THEORETICAL CONCEPTS OF VALUE AND DEFINITIONS

THEORETICAL CONCEPTS OF VALUE AND DEFINITIONS

Definition of Appraisal

To appraise means the act or process of developing an opinion of value; an opinion of value. (USPAP, 2010-
2011 Edition, pg. U-1) 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.

These interests - ownership in fee simple and other lesser interests - have been discussed in preceding chapters.

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. Recognizing this, California statutes enforced by the Office Of Real
Estate Appraisers (OREA) require continuing education for licensed and certified appraisers. Those
requirements are set forth in the OREA portion at the end of this chapter.

Appraisal Report

An appraisal report sets forth the data, analysis and conclusions of the writer. When put in writing, it protects
both appraiser and client. Reports vary in scope and length. The following information should be included and
is more specifically outlined in Standards 1 and 2 of USPAP:

1. A final value opinion is expressed in terms of dollars for the property which is being appraised.

2. The value opinion can be made for any date in the past, and, with some care, for any date in the future.
The time of inspection of the physical improvements is generally taken as the effective date of value unless
otherwise informed by either the property owner, owner’s attorney, or a court of law. The date of the final
writing and delivery of the report is the date of the appraisal, not to be confused with the effective date of
value.

3. Adequate description of the property. The street address, including city and state, as well as a complete
legal description as set forth by the deed in the County Recorder’s Office, should be shown, and the
physical structures should be clearly described. The length of this description will depend upon the length
and extent of the report.

4. The latitude of the reasoning in determining the value opinion will depend upon the type of report and
the complexity of the appraisal problem.

5. Market data, and other factual data. This includes information on the city and neighborhood which
affects the value opinion; information gathered on the site, improvements and the environment of the
neighborhood which should be processed by means of one or more of the approaches to value; and, the
preliminary estimate of value should be reconciled by means of logic and reasoning in order to arrive at one
value conclusion for the property. Lengthy details are usually omitted in letter reports, but appraiser retains
the information as backup in a work file.

6. Signature and certification. Appraisal reports must be signed by the writer, include the license number,
and in most instances are preceded by a statement to the effect that the writer has no present or
contemplated interest in the property. Requisites of an appraisal are set forth in the USPAP, which was
adopted in 1989 by the Appraisal Standards Board of the Appraisal Foundation.

Types of Appraisal Reports (and USPAP Terminology)

1. Letter report. This type of report is generally used when the client is familiar with the area, and the
reporting of supporting data are not necessary. The report consists of a brief description of the property, the
type of value sought, the purpose served by the appraisal, the date of value, the value opinion and the
signature of the appraiser. This is known as a Restricted Use Report and is governed by Standards Rule 2-
2(c) of the USPAP. Specific language is required to put readers on notice that this report type is for use by
the client only with restrictions.

2. Form report. To ensure uniformity in the underwriting of loans, common property types have standardized
form reports. Examples of form reports include the Uniform Residential Appraisal Report (URAR) and the
Small Residential Income Property Appraisal Report (SRIPAR). This type of report is normally used by
lending institutions, such as banks, insurance companies, saving and loan associations, and governmental
agencies. Generally, it consists of simple check sheets or spaces to be filled in by the appraiser. The report
varies from two to eight pages in length and includes the pertinent data about the property, with photos,
maps, plats and sketches. Today these types of reports are classified as Summary Reports and are governed
by Standards Rule 2-2(b) of USPAP. This category of report can also be a narrative format, but the data
presented will be generally in a summary format with more information than a restricted report.

3. Narrative report. This type of report can be a complete document including all pertinent information
about the area and the subject property as well as the reasons and computations for the value conclusion. It
includes: maps, photographs, charts and plot plans. It is written for court cases and out-of-town clients who
need all of the factual data. It gives the comprehensive reasoning of the appraiser as well as the value
opinions. These reports are often classified as Self-Contained Reports, which are governed by Standards
Rule 2-2(a) of USPAP. Narrative reports can also be prepared in a summary format, which are regulated
by Standards Rule 2-2(b) in USPAP.

Any of these report types could be done on a form or in a narrative format. The contents and the depth of
discussion, not the format, define the report type in USPAP terms.

Purposes and Uses of Appraisals

The basic purpose of an appraisal is to estimate a particular value, i.e., market value, check for support of sales
price, loan value, investment value, etc. Some of the uses for requiring the estimate of value are:

1. Transfer of ownership of property.

a. An appraisal assists buyers and sellers in arriving at a fair and equitable sales price. An appraisal of
physical property may also include an opinion of its age, remaining life, quality or authenticity.

b. The listing agent needs an estimate of value of the property before accepting a listing from the owner.
If the agent can show by means of an appraisal the appraised market value of the property, and obtain a
listing at that figure, a sale more likely will result. The real estate practitioner should be prepared to
demonstrate a knowledge of both comparative and economic values.

c. Where a trade is involved, appraisals tend to assist in clarifying the opinions of value formed by both
parties to the trade.

d. Valuations are necessary for the distribution of estate properties among heirs.

2. Financing and credit.

a. The lender has an appraisal made of the value of the property to be pledged as security for a mortgage
loan.

b. Measuring economic soundness of real estate projects involves feasibility studies in relation to
financing and credit.

3. Appraisal for taxation purposes.

a. Appraisals are needed by governmental bodies to establish the proper relationship between land and
improvements for real estate taxes (ad valorem taxation).

b. Properties subject to estate taxes must be evaluated for the purpose of levying federal and state taxes.

c. Appraisals of income-producing properties are necessary to property owners for the basis of
depreciation. Normally, only improvements can be depreciated, not the land. An allocation of the
market value between land and improvements is a requisite for accounting and taxation purposes.

4. Condemnation actions.

a. With the right of eminent domain being vested in governmental agencies, it is important that properties
under condemnation be evaluated at market value to properly estimate purchase price, benefits, and
damages to the property being affected.

5. Insurance Purposes.

a. Appraisals are based principally upon the cost of replacement. This is important for the purpose of
insuring properties for fire insurance.

b. Appraisals are useful in setting claims arising from insurance contracts after a property has been
destroyed.

6. Miscellaneous reasons for appraisals.

a. Catastrophic damage. Establishing market value of property before and immediately after the damage.

b. Estimating market rents for negotiation of leases.

c. Appraisals for inheritance and gift tax purposes.

d. Fraud cases.

e. Damage cases.

f. Division-of-estate cases. A distribution of property under the terms of a will, in divorce proceedings, or
between rival claimants, frequently requires that the value of the property involved be determined by
appraisal.