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Real Estate Appraisal: Chapter 3 The Appraisal Process

Terms in this set (40)

How does an Appraisal differ from other methods of Value Estimation?
Appraisal are 99% more accurate than most CMA's, BPO's, and AVM's due to the 8-Step Appraisal Process

Appraisers have developed an orderly systematic method called the 8 Step Appraisal process to arrive at an estimate of value.

This orderly systematic process if the reason that an appraisal is different from a(n):

-Comparative Market Analysis (CMA) of a realtor

-Broker Price Opinion (BPO) of a licensed real estate broker

-Automated Valuation Model (AVM) like Zillow or similar statistical analysis. Remember: An AVM such as Zillow is like a monkey throwing darts!
8-Step Appraisal Process
1. Define appraisal problem.
2. Determine the scope of work.
3. Collect and verify the data.
4. Analyze the data.
5. Estimate the value of the site.
6. Apply three approaches to value.
7. Reconcile various value indicators to reach final value estimate.
8. Prepare and deliver appraisal report.
Appraisal Process Steps: Defining the problem
To form definition of the appraisal problem, four questions must be answered:

-What is to be appraised?
-When is it to be appraised?
-Why is it to be appraised?
-How is it to be appraised?
Defining the Problem: What is to be appraised?
The appraiser must identify three things to define the "what" of the problem:

-What INTEREST being appraised? (e.g., fee simple, leased fee, leasehold interest)

-What is the INTENDED USE (purpose) of the appraisal?

-Who is the INTENDER USER (e.g., lender, County Assessor for property tax appeals, IRS for estate appraisals, government agency for condemnation appraisals, etc.)
What is to be appraised?: Identifying the real estate
Property must be identified by a legal description.
Street addresses and building names are not appropriate.

Appraiser must identify any repairs to be made or improvements to be added.
What is to be appraised?: Identifying the real property interest
Appraiser should also be aware of other restrictions which may apply to property, including:

-Zoning ordinances
-Rights-of-way
-Private deed restrictions (e.g., HOA, historic register restrictions)
-Property taxes
-Easements (e.g., easements in gross, easements appurtenant)
What is to be appraised?: Purpose of appraisal
The purpose of an appraisal requires knowing what type of value the client would like you to estimate.

-Purpose = type of value client would like estimated

-Use = why client wants to know the particular value
Defining the Problem: When is it to be appraised?
Effective Date

Specific date for which the estimate of the property's value is valid.

The Effective Date is agreed on in advance with the client and therefore it is NOT always the same as the date of inspection.
When is it to be appraised?: Effective Date of appraisal
The client may wish to know a past or future value of the property, e.g. RETROSPECTIVE (past) or PROSPECTIVE (future).

Examples:
-For estate work, the effective date is the "date of death" and therefore is in the past or retrospective.

-For new construction, the effective date is the "date of building completion" and therefore is in the future or prospective.
When is it to be appraised?: Date of appraisal report
The date on which the appraisal report is SIGNED and ISSUED.

The Date of the Report is NOT the same at the appraisal's Effective Date.
Defining the Problem: Why is it to be appraised?
Appraisal reports are generally limited to client's intended use.

-limits appraiser's liability
-allows appraiser to tailor approach to client's needs
Defining the Problem: How is it to be appraised?
Appraiser should determine:

-General assumptions
-Extraordinary assumptions
-Hypothetical conditions
-Limiting conditions
How is it to be appraised?: Assumptions
Extraordinary Assumption

An assumption about a condition which, if found to be false, could alter the opinion of value.

Appraisers use Extraordinary Assumptions when they have reason to believe that there may be additional or hidden problems, the extent of which cannot be known without expert opinions by specialized contractors doing on site inspections.
How is it to be appraised?: Extraordinary Assumption - Example
Extraordinary Assumption

An assumption about a condition which, if found to be false, could alter the opinion of value.

Example:
"I have assumed that the comparable sales and rental information of similar competing properties taken from public record information (Multiple Listing Services and NDC data) and the information obtained from interviews with owners, tenants, listing agents, selling agents are credible."
How is it to be appraised?: Hypothetical Conditions
Hypothetical Condition

That which is contrary to what exists, but is supposed for the purpose of analysis

Hypothetical conditions assume conditions contrary to know facts about physical, legal or economic characteristics of the subject property; or about conditions external to the property, such as market conditions or trends; or about the integrity of the data used in an analysis.
How is it to be appraised?: Hypothetical Condition - Example
Hypothetical Condition
That which is contrary to what exists, but is supposed for the purpose of analysis
Example:
"The subject property is currently zoned for multifamily but is being appraised as a hotel for feasibility purposes only. The owner is currently processing a request for re-zoning to allow a grand-fathered use."
How is it to be appraised?: Limiting conditions
Limiting condition

Statement or explanation that limits the application of the report's conclusions.

Common statements of limiting conditions:

-Only purpose of appraisal is to estimate value.
-Appraisal does not constitute a survey.
-Appraisal is not a legal opinion regarding title.
-Appraisal does not constitute an engineering report.
-Appraisal is based on a limited amount of data.
Appraisal Process Steps: Step 2: Determining the scope of work
Scope of work

-depends on complexity of assignment
-includes work plan and schedule
-allows appraiser to establish fee
Appraisal Process Steps: Preliminary analysis
In combination, the first two steps in the appraisal process are sometimes referred to as the preliminary analysis:

1. Defining the appraisal problem, and
2. Determining the scope of work.
Appraisal Process Steps: Step 3: Collecting and verifying data
Types of data:

-General data
-Specific data
-Primary
-Secondary
Collecting and Verifying Data: Identifying necessary data
Two subcategories of specific data:
-General data
-Market trend data
-Competitive supply and demand data

-Specific data
-Subject property data
-Comparable property data
Identifying Necessary Data: Market trend data
Market trend data describe how social, economic, governmental, and environmental forces interact to affect value.

-Social
-Economic
-Governmental
-Environmental
Identifying Necessary Data: Competitive supply and demand data
Appraiser must collect both supply and demand data.

Supply data :
May include number of existing/proposed properties on the market.

Demand data:
May include information on health of local economy (income and employment).
Identifying Necessary Data: Subject property data
Subject property data

Data about property being appraised, including:

-Size
-Location
-Condition of improvements
-Other physical characteristics
Identifying Necessary Data: Comparable property data
Comparable property

Property similar to subject in several ways, including:

-Physical characteristics
-Competitive with subject property
-Located in same market area
-Sold recently (last 6 months)
Collecting and Verifying Data: Data sources
Potential sources for data:

-personal inspection of properties
-interviews with owners, lenders, etc.
-data published by local agencies
-appraiser's own files
Collecting and Verifying Data
After collecting necessary data, an appraiser must verify the information collected, i.e., check the data for accuracy.

The method of verifying information depends on the nature of the data and the scope of the work.
Appraisal Process Steps: Step 4: Analyzing the data
In addition to verifying data (for accuracy), an appraiser must also analyze data for relevance.

Two key aspects of the data analysis are market analysis and highest and best use analysis.

For improved property, appraiser will analyze property's highest and best use:

-for current use, and
-for property as if vacant
Appraisal Process Steps: Step 5: Valuing the site
Improved property:
Site valued as if vacant.

Vacant property:
Site's value same as property's value.
Valuing the Site
Separate site valuation is necessary for:

-highest and best use analysis
-certain valuation methods
-different types of appraisals
Appraisal Process Steps: Step 6: Applying approaches to value
-Cost approach
-Sales comparison approach
-Income approach
Applying Approaches to Value: Cost approach
Value of site
+ Cost to construct replacement
- Depreciation of improvements
= Value of improved property
Depreciation
Any difference between what an improvement would cost new and its current value.
Applying Approaches to Value: Sales comparison approach
Appraiser must:
1. Select comparable properties.

2. Adjust sales prices of comparables to reflect differences between them and subject property.
Applying Approaches to Value: Income Approach
The Income Approach focuses on the amount of income a property will generate.

(What is the Principle of Value which forms the foundation for the Income Approach?)

Appraiser must:
1. Identify property's NET OPERATING INCOME.
2. Choose appropriate MULTIPLIER to apply.
Appraisal Process Steps: Step 7: Reconciling the value indicators
Reconciliation

Arrive at one estimate of value based on the three indicators of value.

-Appraiser must review and analyze the reliability of each of the value indicators.
-Appraiser must consider the INTENDED USE (purpose) of the appraisal
-DO NOT average the value indicators.
Appraisal Process Steps: Step 8: Reporting value estimate
Appraisal reports are prepared in one of three (3) basic formats and the difference is the level of detail provided to the Intended User:

1. Self-contained reports - most comprehensive and written in narrative format.
2. Summary report - less detailed and used primarily in residential lending appraisals
3. Restricted use report - least amount of information. The detail required will depend on the circumstances and needs of the client.
Appraisal Process: Apply Your Knowledge
Q: How many appraisers are needed to change a light bulb?

A: Four. The first appraiser changes the wrong light bulb so the lender calls a second appraiser who changes the correct light bulb, but the wattage is too low! (Sound familiar?) Next a third appraiser who was licensed in 2006 is called to change the bulb, but the wattage is too high! Eventually a Bulb Management Company (BMC) engages a fourth appraiser to change the bulb with the most probable wattage.
Appraisal Process: How Many Appraisers Are Needed to Change a Light Bulb?
A: Three. One to research it, one to inspect it and one to call the client to ask exactly what number wattage to use.

A: One. If in the appraiser's opinion, the original light bulb should be changed, the appraiser must identify and set forth any additional data considered and relied upon and the reasoning and basis for using a new light bulb.

A: Appraisers do not screw in light bulbs. They make an assumption that the light bulb has been screwed correctly, then forecast the light.

A: Appraisers do not screw in light bulbs. They watch others do it, interview them about their motivations and then write a report about it.
Appraisal Process: How Many Appraisers are Needed to Change a Light Bulb?
A: Seven. One to research the light bulb comparables, 1 to verify the data, 1 to review USPAP and select the right approach/technique, 2 to write the report, 1 to review the report and 1 to deliver the report.

A: More than Four. Mega Watts hired 4 trainees to provide unbiased and defensible support for her final conclusion. She gave each trainee a copy of USPAP and took them to the hardware store and pointed out the various types of light bulbs they might encounter in the field. She then took the trainees into an actual building and demonstrated how to locate a light bulb receptacle. Either there is a power outage in San Diego currently or the trainees mistakenly attempted to screw in the light bulb counter-clockwise because they are all still there standing in the dark.

A: One. Appraiser #1 is cool, calm and collected. When she spots the Bat-Signal, Appraiser #1 goes to work. She understands the value of the Principle of "Righty Tighty Lefty Loosy" and knows how to comply with USPAP and keep those reviewer appraisers at bay. Experience tells her what light bulb approach to use. Whether it's Cost, Sales, or Income... she has a job to do. She uses an LED light bulb to save energy consumption and this assignment calls for the super green Bulborama Turbo Life Millennia Bulb ... and she knows how to use it.

A: None The investor's "opportunity" property has seen its better days (about 20 years ago) ... but it could be just the miracle flip. But is it worth the list price? She makes a quick call to Mr. A. The 6' 10" super hero parks his Shelby on the street and strides into the house where the front door used to be. He quietly (but confidently) does a quick survey of the property reaching for his 1600 LM CREE 6-LED Flashlight hanging from his leather work belt. Entering the hallway, Mr. A reaches up to the ceiling and lightly pushes open the entrance to the attic. (There's no need for a ladder when you are 6'10" tall). The powerful beam from the 1600 LM CREE 6-LED flashlight combined with Mr. A's incredible intelligence and stellar professional background reveal the answer to the problem. There is no need for a light bulb because there isn't any electrical wiring in the house! Mr. A has seen this before - the house was stripped for copper wiring by vandals while it sat vacant. The "No Trespassing" sign on the front boarded up window was not a deterrent for these thieves! Mr. A was called to the rescue and solved the problem - you can't turn the lights on even if you screw in the bulb! Ms. Investor, awed by the heroic Mr. A, can now make an informed decision on her flip property - walk away or go back to negotiate a lower list price.

A: 101 One to change the light bulb and 100 others to evaluate the reasons for changing the light bulb, whether it is the highest and best use to change the bulb, did the appraiser utilize appropriate light bulb changing techniques, did the appraiser comply with ethical standards, and whether or not the appraiser should be referred to the State Light Bulb Board for license revocation.

Some appraisers have been likened to Dalmatians (e.g., 101 Dalmatians. It seems that some appraisers and dalmatians have a doggone spotty past!

What do YOU think?
Light up your imagination with a humorous STORYLINE that reflects the 8 Step Appraisal Process!

Numerous studies have shown that HUMOR creates an optimal environment for learning.

Instructor's Best Answer (with a Humorous Storyline):

None!

After stopping at Starbucks for a Green Tea Latte to stimulate his 8-Step Appraisal Process critical thinking skills, Appraiser Buck Deerwood arrives at the subject property located at 11 Wigwam Trail. It is an overcast, cloudy day and Buck found the interior of the subject teepee was too simply too dark to take properly exposed photos. The owner stated that installation of any and all utility lines within the subject Indian reservation was expressly prohibited, so there was no available electrical wiring. Fortunately however, the owner had borrowed a gas-powered light generator from the reservation elder, but the light bulb was found to be broken. The owner asks Appraiser Buck if he is able to change the light bulb.
Buck replies that changing a light bulb is beyond the Scope of Work of an appraisal assignment and advises that an appraiser simply reports whether a fixed lighting source is present and functional. The owner or intended user must hire a light bulb installer after a state licensed contractor first determines the proper wattage.
The resourceful owner then saves the day by gathering some fireflies in a jar and hanging them from the top of the teepee to illuminate the interior for the appraiser's photos.
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