Theoretical Concepts of Value and Definitions

Appraisal and Valuation

Property valuation may be considered the heart of all real estate activity. Only a practical understanding of real estate values will enable real estate brokers to carry out their functions in a useful and dependable manner in serving their clients and in meeting their obligations to the general public.

Brokers should have a good understanding of: the theoretical concepts of value; the forces which influence value; and the methods by which such value may be estimated most accurately.

Probably the question most frequently asked brokers by clients is, “How much do you think the property is worth?” It is a daily occurrence for the real estate broker to have clients ask about the fair price, fair rental, fair basis for trade, or a proper insurance coverage for property. A broker needs to know how to answer such questions correctly.

To be successful in business, an agent must determine whether time can profitably be spent in trying to sell property at a listing price set by the owner. The agent must keep in mind that in accepting a listing, the agent is obligated to put forth best efforts to find a buyer for the property at that price. A seller’s unrealistic asking price is a roadblock that can be remedied by a knowledgeable broker capable of making a market analysis and using the three approaches to value. Such ability assists the seller to set the most appropriate listing price.

The real estate professional is cautioned, however, not to claim greater appraisal ability or expertise than is actually possessed. Great harm can come to the client and to the professional if significant appraisal mistakes are made. When unable to competently perform a valuation, the advice of a professional real estate appraiser should be sought. Licensed or certified appraisers are governed in their competency by the Competency Rule in the Uniform Standards of Professional Appraisal Practice (USPAP), promulgated by the Appraisal Foundation. All licensed and certified appraisers must comply with USPAP in appraisal assignments.

Definition of Appraisal

To appraise means the act or process of developing an opinion of value; an opinion of value. (USPAP) It may be said that value is the present worth of all rights to future benefits, arising out of property ownership, to typical users or investors. An appraisal report is usually a written statement of the appraiser's opinion of value of an adequately described property as of a specified date. It is a conclusion which results from the process of research and analysis of factual and relevant data.

Real estate appraising methods are being standardized by virtue of the experience and practice of qualified people in all parts of the country who encounter the same types of valuation problems, and who by various methods and processes succeed in solving them in an equitable manner. It is natural, however, that differences of opinion may exist as to the value of specific parcels of real estate and the means of estimating their value.

Property rights are measurable. Real estate as a tangible thing can be measured. It includes both land and improvements and exists independent of any desire for its possession. To distinguish between its physical aspects and rights in and to real property, the latter are called property interests in real estate.

Property rights in real estate are normally appraised at Market Value. There are many definitions of Market Value, but a good working definition is the most probable price the property would bring if freely offered on the open market with both a willing buyer and a willing seller.

Rights in real property are referred to as "Bundle of Rights," which infers: right to occupy and use; to sell in whole or in part; to bequeath (give away); and, to transfer by contract for a specific period of time (lease). It also implies the right not to take any of these actions.
These rights are limited by: the government's power of taxation; eminent domain; police power (for safety, health and general welfare of the public, such as zoning, building codes); and, right of property to escheat (revert) to the state in the event the owner dies and leaves no heirs.

The rights in a property must be known by the appraiser before making a proper valuation, and the appraiser must also be able to distinguish between personal and real property. Market value is the object of most appraisal assignments, and appraisals mainly are concerned with fee simple estate valuation as opposed to partial interest
value.

The widespread need for appraisals is apparent. Everyone uses real estate in one way or another and must pay for its use, which involves a decision about value. Practical decisions concerning value must be based upon some kind of an appraisal or evaluation of real property collateral.

The term evaluation has a special meaning and use for institutional lenders since passage of the Federal Institutions Reform, Recovery, and Enforcement Act (FIRREA). In reality, it is an appraisal, an estimate of value.

Although an appraisal may be transmitted orally, it is usually a written statement of an opinion of value and is referred to as an appraisal report.

Traditional Approaches to Value

Basically, there are three approaches to property valuation used by appraisers. Each gives a separate indication of value, yet the approaches are all interrelated and all use market comparison techniques. All three approaches are considered in each complete assignment. However, all three are not always employed, depending upon the property type and the process and report type agreed to by the client and the appraiser.

The approaches to value are: Sales Comparison (or Market Data) Approach; Cost Approach; and Income Approach.

The Appraiser's Role in the Real Estate Profession 

The licensed or certified appraiser, by reason of professional training, experience, and ethics is responsible for furnishing clients with an objective third party opinion of value, arrived at without pressures or prejudices from the parties involved with the property, such as an owner or lender. 

The appraiser has a heavy personal and professional responsibility to be correct and accurate in opinions of value. Otherwise, the appraiser's clients may easily suffer loss and the appraiser's professional reputation may also suffer. 

True forces affecting value - It is necessary that appraisers be exceptionally sensitive to their roles in accurately assessing the true forces affecting value. In accomplishing this, the appraiser cannot allow the general neighborhood composite of ethnic, religious, or minority populations or the general condition of neighborhood improvement to detract from a clear and objective evaluation of the property appraised on its own merits. 

It is also the appraiser's responsibility to keep the appraisals timely in a changing market. It is no longer prudent to rely solely on past sales of comparable property. The appraiser must use all pertinent data and appraisal methods to insure the appraised value is, in fact, the closest estimate of the price the property would bring if freely offered on the open market.

Recent world events has resulted in property appreciation spirals to historic highs, along with creative financing approaches to generate sales This has been followed by a collapse in property values and extraordinary levels of foreclosure and bankruptcy. Such times required exceptional appraiser sensitivity to the true market forces. 

The professional appraisal associations have responded with increased emphasis on education in current appraisal and financial techniques. The dynamics of such a volatile market require the appraiser to keep abreast of new techniques and market forces.