Chapter 13: Appraisal of Property/ Property Valuation

While most people believe that market value is tied to sales price, this is not always the case

A seller may believe a property is worth $200,000 but may not find buyers willing to pay more than $175,000. Therefore, the market value is not driving the sale price; instead the perceived value to a buyer is driving the sale price.

Appraisal

An estimate of the value of property resulting from an analysis of facts about the property. An opinion of value

On a federal level, an appraiser must be a

Certified Residential Real Property Appraiser or Certified General Real Property Appraiser. States often require additional licensing before this person can determine the value of residential or commercial properties.

To expand further on market value, one must understand there are several factors that must be taken into consideration. Some of them include:

Equal Motivation Parties Best Interests Exposure on Open Market Consideration Financing Considerations Pricing of Property Sold

While one may believe the price of the home, cost of the home, and market value of the home will all be similar, this is not always the case

In fact, these values are all likely to be different based on various market conditions

Tax purposes

In some cases, a current market value is needed for tax purposes. This can occur during the estate planning process, when determining taxes for an inheritance or a gift or for other reasons where it may be necessary to provide an estimated assessment value

Here are the various types of property value:

Investment Value Insured Value Value-in-Use Assessed Value Mortgage Value

Example of Principle of Competition

One could reasonably apply this to a sub-division comprised of split-ranch homes which are primarily three bedroom homes. If there are 100 available three bedroom homes and there are 200 buyers looking for three bedroom homes, those properties become more valuable due to the number of buyers. The flip side of this would be if there are 200 available homes and there are only 100 buyers who are looking for this size home; the property would have a lesser value.

Appraiser

One qualified by education, training and experience who is hired to estimate the value of real and personal property based on experience, judgment, facts, and use of formal appraisal process. has at least a Bachelor's degree and had completed specific educational requirements

Smaller families may replace large families, seniors may replace newlyweds, etc. Other factors include:

Population trends Family composition Aging population

Value

Present worth of future benefits arising out of ownership to typical users/investors

Increasing and Diminishing Returns

Property improvements typically increase the value of a property.

Taxes

Property taxes are a concern for those who are purchasing a home. One of the questions most buyers will ask about is the property tax rate, and in many cases, when was the last time the rates increased. In addition, some municipalities have their own tax, separate from the taxes that are collected as property taxes. These taxes will have the effect of depressing property values; the higher the taxes, the fewer people who will be interested in the home.

Chances are, as a real estate professional you will be dealing with competing property values.

The more unique the property, the more challenging is to establish value. While you may be able to give a seller a basic idea of the value of a home, based on the factors that are publicly available to you, only when a professional appraiser is hired will the seller have a firm understanding of the appraised value of their property.

The cost of financing new home construction can get complicated.

There are hard and soft costs involved in all construction project

Areas with a good public transportation system or easy access to interstate highways are often valued higher than more remote properties.

This is because homeowners will always look at convenience when deciding where they prefer to purchase a home

When there are more buyers in a market, the value of a property increases.

This is due entirely to demand. Remember, demand for properties are often cyclical; parents with children in school are less likely to be looking for new homes between Halloween and New Year meaning there is less demand for properties during this time. However, come May or June, parents who are considering a new home will be flooding the market making demand much higher.

Transfer of property

When a buyer and seller are involved in a real estate transaction, there needs to be a value placed on the property. There may also be instances where a property transfers ownership for other reasons that may require a market value.

Financial reasons

When a buyer is borrowing money, a property owner is considering refinancing or a property is being used as collateral, the lender will typically require the property be appraised

As a real estate professional, it is important to understand what factors may negatively impact a property to enable you to discuss sale prices with sellers

While not every factor will impact every property, understanding the unique characteristics that impact individual neighborhoods is an invaluable tool that will help you understand the appraised value of properties.

While most items we purchase have a limited life and are used nearly immediately,

our home values are realized over time

The four factors that impact how quickly a home is sold are

social forces, economic forces, housing construction costs, and governmental matters

While the end goal is to complete a purchase or sale,

the buyer and seller are often working at odds with each other. This is because their interests are not the same; the buyer is interested in getting the home they want at the best possible price, while the seller is interested in making as much profit as possible from the sale.

Principle of Contribution

A component part of a property is valued in proportion to its contribution to the value of the whole. Holds that maximum values are achieved when the improvements on a site produce the highest (net) return, commensurate with the investment. The features of a home will impact the value of the home; however, the value of features may be different from one person to another.

Principle of Substitution

Affirms that the maximum value of a property tends to be set by the cost of acquiring an equally desirable and valuable substitute property, assuming no costly delay is encountered in making the substitution. Real estate values are impacted by the ability to acquire another property that is both desirable and similar in a short period of time.

Principle of Anticipation

Affirms that value is created by anticipated benefits to be derived in the future. While the basis of real estate valuation may appear to be based on today's dollars, the value is tied to the benefits the property may offer buyer in the future

Highest and Best Use

An appraisal phrase meaning that use which at the time of an appraisal is most likely to produce the greatest net return to the land and/or buildings over a given period of time; that use which will produce the greatest amount of profit. This is the starting point for an appraisal. One would not expect to use a single-family home as a restaurant nor would one expect to house a family in a property that was previously a restaurant. The highest and best use for a property may also pertain to the legal use of that property. Again, a town or city would frown on using a restaurant as a home and vice versa. Commercial properties are most often subjected to this valuation method where it is important to understand what the best use of the property is, that will yield the highest net income. Specific types of income producing properties may not be easily adapted to other uses

Social forces are unique to every neighborhood

An example of this is if a neighborhood has numerous small commercial properties and more people are opting to work from home, the office space may remain empty. This would mean the real estate was a riskier investment

Example of Principle of Conformity

An example of this would be if you have a neighborhood that is primarily split ranch homes and one of the homes in the area is an old Victorian style home. The Victorian home would be valued lower than it might be if it were located in a neighborhood that had similar properties, because it is considered non-conforming

Example of highest and best use

For example, a gas station cannot be easily converted to a restaurant. Income producing properties are also impacted by the residents of the surrounding area. For example, an arcade may thrive in a neighborhood which attracts families with children but may not do as well in a neighborhood that is primarily geared towards seniors. Therefore, the better use of that property may be a convenience store, a pharmacy or a coffee shop.

Example of Principle of Contribution

For example, a gourmet kitchen may seem like an attractive selling point unless your buyer is a single person who eats out most nights. A selling feature like an "in-law" apartment may be ideal for a couple who has a parent or older child sharing their home, but may not seem as valuable for a couple with toddlers. Another example of this would be an area that is primarily designed for senior citizens. The potential buyers of these properties would be looking for amenities which may not be sought after for younger buyers such as a community center, handicap bathrooms, etc. The better the amenities available for the target audience for the property, the more likely the property is to be valuable to those who are seeking to purchase and thus the property values are higher. One would not anticipate seeing a playground designed for young children in a senior living development.

Various economic issues will impact neighborhoods

For example, if a specific area loses a large factory, or a large company moves from the city, the home values in the area will suffer as a result. This is largely due to the fact that employment will decrease meaning income levels are decreasing. Conversely, if an area goes through a period where new employers are moving into the area, the employment levels increase, incomes tend to increase, and therefore, property values increase. Remember, someone may want to purchase property but if their income is not stable, they cannot justify the expense.

Example of Increasing and Diminishing Returns

For example, let's take a single-family home with only two bedrooms. If a property owner adds a single bedroom, the value of the property will typically increase; this is particularly true if most of the similar homes in the area have three bedrooms. However, if you add two bedrooms onto the home, you may see a decrease in the value because you are now facing the challenges that come with the property not conforming to the other homes in the area. There is another way to look at this — let's assume for a moment properties in a neighborhood consist of primarily four-bedroom homes with gourmet kitchens. However, one or two homes in the neighborhood were built 15 years ago and have two bedrooms, and a standard kitchen. In this instance, the larger homes may suffer a small decrease in value while the smaller homes may see a small increase. However, if the two smaller homeowners decide to upgrade their homes to five-bedroom homes with a gourmet kitchen, the extra bedroom is excessive and therefore does nothing to further increase the value of the property. The addition of the first two bedrooms does bring the home value up as does the addition of the gourmet kitchen.

Example of Principle of Anticipation

For example, while an appraiser will look at demographics and growth of the neighborhood in the past, this is also used to apply a future value to the property. There are some practical ways to look at this. For example, let's say a local neighborhood that is designed for families has no school or playground. If there is an indication that a playground and a school are in the works, the property in the neighborhood will likely increase because of the anticipation of what will happen in the future.

Principle of Change

Holds that it is the future, not the past, which is of prime importance in estimating value. Change is largely the result of cause and effect. Changing market conditions such as supply and demand, interest rates and property conditions will have an impact on the value assigned to a property.

Principle of Conformity

Holds that the maximum of value is realized when a reasonable degree of homogeneity of improvements is present. Use conformity is desirable, creating and maintaining higher values. There are times when being unique is invaluable. When you are building a home, or looking at homes in a particularl neighborhood, conformity is actually a better option. This is because the value of a home that is unique in the area will typically be lower than if the home was similar to others in the area

Here is how to think about how this applies to the value of a home (Principle of Substitution)

If a seller lists a home for sale for $300,000 and other similar homes in the area are selling for $265,000 then chances are, the home for sale is considered "above market value". If the cost of new construction on a similar home is $255,000, then the property for sale is still too high; substitution would be less expensive than the listing price. There is an important distinction that must be noted in the statement "ability to acquire another property that is both desirable and similar in a short period of time". The period of time is also a consideration. For example, let's say you need to replace a three-bedroom home for a displaced family. Also, let's say that every three-bedroom home in the area is occupied and has not turned over in several years. Suddenly, one of these homes is up for sale. Because of the scarcity of that type of property, the value assigned would be higher — this naturally relates back to supply and demand.

As a real estate professional, you will be involved in the sale of property and possibly helping sellers reach a decision on listing price.

In nearly all cases, you will depend largely on comparative sales in the area to reach a consensus on the home's value. However, before a buyer can obtain financing, a professional appraiser will be required. In effect, the purpose of an appraisal is to determine the value of a property at a fixed point in time.

Properties are valued in differing manners depending on the party who is requesting the value

Investors, insurance companies, mortgage companies and taxing authorities all use different values for the same property which can be confusing

An example of how these varying factors may be different can be seen in this type of scenario: ( Price, Cost & Market Value)

Let us assume for a moment that a developer's goal is to build a house, and sell the home to make a profit. This means the builder would need to factor in all costs such as land acquisition, legal fees, financing fees, construction fees, etc. Once the builder has completed the construction, they now have the final cost. Therefore, based on their costs, they add on their projected profit, review the market, and make an analysis of what the property should sell for. In other words the developer will list the property for sale at a specific price, based on what they spent, what they want for a profit and what they estimate the market will bear. Let's assume that after a sufficient period of time, where the developer listed the property for sale, the best offer is $50,000 below the price they wanted. This decrease is often due to different factors and market conditions. Some of the market conditions that have impacted the seller negatively include increases in interest rates, less demand for property of that size or type, or other factors outside of their control. This may have a negative impact on the seller, but is typically good news for buyers.

Example of Principle of Regression

Let's assume for a moment the sub-division is comprised of two-bedroom homes and abuts two roads that have no property built on them. The property on those two roads is subsequently sold to someone who manages owner-occupied mobile homes. As a result, the sub-division is now surrounded by two mobile home parks that are individually valued. Since mobile homes are generally valued lower than stand-alone residential homes. Therefore, the higher valued properties in the sub-division will be considered worth less because of the surrounding property values.

Stop and think about a suburban neighborhood with 50 - 100 homes where more than half of the residents are employed by a large employer in a nearby city

Should that employer shutter their doors? Many of these locals could potentially need to sell their homes to find a more affordable home. This means a glut of real estate in the market resulting in lower prices.

Principle of Competition

Supply and demand is always a factor in property valuation. The more buyers there are, the higher the demand for a property thus driving the value up. The fewer the buyers, or the more properties that exist, the lower the value of the property

Market Value

The highest price in terms of money which a property will bring in a competitive and open market and under all conditions required for a fair sale, i.e., the buyer and seller acting prudently, knowledgeably and neither affected by undue pressures

Principle of Regression

The worth of a lesser valued residence tends to be enhanced by association with higher valued residences in the same area. Real estate values are tied to the value of properties in the area. Think about the structure of most sub-divisions; each property conforms to a similar size, style and therefore each has a similar value.

To properly value a piece of property,

all appropriate elements must be taken into consideration

To complete an appraisal,

analysis of data and facts about the property must be completed. This analysis is completed by an appraiser.

Finally, another factor that is likely to play a role in home value and construction costs is the

area weather

the purpose of an appraisal is to

arrive at a market value of a given property. Keep in mind, an appraisal is an estimate of the value of a property at a specific time

Demand

as with any commodity, the more popular something is, the more people who are interested in buying. This results in an increase in value. If fewer people are interested, the demand is lower and the value therefore is also lower. The supply of willing and able buyers in the marketplace or lack thereof

It is also important to keep in mind that there is one other factor impacting every property on the market and that is the

availability of capital

Equal Motivation

both the seller and the buyer must be equally motivated. This means neither party is under duress. An example of this would be if the seller is going through a divorce and is being forced to sell the home, they may be willing to accept a lower price for the home than it might be otherwise worth

Appraisers may be hired by a

buyer, a seller, a lender, or any number of other persons who may need to have a property valued

While average temperatures may not impact value directly,

climate issues like flooding, wind, and other natural phenomenon can impact the value of property.

Cost

cost may or may not equal value. There are numerous factors which go into the cost of a home beginning with the land costs. Costs include all money that is spent in developing a property. This means the cost for an architect to design the property, legal services and fees for filing the appropriate titles and deeds as well as legal services. There are other fees including the costs of a contractor, the taxes paid on the property, financing costs, materials for the property and labor costs. Any cost that is associated with the purchase, development, ownership or financing will be taken into consideration. The total dollar expenditure for labor, materials, legal services, architectural design, financing, taxes during construction, interest, contractor's overhead and profit, and entrepreneurial overhead and profit (may or may not equal value).

The elements of the value of real estate are generally known as the acronym "DUST". The acronym means

demand, utility, scarcity and transferability

In addition to the cost of financing,

factors such as location also have an impact on new construction.

Scarcity

if 10 people are trying to find a three-bedroom home and there are only five available in the neighborhood they are interested in, the property has a higher value. If there are five people looking for a three-bedroom home and there are 10 in the neighborhood, the property will have a lower value A lack of supply

Hard costs

include construction materials, the purchase of land, labor, etc

Soft Costs

include items like permits for construction, costs to rezone property for the use the builder intends, and utility connection fees, to name a few. These costs often determine the builder's willingness to develop new properties.

Keep in mind, the market value takes various issues into consideration;

including that both the buyer and seller understand the transaction, that the sale is not based on coercion by one party or the other, and that the transaction is "arm's length" meaning there are no related parties involved in the purchase and sale.

Insured Value

insurance companies will assess the parts of a home that may be destroyed to determine how much insurance coverage a homeowner may need. The value of the land a property sits on is therefore deducted from the overall value of the home. The value of an asset or asset group that is covered by an insurance policy; can be estimated by deducting cost of non-insurable items (e.g. land value) from market value

Other factors that must be considered include

interest rates and the availability of money. When interest rates increase, fewer consumers are eligible for mortgage loans. Additionally, fewer investors will be interested in commercial and rental properties because their cost of funds is higher, meaning the property is less valuable to their portfolio.

Investment Value

investors are going to look at a variety of factors including available financing and terms as well as the tax rate of a property. Different investors may have different criteria when determining value The specific value of an investment to a particular investor or class of investors based on individual investment requirements; distinguished from market value, which is impersonal and detached

Physical conditions such as

land that will not pass perk tests, wetland restrictions and other environmental factors also impact the value of land. These factors have an impact on construction costs because they often consist of higher costs for permits, additional studies, etc.

Market Value — as previously stated,

market value is based on numerous factors including the condition a property is in at the time it is listed for sale. There is an assumption when a property sells in 90 days or less, without repairs, then the value of the property is the sale price. There are certain assumptions that are made with market value including the knowledge of both buyer and seller; both must have an understanding of the transaction they are entering into and both must be negotiating in good faith.

Transferability

most real estate professionals are familiar with clean, clear title. This means the property can be transferred to another person without restriction. This means properties that have an encumbrance such as a right-of-way will typically be valued lower than one with no encumbrance. The ability to transfer ownership of property from one person to another.

Utility

one tends to not think about the utility of a property because of the subjectivity of utility. However, the more useful the property, the higher the value. To put this into perspective, think about the features that would be helpful in a senior housing development. Features like handicap bars in the bathroom would be an example of something of value to seniors, but less attractive to someone in their 20's. The ability to give satisfaction and/or excite desire for possession

If mortgage lending is easily accessible,

property values are likely to show a modest increase. This is particularly true if lenders are motivated to lend.

Keep in mind, when the social makeup of a neighborhood begins changing,

property values may also be impacted

Motivating factors may include:

stable interest rates, low foreclosure rates or strong employment numbers. However, if the opposite happens, lenders may tighten lending resulting in fewer people being able to secure a mortgage to purchase a home. The net result is lower property values because the homes are sitting on the market for longer periods of time because there is less demand.

However, there are governmental issues that have a direct impact on the value of property that you should be aware of, as you pursue your career in real estate. Some of the more common factors include:

taxes, quality of schools and quality of services.

Builders who purchase homes in areas where tornadoes or hurricanes are common,

tend to believe those properties will be lower in value than homes which do not have these types of weather hazards.

The simple way to look at principal of change is

the aging of property. Homes which are built around the same time tend to age in similar manners. However, if someone purchases an empty lot in the neighborhood and builds a home that is similar in style, the newer home will have a lower value simply because the other properties in the area are older and not as modern. If you recall, when analyzing a property value, an appraiser will most probably use the Sales Comparison approach.

Price

the bottom line in all real estate transactions is what the purchaser agrees to pay and what the seller agrees to accept. The price also takes other factors into consideration including whether or not the transaction is conducted in an arms-length transaction. If two family members are involved in a purchase the chance is that the sales price will be lower, compared to a transaction where the persons are not related The amount a purchaser agrees to pay and a seller agrees to accept in an arms length transaction

Financing Considerations

the buyer must be able to secure financing to facilitate the purchase. If banks have frozen lending to all single-family homes with fewer than five bedrooms, then the market value would be negatively impacted on homes with fewer than five bedrooms

Consideration

the buyer must be willing to pay for the property in cash or the equivalent of cash. This will typically involve the buyer making a cash down payment and securing reasonable financing in return for the purchase of the property. Basically, the buyer is not trying to exchange the home for something of lesser value; for example, one would not expect the seller to accept a rake in return for a home.

In most cases where a real estate agent is involved in the purchase or sale of a property,

the lender will hire an appraiser of their choice.

It is important to keep something in mind: if a buyer or seller hires an appraiser before there is a purchase and sale agreement in place,

the lender working with the buyer may not accept that appraisal for the purposes of approving a loan. This could ultimately result in two appraisals being ordered on a single property.

Family composition

the makeup of families has an impact on real estate. Today, more than ever, we have blended families where you may have parents living with children, children living with parents or you may have two parents who are now sharing a home. This means the demand for specific property configurations is different; let's face it, a two bedroom ranch will not be suitable for two parents who have four children between them.

Exposure on Open Market

the market for the property must be considered open. This has two factors: time and exposure. First, there must be a reasonable time the property is listed for sale. Second, the property must have exposure to the open market. One could not post a property for sale on a supermarket bulletin board for three weeks and assume that will insure the proper level of exposure, nor that access to the open market was achieved

Pricing of Property Sold

the price must be considered normal consideration for similar properties. In other words, if the seller was to make concessions like agreeing to pay the buyer's mortgage for the first year in the home, this would fail the normal consideration test.

While property values may be based on the previous sales in the area, the condition of the property and other factors,

there are certain principles of value that will also be evaluated during an appraisal. Understanding these principles will help you understand the value of nearly any property.

Regardless of how well a property is maintained,

there are external forces which have an impact on home values, which are out of the homeowner's control. These factors, individually, or combined, impact real estate value and may also have an impact on how quickly a home is sold

While a seller may have taken extraordinarily good care of their home,

there are factors beyond their control that may still make the property less valuable than they believe.

Aging population

there is no question that the overall population of the United States is getting older. Real estate that is specifically designed to meet the needs of an aging population, such as senior housing developments, will see values increasing while starter homes, those designed for young couples who may be considering starting a family, will decline. Seniors are typically interested in smaller homes, usually with a single floor and need easy access to medical care making neighborhoods that fit this mold more popular and therefore more valuable to seniors

Real estate professionals must be aware of all factors impacting property value because

they will have an impact on how you help sellers determine the price at which a property will be listed, as well as provide realistic information about how long a property will remain on the market before being sold.

Mortgage Value

this figure is determined by the amount of the mortgage of the property. This value changes in the event a property owner takes out a new mortgage. However, the mortgage value is not impacted if the property increases or decreases in value

While a real estate professional may rely on data obtained from recent sales to reach an estimated value,

this is not considered an appraisal, instead it will result in an estimate of what the seller may reasonably expect to receive when a property is sold. This is typically called a market valuation and not an appraisal.

Assessed Value

this value is assigned by municipalities for the purpose of determining the tax rate for a property A valuation placed upon a piece of property by a public authority as a basis for levying taxes on the property

Quality of schools

this will be particularly important in areas where there are single family homes that attract couples with children. If the quality of the schools in the area is lacking, the property values will be depressed because parents will not want to be in the area. This is one factor that may not impact property values in places like retirement communities but in most neighborhoods it will certainly play a role in property values

Normally an appraisal may be used in three cases:

transfer of property, financial reasons and tax purposes

Value-in-Use

typically used for commercial properties. This valuation is determined by the current use of the property. For example, a single-site retail facility which is currently operated as a pharmacy may not covert well to be a single-site restaurant. Therefore, the empty facility would be less valuable to a restaurant investor than to another retail investor.

One would not use an appraisal of a property from a year ago as the value today;

values fluctuate over time depending on numerous factors

Real estate professionals must have an understanding of the

various economic forces that could have an impact on real estate values. These numbers are tied not only to available opportunities in the area, they are also tied to the age of the population in a neighborhood. An example of this would be an area that is remote and has no large employers. These areas are likely to attract only older people without children since chance is there are fewer opportunities and likely fewer local services or schools.

The market value of a property is based on

what the property, in the condition it currently exists in, will sell within a reasonable period of time. In a stable real estate market, this usually means what the property could sell for within a 30 to 90-day period

Population Trends

when a neighborhood is going through a period of stability, housing values tend to be stable. Should the neighborhood go through a period of growth with new properties being built, making a neighborhood attractive, the price of housing will typically increase. In times when people are fleeing the neighborhood due to various forces, such as crime rates, the homes in the area tend to decline.

Quality of services

when we think of town-supplied services we tend to think about fire and police. However, factors like town or city sewer, internet access and trash pickup can also play a role in property values. Let's take a look at simply internet access; today, more people are gravitating to working part or full-time from home which means they need reliable internet access. If a community lacks even basic internet this will decrease property values because fewer people, particularly young people, will be interested in the property in the community.

Local transportation issues,

which are largely dependent on the location of a property will also play a role in property values.

Parties Best Interests

while the interests of the buyer and seller may be different, both parties must be well-informed about the risks and rewards associated with the pending agreement. For example, if a buyer sees a home they like and the home's roof is 20 years old, the buyer must be informed about this. When the final decision is made as to whether to move forward with a purchase and sale, both parties must be taking their own interests into consideration.