INTRODUCTION
Real estate appraisal, property valuation or land evaluation: This is the
process of valuing real property. The value usually expected is the property's
market value.
Apart from corporate stock, real estate transactions which occur very
infrequent, the essence of property valuation is that every property is
different from the other.
And a centralized Walrasian auction setting can’t exist for the trading of
property assets, such as the ones that exist to trade corporate stock (i.e. a
stock market/exchange).
This product differentiation and lack of frequent trading, unlike stocks, etc.
which means that specialist qualified appraisers are needed to advise on the
value of a property.
The appraisers usually provides a written report on this value to his or her
client. These reports are used as the basis for mortgage loans, for settling
estates and divorces, for tax matters and so on. Sometimes the appraisal is
used by both parties to set the sale price of the property appraised.
Types of value
•
Market value – The estimated amount for which an asset or liability
should exchange on the valuation date between a willing buyer and a willing
seller in 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 (NPV) 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 the property.
•
Investment value – is the value to one particular investor, and 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.
It can also be defined as the value of an asset to the owner or a prospective
owner for individual investment or operational objectives.
•
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
proceedings. It assumes a seller who is compelled to sell after an exposure
period which is less than the market-normal time-frame.
Price
versus Value
There can be differences between what the property is really worth (Market
Value) and what it cost to buy it (Price). A price paid might not represent
that property's market value. Sometimes, special considerations may have been
present, such as
•
special relationship between the buyer and the seller where one party had
control or significant influence over the other party.
•
the transaction may have been just one of several properties sold or
traded between two parties.
•
the price paid for any particular piece is not its market 'value' (with
the idea usually being, though, that all the pieces and prices add up to market
value of all the parts) but rather it's market 'price'.
For example, this can occur when a merger or acquisition happens at a price
which is higher than the value represented by the price of the underlying
stock.
The usual explanation for these types of mergers and acquisitions is that 'the
sum is greater than its parts', since full ownership of a company provides full
control of it. This is something that purchasers will sometimes pay a high
price for. This situation can happen in real estate purchases too.
•
But the most common reason why the value can be different than the price
paid, is that one of the two parties (buyer or the seller) is uninformed as to
what a property's market value is, but nevertheless agrees to buy or sell it at
a certain price which is too expensive, or too cheap.
This is unfortunate for one of the two parties. It is the obligation of a Real
Property Appraiser to estimate the true 'market value' of specific real
property and not its 'market price'.
Three
approaches to value
There are three general groups of methodologies for determining value.
These are usually referred to as the "three approaches to value"
which are generally independent of each other:
•
The cost approach
•
The sales comparison approach and
•
The income approach
The cost
approach
It was formerly called the summation 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. The value of the improvements is often referred to by the
abbreviation RCNLD (reproduction cost new less depreciation or replacement cost
new less depreciation). Reproduction refers to reproducing an exact replica.
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.
In practice, appraisers almost always use replacement cost and then deduct a
factor for any functional dis-utility associated with the age of the subject
property. 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 the destructive event (fire, etc.) is the goal.
The sales
comparison approach
The sales comparison approach in a real estate appraisal is based primarily on
the principle of substitution.
This approach assumes a prudent 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
Data
collection methods and valuation process
Data are collected on recent sales of properties similar to the subject being
valued, called comparables. Sources of comparable data include real estate
publications, public records, buyers, sellers, real estate brokers and/or
agents, appraisers, and so on.
Important details of each comparable sale are described in the appraisal
report. Since comparable sales aren't identical to the subject property,
adjustments may be made for date of sale, location, style, amenities, square
footage, site size, etc.
Steps in
the sales comparison approach
•
Research the market to obtain information pertaining to sales, listings,
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.
•
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
of the comparable sales into a single value indication.
The
income capitalization approach
This is often referred to simply as the “income approach”. It 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).
Alternatively, multiple years of net operating income can be valued by a
discounted cash flow analysis (DCF) model. The DCF model is widely used to
value larger and more expensive income-producing properties, such as large
office towers or major shopping centres.
CONCLUSION
In lieu of the fore-going dynamic market strategies, it is immensely important
to seek the advise of a professional appraiser, in every transaction that has
to do with property acquisitions etc.
For instance, if you wants to acquire a parcel of land or any property,
they should include the services of a professional appraiser like an estate
manager to assist, and to ensure a fair deal.
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REAL ESTATE APPRAISAL
