THE FORMAL APPRAISAL PROCESS Chapter 3

CHAPTER TERMS AND CONCEPTS Appraisal process Appraisal report Assignment conditions Client Contractual conditions Cost approach Credible appraisal Definition of the appraisal problem Effective date of value Exposure time Extraordinary assumption Form report Hypothetical condition Income approach Intended use Intended users Letter report 2

CHAPTER TERMS AND CONCEPTS Limiting conditions Market data Market exposure Market value Marketing time Narrative report Reconciliation Restricted Use Appraisal Report Sales comparison approach Scope of work Self-Contained Appraisal Report Subject property Summary Appraisal Report Type of value Value in exchange Value in use 3

LEARNING OUTCOMES 1.Explain the four steps in the appraisal process. 2.Name the six elements that define the appraisal problem. 3.Define the term scope of work. 4.Explain the difference between value in use and value in exchange. 5.Define the term market value, and explain how it differs from market price. 6.Outline the three approaches to value, and explain how they are used in appraisals. 4

THE APPRAISAL PROCESS AND USPAP The Appraisal Process  Is Defined by USPAP  USPAP must be followed by o Appraisers completing Federally Insured Transactions o Licensed or Certified Appraisers in Mandatory States o Most Professional Organizations require compliance with USPAP 5

CONFORMITY WITH USPAP REQUIRMENTS Standard 1  How an appraisal should be developed Standard 2  How an appraisal should be reported 6

FOUR STEPS IN APPRAISAL PROCESS I.Identify the Appraisal Problem II.Identify Appropriate Solutions – The Scope of Work III.Execute the Appropriate Scope of Work IV.Report Findings and Conclusions 7

Step 1: Identify the Appraisal Problem The elements to be identified 1.The client and any other intended users 2.The intended use of the appraiser’s opinions and conclusions 3.The type and definition of value 4.The effective date of the appraiser’s opinions and conclusions 5.The Subject of the Assignment and its relevant characteristics 6.Any assignment conditions 8

RELEVANT CHARACTERISTICS  Intended use of the appraisal and report  What the appraiser finds out about the property, and  What is important to the buyers of such property, as reflected by the market data 9 Consider:

1. IDENTIFICATION of the CLIENT  The client engages the appraiser o The client defines the other intended users  The client’s name must be in the work file o Client’s name does not have to be in report  Three key points for intended users: o Decision between client and appraiser at the engagement o Parties that are directly involved in appraisal o Only includes those to whom the appraiser must clearly communicate the results. 10

2. INTENDED USE Different Users Have Different Needs Federally Insured Institutions Require USPAP Compliance Type of Report  Self Contained  Summary  Restricted Use Report 11

3. TYPE & DEFINITION OF VALUE Opinion of Market Value  Most common type  Must be agreed on at the beginning of assignment  Requires an estimate of Exposure Time. o time to sell prior to effective date  Client may wish to have a marketing time o time to sell after the effective date 12

4. EFFECTIVE DATE OF APPRAISAL Must be Agreed on by the Appraiser and Client at the start. Three Possible Dates 1. The effective date of value 2. The date of inspection 3. The date of the report Date of Value May Be: o Retrospective – In past o Prospective – In future o Current 13

5. THE SUBJECT’S RELEVANT CHARACTERISTICS Identification of Subject  Address  Legal Description  Tax I.D. Number  Map reference  Survey  Property sketch  Photographs  Personal property identified  Property rights appraised o Fee simple o Leased fee o Other Partial Interests 14

6. ASSIGNMENT CONDITIONS 1.USPAP 2.Supplemental Standards 3.Jurisdictional Exceptions 4.Extraordinary Assumptions 5.Hypothetical Conditions 6.Regular Assumptions and Conditions 7.Contractual Conditions 15

STEP 2: IDENTIFY APPROPRIATE SOLUTIONS 1.Defining the Scope of Work  The extent of identification of the property  The extent of property inspection  The type and extent of data researched, and  The type and extent of analysis employed to reach a conclusion. 16

EXTENT OF IDENTIFICATION How much Identification of a Property is Necessary? Legal Descriptions Address Tax ID numbers Ground and Aerial Photographs Property Rights?  Fee Simple  Leased Fee  Leasehold  Other 17

EXTENT OF PROPERTY INSPECTION How Extensive the Viewing of the Subject Property?  Interior and exterior viewing?  Drive-by appraisal?  Desktop appraisal? Appraisal must be Credible  Appraiser must have adequate information from other sources for a drive by or desktop appraisal  Appraisers view a property  Home Inspectors Inspect 18

TYPE & EXTENT OF DATA RESEARCHED 19

STEP 3. EXECUTE SCOPE OF WORK 1.The Sales Comparison Approach to Value 2.The Cost Approach to Value 3.The Income Approach to Value 20

STEP 4. REPORT FINDINGS & CONCLUSIONS 1.Three Types of Written Reports a. Self-Contained Appraisal Report The report describes the material and analyzes to solve the problem b. The Summary Appraisal Report The report summarizes the material and analyzes to solve the problem c. The Restricted Use Report States the answer to the problem d. With the Minimum required content 21

FORMATS OF APPRAISAL REPORTS 1.Letter Report Word Processed 2.The Form Report Generated by appraisal software 3.The Narrative Report Generated on narrative report generating software and/or word processed 22

TYPES OF VALUE Assessed value Book Value Capitalized value Cash value Depreciated value Economic value Exchange value Face value Fair value Going concern value Inheritance tax value Insurance value Leased value Liquidation value Listing value Loan value Market value Nuisance value Potential value Rental value Salvage value Use Value Value in foreclosure Value in place 23 Each type of value needs its own definition

VALUE IN USE VS. VALUE IN EXCHANGE Value in Use Value of an item or object to a particular user Value in Exchange Value of a thing to people in general 24

DEFINING MARKET VALUE Market Value  What a property should normally sell for, assuming a willing buyer and a willing seller. Market Value for Federally-Related R.E. Transactions  ….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, knowledgeably, and assuming the price is not affected by undue stimulus. 25

CRITERIA FOR MARKET VALUE Conditions 1.Typical Motivation 2.Informed Parties 3.Market Exposure 4.Terms of Sale 5.No Sales Concessions 26

PRICE VS. VALUE 1.Factors Influencing Price as Distinguished from Value: a. Unusual financing b. Distress sale c. Forced purchase d. Uninformed parties e. Misrepresentation of facts 27

CLASSICAL APPROACHES TO VALUE 1.The Sales Comparison Approach to Value 2.The Cost Approach to Value 3.The Income Approach to Value 28

STEPS for SALES COMPARISON APPROACH 1.Investigate Comparable Sales 2.Compare Sales to Subject Property 3.Adjust for Differences 4.Arrive at Value for Subject 29

STEPS IN THE COST APPROACH 1.Estimate Land Value as if Vacant 2.Estimate the Cost to Build the Existing Structure 3.Estimate the Amount of Accrued Depreciation, or Loss in Value 4.Subtract Accrued Depreciation 5.Add Land Value to the Depreciated Cost of Improvements 30

Example of Cost Approach 31

Steps in the Income Approach 1.Estimate Market Rent and Potential Gross Income 2.Estimate Annual Vacancy and Collection Loss 3.Subtract to Arrive at Effective Gross income 4.Subtract Annual Operating Expenses from Effective Gross to Arrive at the Net Operating Income 5.Decide on Capitalization Method and Rate 6.Capitalize Net Income into an Estimate (Opinion) of Value 32

EXAMPLE OF INCOME APPROACH 33 The appraiser selected the direct capitalization method and a 10% capitalization rate, based on the market rate analyzed.

SUMMARY 34 The steps in the appraisal process are to: 1. Identify the appraisal problem to be solved 2. Identify appropriate solutions 3. Execute the appropriate scope of work 4. Report the findings and conclusions reached

SUMMARY 35 The six elements of defining the appraisal problem are: 1.The client and any other intended users 2.The intended use of the appraisal and report 3.The type and definition of value 4.The effective date of the appraiser’s opinions and conclusions 5.The subject of the assignment and its characteristics 6.Any assignment conditions

SUMMARY 36 The scope of work includes four issues: 1. The extent of property identification 2. The extent of property inspection 3. The type of data researched and the extent of research 4. The types and extent of data analyses used

SUMMARY 37 Three approaches are used for valuing real estate: Sales Comparison / Cost / Income 1.The sales comparison approach is often the most reliable. 2.The cost approach estimates the value of a property by adding its land value to the estimated cost to replace the existing structures less depreciation. 3.The income approach compares the income-producing capability of the property with that of properties that have been sold.