What is an Appraisal?
The appraisal process is the procedure used to determine if the purchase
price is realistic in today's market. The process of determining the current market value of the property is
paramount to the successful security of the investment in real estate. Prudent investors rely on unbiased
professional valuation experts in making real estate investment decisions.
An appraisal is defined as "the act or process of estimating value". Real
estate appraisal involves performing sufficient market research that is professionally analyzed to determine the
market value of the property as it relates to other competing properties in the market place. Real Estate
Appraisers must be proficient in performing; research into appropriate market areas; assembling pertinent data,
using appropriate analytical techniques; through the application of sufficient knowledge, experience and
Therefore, an appraisal is an educated, adequately researched, market driven
opinion of value. Its reliability is dependant on the appraiser's knowledge, experience and integrity as a member
of the profession. Other than education and experience; integrity plays a major role in the reliability of the value estimate. Integrity is the cornerstone
on which appraisals stand in the market place. Appraisals are only as good as the integrity of the data,
analysis and the person preparing the value estimate. It is important to note that the property may sell for
something other than the appraised value. This can be precipitated by seller or buyer motivation or unusual
circumstances outside of the normal market. The appraiser will generally provide a value indicated by typical
market characteristics for that type of property as of the date of valuation.
Appraisers are not all cut from the same cloth. They come in all sizes,
shapes, education, experience and integrity. All appraisers must be licensed by the state in which they earn their
living. They can also be licensed in more than one state. Licensing levels vary slightly from one state
to another. The top two levels in all states are Certified Residential and Certified General. Certified General is
the top classification; this level of licensing requires the most knowledge and experience; and allows the
appraiser to appraise all types of real estate. The Residential level allows the appraiser to appraise only
residential type properties from one-four families. Appraisers are always required to provide their unbiased
opinion of value. All appraisals are required to conform to the Uniform Standards of Professional Appraisal
Practice (USPAP). These standards were designed to provide a way to increase the reporting integrity of the
written appraisal. As a way of keeping appraisers up to date on the latest rules, regulations and techniques;
states require ongoing education for appraisers on an annual or semi-annual basis. Renewal of licenses
depends on completing the required hours of classroom education in the specified time.
Definition of Market Value
The most widely accepted definition of Market Value is as follows: 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 and 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:
Buyer and seller are typically motivated
Both parties are well informed or well advised, and acting in what
they consider their own best interest
A reasonable time is allowed for exposure in the open
Payment is made in terms of cash or in terms of financial
arrangements comparable thereto; and
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
Adjustments to the comparables must be made for special or creative
financing or sales concessions. No adjustments are necessary for those costs that are normally paid by sellers
as a result of tradition or law in a market area. These costs are readily identifiable since the seller pays
these costs in virtually all sales transactions. Special or creative financing adjustments can be made to the
comparable property by comparisons to financing terms offered by a third party institutional lender that is not
already involved in the property or transaction. Any adjustment should not be calculated on a mechanical dollar
for dollar cost of the financing or concession, but the dollar amount of any adjustment should approximate the
market's reaction to the financing or concessions based on the appraiser's judgment.
Market Value "as is" means an estimate of the market value of a property in
the condition observed during the inspection and as it physically and legally exists without hypothetical
conditions, assumptions, or qualifications as of the date the appraisal.
"Prospective or future value when completed" means the prospective future
value of a property on the date that construction is completed based upon market conditions forecast to exist as
of the anticipated date of completion, assuming completion is not delayed.
"Prospective future value upon reaching stabilized occupancy" means the
prospective future value of a property at a point in time when all improvements have been physically constructed
and the property has been leased to its optimum level of long term occupancy.
Highest and Best Use
The reasonable and probable use that supports the highest present value of
vacant land or improved property, as defined, as of the date of appraisal.
The reasonably probable and legal use of land or sites as though vacant,
found to be physically possible, appropriately supported, financially feasible, and that results in the highest
present land value.
Ultimately, the most profitable use is the highest and best use.
The actual inspection begins not on the property, but in the office.
Before the appraiser visits the property, he or she will generally research the tax records in the assessor's
office, obtain a copy of the deed for the present ownership, a copy of the recorded survey, obtain a copy of the
zoning map and zoning ordinance and a copy of the applicable flood map and flood designation for the subject
property. Once this information has been obtained, he or she will inspect the subject property. The
inspection will involve measuring the buildings, while paying particular attention to the different sections of the
building. This is necessary to determine the square footage of those areas that cost more or less to build based on
there level of finish. During the measurement process it is important to determine setbacks from property lines and
the street. This information is used to help determine whether the subject property is a conforming use under the
present zoning ordinance. The property lines are located and any easements or encroachments are observed to
determine their affect on the property. The yard or lot improvements are observed and recorded as to type, quantity
and condition. A detailed exterior inspection of the building is necessary to determine the type of construction
and level of structural & physical integrity of the roof, walls, siding, entrance doors, windows, gutters,
screens and foundation. The next step is the interior inspection. This is generally where the greatest amount of
depreciation is evident in buildings. Particular attention is given to evidence of roof leaks, floor covering
condition, wall surfaces, plumbing, heating, air conditioning, kitchen and bathroom facilities, closet space, floor
layout, settlement, lighting and decorating.
The appraiser is looking for items of accrued depreciation during the
inspection. There are three types of accrued depreciation: Physical Deterioration, Functional Obsolescence and
Physical deterioration is the wearing away of the building over its economic
life. All sources of depreciation that relate to the actual physical characteristics fall into this category; such
as, roof condition, painting, papering, floor condition, wall condition, structural condition, plumbing condition,
electrical condition, heating & air conditioning condition. Therefore, anything related to the condition of the
property is considered Physical Deterioration.
Functional Obsolescence has to do with the level of functional utility or
inutility found during the inspection. Functional inutility depreciates the value of the building from such things
as; inadequate closet space, access through one room to another, low ceilings, inadequate plumbing, inadequate heat
or air conditioning, inadequate lighting, inadequate kitchen facilities, inadequate electrical service, inadequate
bathroom facilities. This category relates to any observed inadequacies of the functionality of the property.
Included are functional inadequacies created setbacks, elevation above or below grade, vehicle access, vehicle
storage and design.
Economic Obsolescence relates to any outside the property influences on
value. Economic Obsolescence is also know as external obsolescence. Therefore, any adverse external factors outside
the subject property must be considered in the appraisal process. These can be from sight, sound, vibration and
smell. They can also be from physical and mental sources caused by neighborhood problems. They can also be from
abutting property uses that are uncharacteristic in the market. Most external factors affecting the entire subject
neighborhood are characteristic through out the neighborhood market and all properties are similarly affected. In
the comparison of sales data, those items that are only characteristic of the subject must be taken into
consideration in the value estimate. The proximity of the subject to outside undesirable influences can be caused
by what is known as progression or regression. These two terms denote a positive or regressive affect on the value
of the subject caused by its location among higher or lower priced homes in the neighborhood. Therefore, the best
investment is usually to acquire the lowest priced property in the neighborhood, because it has the best upside
There are three generally accepted methods of valuing real estate; namely,
the Cost Approach, the Income Approach, and the Sales Comparison Approach.
The Cost Approach values the building and site improvements
according to their depreciated replacement and/or reproduction costs, and adds these costs to the estimated land
value to arrive at an indicated value of the total property. This method is most applicable on newer
improvement, that suffer from limited amounts of accrued depreciation. As the level of depreciation increases
this method becomes less reliable as an indication of value. Therefore, the cost approach has limited usefulness
as a valuation tool on older buildings.
The Income Approach is a method of capitalizing a stabilized net
income stream into an indication of value. This method of valuation inherently requires that the property being
valued have the capability of producing a net income flow, that there is an anticipated benefit to ownership of
the income flow, and that there is a market for the transfer of the property. Of particular concern is not only
the quantity of income flow but also the quality and durability of the income flow as well as the expenses
associated with receiving those income flows. In cases where a stabilized net income flow is not expected, a
discounting method can be utilized to convert fluctuating income flows to a present value estimate. Both of
these methods, the Direct Capitalization Method, in the case of stabilized net income flows, or the Discounted
Cash Flow Method, in the case of fluctuating income flows, reduces to a present value the anticipated future
benefits associated with the ownership of the property producing the income flows. The income approach generally
provides the most reliable indication of value of income producing properties.
The Direct Sales Comparison Approach is a valuation method
utilizing sales of properties similar to the subject and adjusting the sales for the varying degrees of
comparability. This adjustment process produces various indicated values which the appraiser correlates into a
single value estimate. This method of valuation is particularly useful when the real estate market is quite
active and a significant number of recent transfers of sufficiently comparable properties to the subject have
occurred. The sale comparison approach is most applicable on older properties, where there is limited supporting
evidence of market rental data comparable to the subject or when the subject is not income producing.
Reconciliation & Final Estimate
Reconciliation is the process used to develop the final value estimate from
the analysis performed in the three approaches list above. Generally, the appraiser will arrive at a value for the
subject using all three approaches. The three values must then be resolved into one final value estimate.
Typically, the most weight is accorded the approach supported by the most reliable data. Each approach is accorded
its relevant weight. From this analysis a final estimate for the property is extracted for the subject