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Related to Appraisals: Real Estate Appraisals
appraisalsee PERFORMANCE APPRAISAL.
The process of developing an opinion about a property's value. That opinion is supposed to reflect what a willing buyer would pay a willing seller after reasonable exposure to the marketplace,with neither buyer nor seller operating under any sort of duress or pressure.An appraisal is generally required when property is financed,and should be required before a real estate agent attempts to market anything significantly different from properties commonly and frequently sold in the marketplace.It may not be necessary to obtain an appraisal of a four-bedroom ranch house in a good school zone, but some assistance may be needed in arriving at a price to market an 11,000 square foot ski-lodge-type home in a small town.
• There are three common approaches to estimating the fair market value of a property. They are comparison, cost, and income.
• The comparison approach to appraisal seeks to obtain information about recent sales of comparable properties. It would be highly unlikely for the properties to be identical, so the appraiser will make adjustments in the sale price of the other comparable properties— called comps for short—in order to calculate what the sale price might have been if it were identical to the subject property. For example, if the subject property had no garage, but the comp had a two-car garage, the appraiser might subtract $50,000 from the sale price of the comp. The appraiser might then add $30,000 because the subject property has a finished attic providing more livable square footage, and another $15,000 because the subject property is brick while the comp is wood frame needing new paint. A residential appraiser will typically use three comps, commercial appraisers will employ more because it's generally difficult to find truly comparable properties, resulting in a large number of adjustments. The more adjustments, the more likely error will creep into the calculations. At the end of the process, the appraiser will have a value based on the comparison approach.
• Cost approach. This approach uses an estimate of the reproduction or replacement cost of the improvements, less depreciation, plus land value. The reproduction cost is the amount necessary to build exactly the same building. Replacement costs are those necessary to build an improvement with substantially the same usefulness using today's materials and techniques, but not necessarily the same exact characteristics.
• Income approach. This approach assumes that the value of the real estate is directly related to the value of the income generated by that real estate, such as shopping centers, apartments, and office buildings. The appraiser will calculate a net operating income (NOI) for the property by taking all possible income over the course of a year, and then subtracting operating expenses, insurance, real estate taxes, reserves for bad debts, a certain percentage for anticipated vacancies, and sometimes a certain dollar amount for the value of the owner's management and supervision. The bottom line number, the NOI, is then capitalized by dividing it by a certain percentage. That percentage rate is supposed to reflect the return an investor would expect on his or her money taking into consideration all the variables associated with the property. Variables could include the strength of the tenants, the likelihood of default, the remaining term on the leases, the prospect of future rent increases built into the leases, the likelihood of lease renewals at the expiration of current terms, the cost of financing to purchase the property, the availability of other investment sources and their rates of return, and other such factors. If a property had an NOI of $100,000 and a capitalization rate (cap rate for short) of 10 percent, then you divide $100,000 by 0.1 and arrive at a value of $1,000,000. Increasing the cap rate to 11 percent decreases the value to $909,090. Decreasing the cap rate to 9 percent increases the value to $1,111,111.
• Integration. Sometimes the appraiser will have to employ several methods in order to account for different aspects of the property. An income-producing property might include additional acreage for future development. The appraiser would value the current improvements using the income approach, and the surplus or excess land using the comparable approach.
• Reconciliation. At the end of the analysis, the appraiser will take all methods employed, as appropriate to the property, and reconcile the differing values into one value. This will then be the appraised value of the property.
A written estimate of a property's current market value pre- pared by an appraiser.