BASIC VALUATION DEFINITIONS

BASIC VALUATION DEFINITIONS

Value Designations

There are many different designations or definitions of value. They may be divided into the following two main
classifications:

Utility Value, which is value directed toward a particular use. This frequently is termed subjective value and
includes valuation of amenities which attach to a property or a determination of value for a specified
purpose or for a specific person.

Market value, which represents the amount in money (cash or the equivalent) for which a property can be
sold or exchanged in prevailing market conditions at a given time or place as a result of market balancing.
It may be based on a “willing buyer” and “willing seller” concept. This is frequently termed the objective
value, since it is not subject to restrictions of a given project.

Appraisers carefully define the value being sought. Types of values include Liquidation Value, Market Value,
Investment Value and, of course, Assessed Value (for taxation).

The real estate market sometimes places great importance on real estate financing terms. Market Value might be
estimated for specific financing arrangements: seller carry-back, balloon payments, renegotiable mortgages or
other “creative” financing techniques.

Market Value Defined

In appraisal practice, the term Market Value is defined by agencies that regulate federal financial institutions in
the U.S. That definition is given as:

“The most probable price which a property should bring in a competitive and open market under all
conditions requisite to a fair sale, the buyer and seller each acting prudently and knowledgeably, and
assuming the price is not affected by undue stimulus.”

Implicit in this definition is the consummation of a sale as of a specified date and the passing of title from seller
to buyer under conditions whereby:

1. buyer and seller are typically motivated;

2. buyer and seller are well informed or well advised and acting in what they consider their own best interest;

3. a reasonable time is allowed for exposure in the open market;

4. payment is made in terms of cash in United States dollars or terms of financial arrangements comparable
thereto; and

5. the price represents the normal consideration for the property sold, unaffected by special or creative
financing or sales concessions granted by anyone associated with the sale.

(Source: Uniform Standards of Professional Appraisal Practice, Appraisal Foundation, 2010-2011 Edition,
page A-105.)

Fair Market Value Defined

Courts and accounting practice sometimes require “fair market value” opinions. The legal definition of Fair
Market Value under California law is found in the Code of Civil Procedure, Section 1263.320, as follows:

“The fair market value of the property taken is the highest price on the date of valuation that would be
agreed to by a seller, being willing to sell but under no particular or urgent necessity for so doing, nor
obliged to sell, and a buyer, being ready, willing, and able to buy but under no particular necessity for so
doing, each dealing with the other with full knowledge of all the uses and purposes for which the property
is reasonably adaptable and available. The fair market value of property taken for which there is no
relevant, comparable market is its value on the date of valuation as determined by any method of valuation
that is just and equitable.”

Cost and Price in Relation to Value

Appraisers carefully distinguish between their defined value, cost and price in refining their appraisal opinions.

Cost is defined in USPAP as follows: “The amount required to create, produce, or obtain a property.” USPAP
notes that cost is either a fact or an estimate of fact.

Price is defined in USPAP as follows: “The amount asked, offered, or paid for a property.” USPAP notes that
“Once stated, price is a fact, whether publicly disclosed or retained in private. Because of the financial
capabilities, motivations, or special interests of a given buyer or seller, the price paid for a property may or may
not have any relation to the value that might be ascribed to that property by others.”

Value is defined in USPAP as follows: “The monetary relationship between properties and those who buy, sell,
or use those properties.” USPAP notes that “Value expresses an economic concept. As such, it is never a fact,
but always an opinion of the worth of a property at a given time in accordance with a specific opinion of value.
In appraisal practice, value must always be qualified – for example, market value, liquidation value, or
investment value.”

Generally speaking, a broker or salesperson will focus on price. Examples include list price, offer price,
contract price, and broker’s price opinion (BPO). Those providing a service or product normally speak in terms
of cost. Appraisers will consider prices and costs in the valuation process when developing a value opinion

Purposes and Characteristics of Value

The purpose of a valuation or an appraisal is usually indicated in the value concept employed, for example:
market value, assessed value, condemnation value, liquidation value, cash value, mortgage loan value, fire
insurance value, etc. The purpose of an appraisal frequently dictates the valuation method employed and
influences the resulting estimate of value.

Intended use and intended user(s) of the appraisal report. Appraisers are required to identify the intended use
and intended user(s) of the appraisal assignment. The intended use and intended user(s) of the report have
become distinct from the purpose of the appraisal. This relates to how the process has been separated from the
writing of the report (Standard 1 vs. Standard 2 in USPAP). The purpose of the appraisal may be, for instance,
to help in settling an estate. The intended use of the report may be to communicate the value findings to heirs
only, or may include attorneys and/or taxing authorities. The purpose helps to define how the appraisal process
will be laid out. The identification of the intended use and intended user(s) will help to determine which report
type is most appropriate for communicating the results of the process.

Appraisal Client. USPAP defines the client as follows: “The party or parties who engage an appraiser (by
employment or contract) in a specific assignment.” USPAP further comments on the client: “The client
identified by the appraiser in appraisal, appraisal review, or appraisal consulting assignment (or in the
assignment workfile) is the party or parties with who the appraiser has an appraiser-client relationship in the
related assignment, and may be an individual, group, or entity.

Confidentiality. The Confidentiality Section of the Ethics Rule in USPAP states that the appraiser must protect
the confidential nature of the appraiser-client relationship. This is significant because the appraiser must not
disclose confidential information in the report or the assignment results to anyone other than the client or
persons authorized by the client. Note that the state appraiser regulatory agencies and third parties duly
authorized by law are also authorized to obtain the confidential information found in an appraisal report. This
prohibits the appraiser from discussing assignment results or providing copies of the appraisal reports to agents
or borrowers unless they are the client identified in the appraisal report.

Four elements of value. There are four elements of value, all of which are essential. These are utility, scarcity,
demand (together with financial ability to purchase), and transferability. None alone will create value, but all
must be present to achieve value for a property. For example, a thing may be scarce but, if it has no utility, there
is no demand for it. Other things, like air, may have utility and may be in great demand, but are so abundant as
to have no commercial value. Utility is the capacity of a commodity to satisfy a need or desire. To have utility
value, real estate should have the ability to provide shelter, income, amenities or whatever use is being sought.
Functional utility is an important test for determining value. Likewise, the commodity must be transferable as to
use or title to be marketable.

Generally speaking, a commodity will have commercial or marketable value in proportion to its utility and
relative scarcity. Scarcity is the present or anticipated supply of a product in relation to the demand for it. Utility
creates demand, but demand, to be effective, must be implemented by purchasing power. Otherwise, a person
desiring a product cannot acquire it.

Real estate cycles cause fluctuations in the four elements of value. For example, when interest rates increase,
fewer buyers are able to qualify for loans. This in turn reduces demand for real estate. This may lead to an
over-supply of properties for sale (or a lack of scarcity).