CHAPTER
17

Appraisals

In This Chapter

Prior to the 1990s, no commonly accepted standards existed for either appraisal quality or appraiser licensure. In the 1980s, an ad hoc committee representing various professional appraisal organizations in the United States and Canada met to codify the best practices into what became known as the Uniform Standards of Professional Appraisal Practice (USPAP). As a result, all real estate appraisers must be state-licensed and certified today.

The Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) demanded all states develop a system for licensing and certifying real estate appraisers. The practice of appraising is regulated by each state, but the federal government regulates appraisers indirectly. Should it find that a state’s appraiser regulation and certification program is inadequate, then under federal regulations, all appraisers in that state would no longer be eligible to conduct appraisals for federally chartered banks. Also, all state and federal courts have adopted USPAP for real estate litigation.

In this chapter, we will cover the methodology of how an appraiser completes an appraisal and the techniques used to arrive at a value. We will talk about the three types of appraisals and when to use each one based upon the property type. We’ll discuss the difference between the REALTOR’s competitive market analysis and the appraisal. Finally, we will explain the mathematical process used by appraisers to arrive at a property’s value.

The Importance of Real Estate Appraisals

Before you buy real estate, it’s important to get an appraisal of the property. This evaluation verifies, to you and your lender, that the property is worth at least the amount that you want to borrow to pay for it. A real estate appraisal is an expert opinion put together by an educated and qualified person, an appraiser, trained in the methods of determining the value of real estate.

DEFINITION

An appraisal is a valuation of real property. An appraiser is a person trained in the techniques used to determine the appraisal.

The appraisal process is a series of steps that must be followed to ensure the correct answer is determined. The appraiser uses various types of data in these steps. Most commonly the data is of two types: general and specific. General data regards the neighborhood, the market in general, crime statistics, and overall information regarding the property’s surroundings. Specific data focuses on the subject property, the house being evaluated, and all the specific information about the target property used to determine its value.

Every property differs in location, size, shape, use, etc.; however, all appraisals are performed in the same manner—through the systematic application of the valuation process. In the valuation process, the problem is identified; the work necessary to solve the problem is planned; and relevant data is collected, verified, and analyzed to form an opinion of value.

The steps in the valuation process could depend on the nature of the appraisal and the data available. But in all cases, the same basic steps are followed:

1. Identify the problem

2. Determine the scope of the work

3. Collect the necessary data and property description

4. Analyze the data

5. Determine a site value opinion

6. Apply the approaches to value

7. Reconcile the value

8. Report the defined value

The first step in the valuation process is to identify the problem. In this step the appraiser identifies the following:

Next the appraiser determines the amount and type of information he or she will need to research and analyze for the assignment. The scope of work must be clearly disclosed in the appraisal report.

From there, the appraiser gathers data. He or she collects general data related to property values in an area and specific data about the property being appraised, the subject property, and the data of the comparable properties that have been sold or leased in the local market.

The general data is then evaluated regarding the national, regional, and local trends. Supply and demand data is studied to understand the competitive position of the property. Data analysis of specific data, such as properties similar to the subject property, helps the appraiser find sale prices, incomes and expenses, capitalization rates, construction costs, economic life, and rates of depreciation. These figures are used in the calculations that result in the valuation of the subject property.

Highest and best use is a critical step in the development of a market value opinion. In highest and best use analysis, the appraiser considers the use of the land as though it were vacant and the use of the property as it is improved. The highest and best use must satisfy four criteria: it must be legally permissible, such as zoning laws; it must be physically possible, such as lot dimensions; it must be financially feasible, such as cost to build in the area; and it must be maximally productive and make sense in an area. A market analysis provides the basis for an appraiser’s decisions about the highest and best use of a subject property.

A site value opinion is determined by a variety of methods derived from the three approaches to value: a sales comparison, or a value based on the sales of other homes; a cost approach, or a value based on the cost to build other homes; and an income approach, or a value based on the income the property generates. (These are discussed in depth later in the chapter.)

Next, the appraiser begins to apply one or more of the three approaches to value and form an opinion of property value. The method used to create this opinion depends on the type of property as well as the intended use of the appraisal and the quality and quantity of the data available.

During the reconciliation of value step, the appraiser analyzes alternative answers and chooses a final opinion based on the values from among two or more indications of value. After making a thorough review of the entire valuation process, he or she makes a reconciliation of the results. The appraiser draws on his or her experience, expertise, and professional judgment to resolve differences among the values derived from each of three approaches.

DEFINITION

Reconciliation is the process by which the appraiser evaluates, chooses, and selects from among alternative results to reach a final value estimate.

The appraiser determines a weight, or probability, of each answer as to the possibility of use based on the data collected. For example, when appraising a single-family home, the appraiser may calculate the values using all three methods, but during the reconciliation process, he or she may determine the probability of the income approach to be low because the property won’t be used as a rental property.

An appraisal assignment is not completed until the conclusions and findings have been stated in a report and communicated to the client. The report of defined value will vary in type, format, length, and contents depending on the client’s requirements and the scope of work criteria.

The USPAP has specific requirements for appraisal reports, which may be presented in one of three written formats: self-contained reports, summary reports, and restricted-use reports. A self-contained report fully describes the data and analyses used in the assignment as well as the comprehensive information contained within the report itself. A summary appraisal report summarizes the data used in the assignment. A restricted-use appraisal report only states the conclusions of the appraisal. This type of report may be provided when the client is the sole user of the report.

When circumstances permit, the appraisal also may be communicated by means of an oral report.

Who Do Appraisers Work For?

Many people believe the appraiser works for the buyer, but that’s a misconception. Actually, the appraiser is hired by the lending institution to protect its interest in the real property. The lending institution hires the appraiser to determine a value of the real property to verify that it will be sufficient collateral for the loan it’s being asked to make to the borrower.

Think of it like this: if you, the lender, were asked to loan a friend $10 to buy something, you might ask for some collateral to secure that loan. If your friend offered a pencil for collateral, you would hire a pencil expert—in this analogy the appraiser—to tell you the value of the pencil. If that expert determines the value of the pencil to be $10, or hopefully greater, you would make the loan to your friend and accept the pencil as collateral. If the value of the pencil is less than the amount your friend is requesting, you’d put yourself at risk loaning him the money due to insufficient collateral.

This is exactly how the lender protects himself when hiring an appraiser to determine the value of real property when the borrower requests a loan.

Determining Value

Value of real property is very subjective and is influenced by factors like demand, scarcity, utility, and transferability.

The demand for a property can drive its value upward compared to a property that has little or no demand. Scarcity also can tie into this definition because it can be similar in nature to demand when it comes to determining the value.

Imagine a piece of real property on an exclusive, high-end lake going for sale—say one of the 50 lakefront lots around the lake. The demand for that property will affect the value, and it will sell for a premium. The fact that there are a very limited number of parcels on that lake, or scarcity, ensures the property commands a premium. Contrast that with millions of acres of farmland, which are neither scarce nor in high demand (relatively speaking) and, therefore, won’t command the same value per acre as the lakefront property.

Utility, or the manner in which the property could be used, is another factor that creates or drives value in a property. If a residential property is listed for sale but can be converted to commercial due to its location and surrounding growth of the city, it potentially will have more buyers and create more value to the owner when selling.

Finally, if a property can be transferred easily between buyer and seller, the value can be increased. For example, a property that’s free and clear can be transferred easier than a property that has a mortgage. Likewise, a commercial piece of real estate that has some environmental issues with cleanup costs in the millions of dollars may have no value at all.

DEFINITION

A free-and-clear property is one with no money encumbrances, or liens, placed on it.

Understanding Market Value

Market value is the most common value appraisers estimate; at least 90 percent of all appraisals address market value. Although the exact definition of market value has changed over the years, it has become more standardized recently.

The most widely accepted definition of market value is from USPAP: “The most probable price which a property should bring in a competitive and open market using cash, or its equivalent, in an arm’s length transaction between a knowledgeable buyer and seller, each acting prudently, and assuming the price is not affected by undue pressure.” In some states, the definition of market value may vary slightly from USPAP’s. In these instances, the appraiser should state his version of the definition and be sure his value is consistent with the definition he defined in his report.

HELPFUL HINT

Market price is what the property actually sells for and is determined by negotiation between the seller and buyer. If an agent can get market value to equal market price, it is called a sale.

There are many ways in which to express value.

The principle of anticipation states that value is simply a function of the present worth of future benefits—that is, people are paying current dollars for future benefits. The principle of anticipation is the basis for the income approach. Under this principle, the past values are only important because they tend to predict future values. A buyer for a home might look at current house values of a neighborhood, and through the principle of anticipation, he may determine the future value of the property. Furthermore, using this past information gives the buyer insight as to what to pay for the property today.

The principle of balance relates one property to the other properties in the neighborhood. For example, if a builder builds houses in a neighborhood of 1,500- to 2,000-square-foot homes priced from $100,000 to $120,000, then using the principle of balance, the builder would expect to receive a higher value for a larger home.

The principle of change claims that as time and market conditions change, so do supply and demand for real estate, and so does the value of real estate. Under the principle of change, value changes as surrounding factors change, either up or down.

The principle of conformity, like the principle of balance, relates to real estate characteristics and the surrounding properties. It holds that maximum value is achieved and maintained when there’s reasonable conformity among properties. Basically, the more a property conforms to the surrounding properties, the more value can be expected. Under the principle of conformity, a residential house that does not conform to the surrounding commercial neighborhood is worth less due because it doesn’t conform.

The principle of contribution is based on the fact that the value of a component is a function of its contribution to the whole rather than as a separate component. This means the cost of an item does not necessarily equal a contribution to value. For example, the cost of a swimming pool might not add an equal amount to the value of the overall property. Perhaps it might even detract from the cost, as an above-ground swimming pool would. In other instances, the value of an additional feature might exceed the cost of that feature. For example, energy-conserving appliances, like a water heater or solar panels.

The principle of competition holds that profits tend to spur competition. The more profitable a venture may appear, the more competition is created. Under the principle of competition, a company moving into a market increases nearby land values simply due to the fact that others will want to compete with it.

The principle of external forces states that four major forces external to the property influence value: social, economic, physical, and governmental:

Social  This includes the number of elderly people, which can cause an increase in demand for more retirement communities.

Economic  Interest rates, employee wages, financing, etc., drive the demand to live in an area.

Physical  Buyers are not willing to buy a property in poor condition when they can buy a property in good condition for the same price.

Governmental  Local and state income taxes and property taxes affect the value of real estate as do the quality of the local schools, police and fire protection, and the availability of health care.

Because value is so subjective, individual buyers’ and sellers’ value can be influenced by forces outside the property.

The principle of highest and best use is defined as the most suitable use that will yield the best value to the owner over a sustained period of time. Simply put, it’s the most valuable use. The four standard tests for highest and best use relate to the use that is physically possible, legally permitted, financially feasible, and maximally productive.

HELPFUL HINT

Properties are normally appraised at their highest and best use.

The principle of increasing and decreasing returns relates to the principles of balance and contribution. The concept is that too much is too much, and there’s a point at which adding more has no net increase in the value. For example, adding one or maybe two yard ornaments to a yard might make the yard look nice, but adding 72 ornaments may be detrimental. At some point, “too much became too much” and the value decreased rather than increased.

The law of increasing and decreasing returns also applies to an office building placed on a parcel of land. Adding stories to the building may increase the property value … until it’s tall enough that an elevator must be added. From this point, the added cost may not result in added value equal with the cost of the improvements.

The principle of opportunity costs says that money allocated to one use cannot be used for another use. For example, if a rental property earns 6 percent return, but at some later time, a better house that’s earning 8 percent return is found, the opportunity cost is 2 percent, or the difference between what a person is currently earning and what the opportunity could have earned with a different allocation of funds. Typically, the risks of the different opportunities are assumed to be equal to consider a true opportunity cost. It would be difficult to measure opportunity cost between a 5 percent government-insured bond and 6 percent return generated by a 30-unit apartment building, for example.

The principle of substitution is the basis for sales comparison approach and should be used in every appraisal and every appraiser’s thought process. The principle of substitution says that houses that have sold can substitute for a house currently listed if the size, location, age, and other characteristics are substantially similar. A smart buyer would pay no more for a home than it would cost him to buy another one that would substitute for it. Substitution keeps the market in balance.

Appraisal Methods

Appraisers commonly think of value in three ways:

  • The substitution method  The value based on recent sales of comparable properties in the market.
  • The cost approach method  The current cost of building a reproduction, or replica, property.
  • The income method  The value based on the property’s earning power in an open market.

These different viewpoints form the basis of the three approaches appraisers use to value property. One or more of these approaches may not be useful in an assignment or may be less probable due to the lack of data available.

The Substitution Method

The sales comparison approach is best used for homes with a history or that can be tracked in a local multiple listing service (MLS). Furthermore, this approach is most useful when several similar properties recently have been sold in the subject property’s area.

Using this approach, an appraiser develops a value by comparing the subject property with similar target properties, sometimes called comparables or comps. The sale prices of comps give the appraiser a range to base the value of the subject property on.

The appraiser estimates the degree of similarity or difference between the subject property and the comparable sales by considering various elements:

  • Location  Geographic location: rural, urban, etc.
  • Physical characteristics  Size, acreage, age, etc.
  • Use/zoning  Residential versus commercial sales
  • Property rights conveyed  Fee simple, life estate, etc.
  • Financing terms  Cash, financing, land contract, etc.
  • Market conditions  REO driven, crime rates, etc.
  • Seller concessions, if any  Closing cost assistance
  • Personal property conveyed, if any  Washer/dryer, or other

Dollar amount adjustments, either up or down, may be applied to the known sale price of each comparable property to get a range of value indications for the subject property.

Through this comparative procedure, the appraiser ultimately arrives at an opinion of value. For example, a subject property may have three bedrooms and two baths, but all the comps have 21⁄2 bathrooms. The appraiser may shift his or her sales price downward by the value of a half bath (in this example $5,000), from $150,000 to $145,000 or whatever value he determines a half bath is worth in that specific market.

HELPFUL HINT

Knowing the market is crucial for appraisers and REALTORS alike.

The Cost Approach Method

The cost approach method is best used for new-build homes or homes that have no history in a local MLS. The cost approach is based on the understanding that value can be related to the cost to build a home. In the cost approach, the value of the land is separated from the cost of the physical structure.

There are three commonly accepted practices to determine the value of a property using the cost approach:

The square-foot method  This is the easiest of the three methods to calculate and is based on the theory that each square foot is equally responsible for the cost of the build. For example, a 1,500-square-foot house that costs $150,000 to build has a $100/square foot cost. Using that rate, the value of a similar property that’s 1,200 square feet would have a value of $120,000. This method is great for production builders whose cost per square foot is virtually the same across all the properties.

The unit-in-place method  This method takes a closer look at the property and determines that the overall subject property is a group of units that can be evaluated individually against the same units in target property. For example, suppose a subject property can be broken into a group of units or subcomponents: roofing unit, flooring unit, HVAC unit, etc. A comparison then can be made between each unit of the target property to get a monetary adjustment per unit. Using the preceding example, let’s say the HVAC unit is +$5,000 better, but the roofing unit is worse by $10,000. The net would be –$5,000; therefore, the property value would be $115,000 ($120,000 – $5,000). This method is good for homes where similar style and construction techniques were used, much like comparing one production builder to another.

The quantity survey method  This is the most comprehensive and complete method of estimating building costs. Using this approach, the appraiser estimates all the material costs, labor costs, overhead costs, administrative costs, and more, as well as the builder’s profit, and then totals these figures to arrive at the value much the same way as in the unit-in-place method. But instead of comparing units, the appraiser compares everything used in the construction. This method requires the blueprints to complete correctly so each part can be evaluated separately, even down to the number of nails, wood framing supports, roof decking sheets, etc. This method is best used for custom home builders when it’s hard to find a house within the area similar to the subject property.

The index method  The index approach is used in circumstances when the original construction cost of the existing improvements is already known. It’s most frequently used in the case of unique or unusual buildings. This approach simply updates the original construction costs to today’s costs using published construction cost indexes. Many companies publish this data to help appraisers and builders. To use this method, the appraiser needs to know the original construction costs of the building and the year in which it was completed. The appraiser then looks up the index value in the year of completion and at the current time. This method is best used for historic or unique buildings. For example, an appraiser is assigned a job to appraise a building built in 1950 at a cost of $50,000. Using a published index of 500 for 1950 and the current index of 2100, here are his calculations:

Depreciation  to the structure must be taken into account in the cost approach. Depreciation is any loss in the value of a property over time. Tax laws allow investors to depreciate the value of the improvements. This depreciation reduces their taxable income and is usually figured using the straight-line method, which assumes depreciation occurs at an even rate over the structure’s economic life.

Economic life  is the length of time during which a piece of property may be used, usually less than its physical life. The effective age is the age of a property based on its condition, not its actual age.

DEFINITION

Depreciation is a property’s loss in value for any reason. The economic life is the lifespan a property can be used for its intended purpose. The effective age incorporates maintenance, or lack thereof, to make a property appear younger or older than its actual age.

For example, a property with a value of $265,000 and an economic life of 261⁄2 years has a depreciation of $10,000 per year. The straight-line depreciation would be as follows:

So, after 10 years (10 years × $10,000/year), the total depreciation would be $100,000 ($265,000 - $100,000 = $165,000), or the value would be $165,000.

Depreciation comes in three different types:

Physical deterioration  This is an impairment of condition and a loss in value inherent in property brought about by wear and tear, disintegration, use, and actions of the elements. It’s either curable or incurable.

Functional obsolescence  This is where the property has lost value due to the reduction in functionality. For example, a house has become condemned due to disrepair over the years.

External obsolescence  This type of obsolescence occurs when some outside force affects the property. For example, if the neighborhood around the property goes downhill, the value of the property goes downhill as well.

Land value is estimated separately in the cost approach. This approach is particularly useful in valuing new or nearly new improvements and properties that are not frequently exchanged in the market.

The Income Method

In the income capitalization approach, value is measured as the present value of the property’s future earning power. Income-producing properties, including residential rentals and commercial properties, are typically purchased as investments so the earning power is a critical element affecting property value.

There are two methods of valuation by using income: net income capitalization rate and some type of multiplier.

In the net income capitalization rate valuation method, the relationship between annual net income and value is reflected by a capitalization rate. The capitalization, or cap, rate is expressed as a percentage and is like a rate of return (ROR) for any investment vehicle. For example, if you bought a certificate of deposit (CD) from a bank paying 4 percent interest, the 4 percent interest paid on the investment would be a very similar analogy to a cap rate. The ratio of the net income to the cap rate determines the value of a property. Here’s the equation used:

Gross operating income (GOI) is all the income that can be generated from an investment, or income, property such as rent, late fees, parking fees, clubhouse rental, laundry machine income, etc. Sometimes, accounts may want to remove a loss and vacancy factor, typically a percentage of the GOI. For example, 5 percent loss and vacancy factor may be used when determining the true gross operating income.

Expenses are the bills that are required to operate an income property, such as payroll, lawn care, advertising, taxes, etc. Typically, this category does not include the mortgage payment. The mortgage payment, called debt service, is subtracted from the net operating income to give the cash flow of a property. Of course, this is before income taxes.

Net operating income (NOI) is the remaining money left over after expenses are removed from the GOI.

Remember these equations:

Gross operating income – expenses = net operating income

Net operating income – debt service = cash flow

Another type of valuation model is the multiplier model. This uses either the gross rents multiplier (GRM) or the gross income multiplier (GIM). The difference between the two would be the gross income number calculated to represent the income being used. GRM would solely use the rents collected from an investment property whereas the GIM would use the entire gross income—rents plus all other sources of income—as the income for the model.

Which should the appraiser use? Good question. Typically, the cap rate valuation is used in retail and office income-generating properties; however, both the GRM and GIM would be used for apartment complexes.

Making Comparisons with Comps

A comparative market analysis (CMA) or comp is prepared by a real estate broker and used to help evaluate how a seller’s home compares against the other homes in the area that are or were recently on the market. The CMA takes an in-depth look at the other homes to determine the best price that will make the seller’s home competitive.

The CMA includes a fact-based report of a home, including information such as square footage, number of bedrooms, number of full and half baths, size of major rooms, age of the home, property taxes, and desirable amenities.

The CMA also looks at the length of time, called days on market, the property has been/was on the market to help determine value.

DEFINITION

Days on market is the total number of days a property has been listed on the MLS.

Depending on the market, a CMA covers a specific geographic range around the home, from one or two streets up to a mile away in some areas and possibly farther if the home is in a rural area. The CMA also takes into consideration a time frame, such as year.

The CMA is best described as an art and not a science. In many cases, one method is acceptable in one scenario but not in another. For example, in one situation, a property may be in a great area among similar properties, which allows for comps to be used for five or six blocks away. However, another property could be bounded in one direction by an area that may be very undesirable or crime-ridden, not allowing for any comps to be used in that direction.

Some Appraisals Math

Appraisers are often seen as the smarter big brother in the real estate world, due to the fact they do many different and varied mathematical calculations. Let’s look at some appraisals math now.

Calculating Acreage and Square Footage

Many times, an appraiser must calculate the acreage of a property based on the lot size or dimensions.

Example 1: The basic area calculation is length times width. A simple lot of 210 feet by 100 feet equals an area of 21,000 square feet. Given the fact that 1 acre is 43,560 square feet (a good number to memorize given the business you’re going into) this lot would contain 21,000 ÷ 43,560 or 0.48 acres of land.

Example 2: How many square feet are in 3.4 acres of land? 3.4 acres × 43,560 square feet per acre is 148,104 square feet.

Example 3: A farmer wants to sell his land for $35,000 per acre. He has it surveyed, and the land measures 1,100 feet by 5,000 feet. For how much will he list the property? 1,100 feet × 5,000 feet = 5,500,000 square feet. 5,500,000 square feet ÷ 43,500 square feet per acre = 126.262 acres of land. At $35,000 per acre, his listing price would be 126.262 acres × $35,000 per acre or $4,419,170 (rounded to nearest dollar).

Example 4: Sometimes commercial property is sold based on the front foot, which is a measure of exposure to the main road the property sits on. If a 2.75-acre property is 475 feet deep and is listed for sale at $10,000 per front foot, what’s the listing price? 2.75 acres × 43,560 square feet per acre = 119,790 square feet of land. If the lot is 475 feet deep, the measure of the front foot can be determined by knowing the area of a rectangle is front foot × the depth of the property or front foot = the area ÷ depth of the property. 119,791 square feet ÷ 475 feet depth equals 252.2 front feet (rounded). If the property is listed for $10,000 per front foot × 252.2 front feet, it would be listed at $2,520,000.

Calculating Value Using Capitalization Rate

Remember, cap rate is a measure of the net income to the value of a property. With some math manipulation, you can see that value equals the cap rate ÷ net income of the property.

Or:

Or:

Cap rate × value = net income

Example 1: Determine the value of a 5-unit strip center if the appraiser knows the follow facts:

Annual rents = $500 per month per unit

Annual expenses = $10,000

Cap rate = 8 percent

First, determine the annual net income of the property:

5 units × $500/unit/month × 12 months = $30,000 gross income

Net income = gross income – expenses, so $30,000 – $10,000 = $20,000 in annual net income.

Example 2: If a property has an annual net income of $35,500 and the appraiser determines its value to be $200,000, what is the cap rate he used in the calculation?

So:

Calculating Value Using Gross Rent and Income Multipliers

Often agents will represent apartment owners as investor clients. Calculating value for apartments uses a slightly different methodology than strip malls or office buildings. Apartment value is based upon the total rent earned by each unit rather than per square foot as we discussed earlier. The gross rent multiplier (GRM) and gross income multiplier (GIM) are common measurements of value for apartments or apartment complexes.

Example 1: Using the information provided, calculate the value of the property. A 30-unit apartment complex earns monthly rental income of $450 per unit. It generates $500 in both laundry and soft drink sales per year as well as $4,500 annual income from the rental of the common area clubhouse. The appraiser knows the GRM is 75 and GIM is 65. Using each method, determine the value of the apartment complex.

GRM: 30 units × $450/unit/month × 12 months = $162,000 in gross rents per year. Using the GRM of 75, the value would be $162,000 × 75 or $12,150,000.

GIM: Gross income would equal rents plus all other income, on an annual basis. $162,000 (rental income) + $6,000 (laundry) + $6,000 (soft drinks) + $4,500 (clubhouse rental) = $178,500 annual gross income. Using a GIM of 65, the value would be $178,500 × 65 or $11,602,500.

Reconciliation

Reconciliation is the process by which an appraiser uses the probability of each type of valuation in the overall determination of the single final value.

Example 1: If an appraiser is hired to appraise a residential home in a residential neighborhood for a lender, he would complete the assignment by doing all three valuation types:

Method Valuation
Sales comparison approach $120,000
Cost approach $115,000
Income approach $125,000

Using his expertise and knowledge, the appraiser reconciles the values by assigning a probability for each occurrence:

Method Valuation
Sales comparison approach 75 percent
Cost approach 25 percent
Income approach 0 percent (not commercially zoned)

Therefore:

Method Valuation
Sales comparison approach $120,000 × 75 percent = $90,000
Cost approach $115,000 × 25 percent = $28,750
Income approach $125,000 × 0 percent = $0

Using the weight, or probability, of each occurrence determines the value to be $118,750 ($90,000+$28,750+$0=$118750).

The Least You Need to Know

  • A real estate appraisal is an opinion by an educated and qualified person.
  • An appraiser is hired by the lending institution to protect its interest in a real estate transaction.
  • Appraisers must be licensed per the FIRREA and follow best practices methodology set forth by the USPAP.
  • Value of a property can be controlled by demand, utility, scarcity, and transferability of property.
  • Appraisers determine the market value of property, while market price is determined by negotiation.
  • An appraiser can use three different methodologies based on the property type: substitution, cost, or income.
  • A CMA is not an appraisal, but rather a range of values generated by a real estate broker, usually free of charge to the client.