Chapter 14 · National foundations
Appraisal, Valuation, and Market Analysis
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Price, cost, and value are different
Price is what someone asks or pays. Cost is the expenditure needed to create or acquire something. Value is an economic opinion under a defined premise, such as Market value An opinion of value under a defined market-value premise, not necessarily asking price or cost. See Chapter 14. Glossary. A $50,000 improvement does not necessarily add $50,000 in market value. An urgent seller's price does not automatically establish the market value of every nearby property.
An Appraisal An opinion of value developed for a defined assignment. See Chapter 14. Glossary is an opinion developed through a defined scope and valuation process. A comparative market analysis, or CMA Comparative market analysis, a brokerage analysis of market positioning and comparable evidence. See Chapter 14. Glossary, helps a brokerage Client A represented principal in a brokerage relationship. See Chapter 8. Glossary evaluate market positioning using Comparable A sufficiently relevant property used as evidence in market analysis or valuation. See Chapter 14. Glossary property information. A broker price opinion, or BPO, is subject to state restrictions and purpose limitations. A brokerage License In property use, permission distinct from an estate; in professional regulation, authorization to practice. See Chapter 5, Chapter 19. Glossary is not a substitute for an appraiser credential when a credentialed appraisal is required. State appraisal programs operate within a federal oversight framework for relevant transactions. S15 S52
Four commonly taught elements supporting economic value are demand, utility, scarcity, and transferability, sometimes remembered as DUST. Effective demand includes purchasing power, not desire alone. Utility is usefulness to a market participant; scarcity is availability relative to demand; transferability concerns the ability to convey relevant rights. These elements help explain value but do not replace a market analysis. S15
The principles that explain value
Substitution Valuation principle involving the cost or price of acceptable alternatives. See Chapter 14. Glossary: A buyer generally will not pay more for a property than the cost of an acceptable substitute, assuming reasonable availability and no unusual delay.
Anticipation Valuation principle linking present value to expected future benefits. See Chapter 14. Glossary: Present value reflects expected future benefits. A credible change in future income or use can affect today's value.
Contribution The value a component adds to the whole, not necessarily its cost. See Chapter 14. Glossary: A component's value is measured by what it contributes to the whole, not automatically by its cost.
Highest and best use Legally permissible, physically possible, financially feasible, maximally productive use. See Chapter 14. Glossary: Analyze use that is legally permissible, physically possible, financially feasible, and maximally productive. “Build the largest tower” fails if Zoning Public regulation of land use and development under authorized governmental powers. See Chapter 6. Glossary prohibits it or demand cannot support it.
Supply and demand: Scarcity relative to effective demand affects prices. Demand requires purchasing ability as well as desire.
Conformity, progression, and Regression A downward value influence on a superior property from inferior surroundings. See Chapter 14. Glossary: Compatibility can support value; a property's surroundings can pull its value upward or downward. These are analytical principles, not guarantees about every neighborhood.
Competition, change, and balance: Excess profits invite competition; markets and property conditions change; productive combinations of land and improvements depend on balance. Increasing and diminishing returns concern whether additional investment produces proportionally greater or smaller added value. S15
The sales comparison approach
This approach compares the subject with relevant sales and adjusts for meaningful differences. Selection considers location, property rights, financing, conditions of sale, market conditions, physical characteristics, and other relevant factors. A listing is not the same evidence as a closed sale.
Adjust the Comparable A sufficiently relevant property used as evidence in market analysis or valuation. See Chapter 14. Glossary, not the subject. If the comparable is inferior to the subject in a particular feature, add to the comparable's price. If it is superior, subtract. A useful memory aid is “comparable inferior: increase; comparable superior: subtract,” but always connect the sign to the economic reason.
Worked comparable
The subject has three bedrooms and a garage. A comparable sold for $280,000 and lacks a garage; supported market evidence attributes $18,000 to that difference. Add $18,000 to the comparable: $298,000. If that comparable also has an extra bathroom worth $7,000 more than the subject's configuration, subtract $7,000: adjusted indication $291,000.
Reconciliation weighs the reliability of indications. It is not necessarily a simple average. A nearby recent sale needing small supported adjustments may deserve more weight than a distant sale requiring many speculative adjustments. S15
The cost approach
A common structure is:
Land value + current improvement cost − accrued Depreciation In appraisal, loss in improvement value; in tax, allocation of qualifying basis under prescribed rules. See Chapter 14, Chapter 20. Glossary = indicated property value.
Reproduction cost Current cost of duplicating the original design and materials. See Chapter 14. Glossary estimates a duplicate using the same design and materials. Replacement cost Current cost of equivalent utility using modern materials and methods. See Chapter 14. Glossary estimates a property with equivalent utility using current materials and methods. Land is valued separately and is not depreciated in the ordinary cost-approach calculation.
Physical deterioration concerns wear or damage. Functional obsolescence Value loss from a property's design, layout, or utility deficiency. See Chapter 14. Glossary concerns a property's design, layout, or features, such as an awkward floor plan. External obsolescence Value loss caused by influences outside the property. See Chapter 14. Glossary arises from influences outside the property, such as an adverse nearby land use. “Curable” generally means correction is economically justified by the value benefit, not merely physically possible.
Example: Land is worth $90,000. Replacement cost of improvements is $260,000, with $35,000 accrued depreciation. The indication is $315,000. Depreciation in Appraisal An opinion of value developed for a defined assignment. See Chapter 14. Glossary is not identical to tax depreciation. S15
The income approach
Income properties can be valued by converting expected income into a value indication. In a simplified direct-capitalization problem:
Value = net operating income ÷ Capitalization rate A rate converting specified annual NOI into value in direct capitalization. See Chapter 14. Glossary.
Start with potential gross income, subtract vacancy and collection loss, add applicable other income, and subtract operating expenses to reach NOI Net operating income before debt service, income taxes, and accounting depreciation under the conventional framework. See Chapter 14. Glossary. Ordinary NOI excludes mortgage debt service, income taxes, and accounting Depreciation In appraisal, loss in improvement value; in tax, allocation of qualifying basis under prescribed rules. See Chapter 14, Chapter 20. Glossary. Capital expenditure Spending for a major improvement or replacement, distinguished from routine operating expense. See Chapter 14, Chapter 18. Glossary and reserves require attention to the problem's specified convention.
If NOI is $72,000 and the market capitalization rate is 8%, the value indication is $900,000. With the same NOI, a higher capitalization rate produces a lower value. A cap rate is not automatically the investor's Cash-on-cash return Annual defined cash flow divided by cash invested. See Chapter 20. Glossary.
A gross rent multiplier, or GRM Gross rent multiplier, using a clearly identified rent period. See Chapter 14. Glossary, compares price with gross rent. Keep periods consistent. A monthly GRM uses monthly rent; an annual multiplier uses annual rent. A multiplier is a shortcut that does not directly account for differences in operating expenses. S15
The appraisal process and reporting
A typical process identifies the valuation problem and intended use, establishes a scope, gathers and verifies data, analyzes the property and market, applies appropriate approaches, reconciles findings, and reports a supported conclusion. Not every Assignment Transfer of contractual rights; not necessarily release of the original party's obligations. See Chapter 10. Glossary requires equal use of all three approaches.
Effective date is the date to which the value opinion applies. It may differ from the report date. Assessed value is used in a property-tax system and need not equal an Appraisal An opinion of value developed for a defined assignment. See Chapter 14. Glossary's Market value An opinion of value under a defined market-value premise, not necessarily asking price or cost. See Chapter 14. Glossary. Insurable value and investment value may use different premises. Know what kind of value the question requests. S15
An inferior comparable lacks a feature the subject has. Should its sale price be adjusted upward or downward for that difference?