchmark of the appraisal profession.
Any Designated Member, or any Candidate Member of the Canadian National Association of Real Estate Appraisers, agrees to abide by the Code of Ethics as promulgated by the Association (CNAREA Bylaws Article 5). In brief summary: The appraiser must perform competently with impartiality, objectivity, independence, and without accommodation of personal interests. The appraiser must not accept assignments which are beyond their knowledge, experience, or professional competence. The appraiser is bound to protect the confidential nature of the appraiser client relationship. The appraiser is obliged to maintain the highest standards of professional conduct with clients, colleagues, and their community