Real Estate Appraiser Guidelines - Part 5i - 7/28/2007 - Expert Real Estate Advice

Real Estate Appraiser Guidelines - Part 5

THE APPRAISAL PROCESS AND METHODS 

Over time, well defined ground rules have been developed by professional appraisers to arrive at an estimate of value. This orderly, systematic procedure is known as the appraisal process. Not every step is used every time or necessarily in the same order. However, this comprehensive check list for the appraisal process should serve to give a better understanding of the importance of properly evaluating the various elements that influence market value and market price. 
 
Overview of the Appraisal Process 
As governed by Standard 1 of USPAP, the orderly steps and considerations of the appraisal process are designed to answer two questions: 

> What is highest and best use?
and 
> What is this use worth? 
 
To reach a legitimate conclusion: 

A. Define the problem. 
1. Identification of the property to be evaluated. 
a. Complete mailing address (including city and state). 
b Complete legal description (by lot, block and tract number, including county where recorded; by metes and bounds descriptions; or by the government survey system). 
2. Description of use of property to be appraised. 
a. Vacant lot. 
b. Single-family residential. 
c. Multi-family residential. 
d. Special purpose (commercial, etc.) 
3. Interests to be appraised. 
a. Which of the bundle of rights are to be evaluated? Rights affect value because they set the limits within which the property may be used. 
b. An appraisal estimates the value of the rights of ownership, not merely the physical land and its improvements. 
c. The extent of the research and the valuation opinion will vary depending upon which of the following rights are involved: 
(1) Fee Simple (complete ownership). (2) Easement across property. (3) Lessor’s or lessee’s interest. (4) Mineral Rights. (5) Miscellaneous interests.
4. Purpose and intended use of the valuation determine the types of information to be gathered and processed, such as: 
a. Fair value for sale of a home. 
b. Value for mortgage loan purposes.
c. Value for insurance purposes. 
d. Value for condemnation proceedings.
e. Miscellaneous purposes and functions. 
5. Date of value is generally the date of the last inspection of the property, although it may be any time in the past. Prospective values may be rendered, such as for proposed developments where “future sales” are projected and discounted to present value. 
 
B. Make a preliminary survey of neighborhood, site and data required for appraisal. 
1. Make a preliminary estimate of the highest and best use of the subject property. 
a. Analysis of the site and improvements. Is it a proper improvement? Does the improvement meet the test? Take inventory of important site utilities and building construction features. 
b. Analysis of the neighborhood. What are the boundaries and what services are available? 
2. The type of property determines the variety of specific data needed. 
a. For a single-family home, emphasis will be placed on data concerning similar lots and improvements. 
b. For a four-plex, emphasis will be placed on data concerning small multi­family units. 
3. A definite plan facilitates the gathering of necessary data as indicated from the preliminary survey. 
 
C. Collect other general and specific data. The value of a property is affected by demand and by purchasing power available. Data should be obtained on population trends, income levels, and employment opportunities. A number of sources should be investigated. 
1. General data are obtained from government publications, newspapers and magazines. 
2. Regional data (metropolitan area) are obtained from monthly bank summaries, regional planning commissions, and government agencies. 
3. Community data (city) are obtained from the Chamber of Commerce, planning commission, city government, banks and savings and loan associations, and real estate boards. 
4. Neighborhood data, obtained from personal inspection, real estate practitioners and builders active in the area, include: 
a. Age and appearance of the neighborhood. 
b. Hazards and adverse influences. 
c. Percentage build-out. 
d. Contemplated development. 
e. Proximity to schools, business, recreation, etc. 
5. Obtain comparable market data, such as sales and listing prices, from: 
a. Assessor’s records and county recorder’s office.
b. Title insurance and trust companies. 
c. Real estate boards and local real estate offices. 
d. Property owners in the neighborhood. 
e. Appraiser’s/other appraisers’ data bases.
6. Collect and analyze data regarding the subject property’s improvements from: 
a. Assessor’s office for age and other non-confidential information.
b. City building department. 
c. Contractors in area. 
d. Personal inspection of improvements. 
 
D. Analyze the data to conclude what is the highest and best use and the estimated worth of this use. As discussed later in this chapter, the following are the three approaches to value which will be used: 
1. Sales Comparison Approach, formerly known as the Market Data Approach. Study of value as indicated by the prices of recent sales and reliable listings of properties similar to the appraised property. 
2. Cost Approach. Study of value by adding the value of the land, if vacant, to the cost new, less accrued depreciation, of improvements 
3. Income Approach. Study of value of the property as an income stream as it would be sold in the open market. 
 
E. Make final estimate of defined value and write the report. The form and extent of the report will depend upon the purpose, type of property, and request of the client. 
 
The Departure Provision 
The Departure Provision sets forth the portions of the USPAP Standards that can be left out or departed from in the appraisal process. Care must always be given in departing from the full appraisal process, since the analysis not undertaken may have a material impact on the final value conclusion. In addition to Standard 1 and the Departure Provision, there is Statement 7 and Advisory Opinions 11, 12, 13 and 15 which provide additional valuable guidance in developing a proper appraisal process. These can all be found in the current edition of USPAP. 
 
METHODS OF APPRAISING PROPERTIES 
There are three approaches to consider in making a market value estimate. These approaches are: 

> Sales comparison approach. Recent sales and listings of similar type properties in the area are analyzed to form an opinion of value. 
 
> Cost approach. This approach considers the value of the land, assumed vacant, added to the depreciated cost new of the improvements. This is considered a substitute or alternative to buying an existing house. 
 
> Income approach. The estimated potential net income of real property is capitalized into value by this approach. 
 
Not only does each parcel of real estate differ in some respects from all other properties, but there are many different purposes for which an appraisal may be made. Each variation of purpose could result in a considerable, yet logical, variation of estimated value. For example the nature of the property, whether non-investment, investment or service; the purpose of the purchase, whether for use, investment or speculation; and the purpose of the appraisal, such as for sale, loan, taxation, insurance and the like, all constitute matters which will influence the proper methods of appraisal approach and the final result reached by the appraisal. 
 
Consequently, the first step in any appraisal procedure is to have a clear understanding of the purposes for making the appraisal and the value to be sought. The adequacy and reliability of available data also are determining factors in the selection of the approaches to be employed. A lack of certain pertinent or up-to-date information may well eliminate an otherwise possible approach. When this is the case, it is not considered a departure from USPAP, since the approach was considered but not workable. 
 
In other instances, proper procedures may only call for an appropriate discounting of conclusions drawn from such data. Thus, based on its adaptability to the specific problem, one method is subsequently the focus of the analysis and the other approach methods may not be employed. This is considered a limited appraisal and a departure from USPAP Standard 1. 
In most appraisals, all three approach methods will ordinarily have something to contribute. Each approach method is used independently to reach an estimated value. Then, as a final step, by applying to each separate value a weight proportionate to its merits in that particular instance, conclusions are reached as to one appropriate value. This procedure is known as reconciliation. 
 
THE SALES COMPARISON APPROACH 
This approach, formerly known as the market data comparison approach, is most generally adaptable for use by real estate brokers and salespersons. It lends itself well to the appraisal of land, residences and other types of improvements which exhibit a high degree of similarity, and for which a ready market exists. The principle of substitution is the basis of this approach. The buyer should not pay more for a property than the cost of acquiring a comparable substitute property. An analysis of market data is necessary in all three approaches to value. 
 
The mechanics of the market comparison approach involve the use of sales and market data of all kinds in order to compare closely the property being appraised with other similar properties which have recently been sold or are offered for sale as to time of the sales, location of the sales and physical characteristics of the improvements. The sources used for determining value include actual sales prices, listings, offers, rents and leases, as well as an analysis of economic factors affecting marketability. 
 
Sources of Data 
Sales or market data are obtained from many sources including: 

> Appraiser’s own files. Information gathered on previous assignments might provide information for the present appraisal.  
> Public records. The county assessor’s office keeps a record of all sales transactions recorded within the county. This information is kept confidential for the assessor’s own use, but an owner can obtain needed information about owner’s property from the assessor’s office. The date of recording of any deed may be obtained from the recorder’s office. The exact legal description as well as legal seller and buyer can be obtained from an inspection of the deed (or facsimile). The documentary transfer tax applies on all transfers of real property located in the county. Notice of payment is entered on the face of the deed or on a separate paper filed with the deed. Tax is computed at the rate of 55 cents for each $500 of consideration or fraction thereof. If a portion of the total price paid for the property is exempt because a lien or encumbrance remains on the property, this fact must be stated on the deed or on a separate paper filed with the deed.  
> Multiple listing offices, fellow appraisers or brokers. Information on listings, offerings, and sales may frequently be obtained from real estate multiple listing facilities, real estate offices or by appraisers familiar with the area. 
> Legal property owner, sellers or buyers. When viewing comparable sales and other pertinent data in an area, additional information is solicited by interviewing property owners living in the neighborhood. The appraiser should try to confirm the sales price and circumstances of the sale with buyer, seller and/or broker. If informed of the appraiser’s purpose, parties will usually verify and explain the sale.  
> Classified ads and listings. Ads are a source of information on properties currently being offered for sale. If possible, the appraiser’s name should be on the mailing list of banks, savings and loan, and other institutions selling properties. > Listing prices may often indicate the probable top market value of a specific property while bid prices may normally indicate the lowest probable value. Both are subject to variation based on motivation, but a reasonable number of properties falling into this category will provide a bracket within which a current fair value may be found. Offers are likely to approach market value more closely than are listings. However, an offer to purchase is not usually a matter of common knowledge. 
 
The Procedure 
The procedure used in the sales comparison approach method is to systematically assemble data concerning comparable properties which are as “like-kind” to the subject as possible in regard to: neighborhood location; size (a comparable number of bedrooms and baths); age; architectural style; financing terms and general price range. The greater the number of good comparable data used, the better the result, provided a proper analysis is made. The approach is based on the assumption that property is worth what it will sell for in the absence of undue stress, and if reasonable time is given to find a buyer. For this reason, the appraiser should look behind sales and transfers to ascertain what influences may have affected sales prices, particularly if only a few comparisons are available.  

Proper comparisons between like properties are ideally based on an actual inspection. Inspections should determine: the condition of improvements at time of sale, not as of date of inspection; room arrangement and room count so that the utility of the data may be compared to the subject property; yard improvements and their influence upon the sales price; the sales price (from buyer, seller or broker), to determine if the sale was an arm’s length or open market transaction; size and topography of the lot. For nearly comparable properties, negative (downward) adjustments should be imposed for the subject’s poor repair, freakish design, existing nuisances, etc. Conversely, positive adjustments should be made for the subject’s superior design, view, special features, better condition, higher quality of materials, landscaping, and the like.  

Unless the sales being compared are of recent date, consideration must also be given to adjusting values in keeping with the economic trend of the district and the worth of the dollar. Financing terms receive value adjustment considerations, e.g., for favorable existing assumable financing, or perhaps seller-assisted financing. 
 
Units and elements of comparison. The common units of comparison used by appraisers in the sales comparison approach are property components that can readily be used for comparison purposes: square footage; number of rooms; and number of units. Elements of comparison are characteristics in either the property or the transaction itself that cause prices to vary. These principal elements of comparison are financing terms, time (the market conditions at the time of the sale), sale conditions (no pressures/arm’s length), location, physical characteristics, and income (if any) from the property.  

Using the appropriate units and elements of comparison for the subject and each comparable, the appraiser assigns an estimated adjusted amount (dollar or percentage) for each difference found in the items of comparison (number of bathrooms, view, square footage, financing, forced sale). An adjusted price is thus established for each comparable property that should realistically reflect what the subject would sell for in the current market. The less comparable properties are then eliminated from consideration and greatest weight is given to the comparable sales most similar to the property being appraised. Through this judgment or reconciliation process, the appraiser arrives at the final estimate of value for the subject property. 
 
Advantages. Some advantages of using the sales comparison approach are: 

> It is the most easily understood method of valuation and in most common practice among real estate brokers and salespersons. 
> It is particularly applicable for appraisal purposes involving the sale of single family residences and loan arrangements therewith. These make up the great bulk of real estate transactions. 
 
Disadvantages. Some disadvantages of the comparison approach method are: 

> Locating enough “nearly alike” properties which have recently sold or been listed. > Adjusting amenities to make them comparable to the subject property. The greater the amount of adjustment or number of adjustments, the less reliable the comparable becomes. 
> Older sales become less reliable in a changing market. 
> Occasional difficulty confirming transaction details. 
> Limitations in rapidly changing economic conditions and periods of high inflation and interest rates, when property appreciation rates may cause hazardous value conclusions. 
 
Application of the Procedure - Residential Sales 
Like properties are always compared. The more current the data the better. The suggested order for making unit and element comparisons is in this sequence: 

> finance terms 
> time (market conditions) 
> sale conditions 
> location 
> physical characteristics 
> other (e.g., special considerations for income property) 
 
The steps. 
> Research the market for bona fide “like-kind” recent market data. Select data. Verify. > Select the appropriate units and elements of comparison. Adjust the sales price of each comparable (or eliminate it from consideration). The adjustment is always made to the comparable, not to the subject property. 
> Each comparable will have its own value indication. Eliminate the less comparable properties. Set out comparison results in chart or grid form. Using judgment and experience, reconcile or correlate the adjusted sales prices of the comparables and, by giving greatest weight to the sale that is most compatible to the subject property, assign an estimated value to the subject. Do not average the adjusted sales prices of the comparables. Reconciliation is a judgment process. It is not mechanical. 
 
Example. Assume that the house to be appraised is a 2,400 square foot, 5-year old, single-family tract home located two blocks from the beach, with a fair view, stucco, 10 rooms, 4 bedrooms, 3 baths, 3 car garage. It is in good condition. 
Prices have been increasing at 1% a month. The appraiser has selected from the neighborhood comparables which are equal in most of their financing and physical characteristics, except as shown on the rating chart. The value or sales price for the subject property is determined as shown on the chart below. 
 
Adjust sales prices to indicate the appraised parcel value by subtracting the adjustment if the appraised parcel (subject) is inferior to the comparable and by adding the adjustment if the subject is superior to the comparable. 

* Inferior means the subject property is inferior to the comparable in this regard. Superior means the opposite. Subtract the adjustment if the subject property is inferior to the comparable property. Add the adjustment if the subject property is superior to the comparable property. 
 
Reconciliation: 
Data 2 is close to the subject property in size, location, and view although not as good as the subject. 
Data 3 is the latest sale, but has the greatest difference in view and location. 
Data 1 is the oldest sale but is most useful for confirming the indication of value. 

Indicated value: $185,000.