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THERE ARE MANY OCCASIONS when a person might need to know how much real estate is worth. Typical real estate appraisal assignments include the following.
- getting a real estate purchase loaN
- refinancing
- getting a second mortgage
- listing property for sale
- buying property
- private mortgage insurance removal
- negotiating lease agreements
- rent surveys
- inheriting property
- divorce
- partnership dissolutions and buy-outs
- estate planning
- charitable donations
- gifts to family members
- conservation easements
- real estate damages
- insured casualty losses
- litigation support
- expert testimony
- boundary line adjustments
- subdividing land
- condemnation by government agencies
- voluntary sales to government agencies
There are many types of real estate value definitions, but the most commonly used is “market value.” Simply put, market value is the most probable price a willing buyer and seller will agree upon in an open market, each being well-informed and under no undue pressure. The key phrase in this definition is “most probable,” which implies the use of probability and statistics. Of course no buyer or seller is that well-informed, everyone is under some kind of pressure to buy or sell and no market is completely open.
As in the stock market, the price that someone pays is not necessarily the same as the value. Statistical analysis has shown that real estate buyers consistently pay from 5 to 10 percent above and below market value for no apparent reason. It’s important to look at a large number of sales to determine where the most probable value lies.
Value is always an opinion. Value is different than “price,” which is the actual amount someone paid or the amount someone is asking. And price is different than “cost,” which refers to the actual cost of construction and development.
Because value is always an opinion, anyone who has an opinion can be a real estate appraiser. However, if you want a reliable opinion the most important appraiser qualifications to consider are impartiality, honesty and integrity; expertise in the local real estate market; expertise in the type of property being appraised; and access to real estate data. Impartiality, Honesty and Integrity Impartiality, honesty and integrity are probably the most important appraiser qualifications. An inexperienced but honest appraiser will always produce a more reliable opinion of value than a biased appraiser with more qualifications and experience. The experienced appraiser knows how to support values slanted in favor of his or her client. The appraiser with real integrity knows how to do it but won’t.
When a real estate agent conducts a listing presentation, their estimate of value is part of the sales pitch. If they recommend a listing price that’s too low, the seller may list with another agent. If they recommend a listing price that’s too high the property won’t sell and they will waste time and money promoting the listing.
Most appraisers are accustomed to clients who pressure them to push the value estimate in their favor. Sellers want high values and buyers want low values. Mortgage underwriters and real estate agents want the appraised value to be identical to the purchase price. People getting tax breaks for charitable donations want high values. People paying taxes want low values. Homeowners seeking second mortgages want the highest possible value.
Even in so-called “voluntary sales” to government agencies, the appraiser is often pressured to support whatever price is negotiated by the buyer and seller. Lawyers want values which support the interests of their clients. In fact, it’s not uncommon for clients to “shop” for values until they find an appraiser who will support their cause. Some clients order multiple appraisals until they find a value they like. Expertise in the Local Real Estate Market Real estate value is based on the complex behavior of buyers and sellers in a specific market. Appraisers need to understand the nuances and characteristics of their local market in order to predict or “model” this behavior.
Wood-burning stoves, septic tanks and dirt roads may be perfectly acceptable in one market but not another. A 3,000 square foot home may be too large for some neighborhoods and too small for others.
Lender clients are notorious for sending their favorite appraisers on far-flung out-of-town appraisal assignments. The appraiser often has no understanding of local market dynamics and no real estate data to work with. Expertise in the Type of Property Being Appraised Some types of real estate requiring special appraisal expertise include golf courses, campgrounds, bed and breakfast inns, mini warehouses, marinas, assisted living facilities, conservation easements and contaminated or “damaged” properties.
Appraisers specializing in these types of properties may travel all over the county (or the world), because buyers and sellers are not confined to a local real estate market.
A good appraiser knows when to refuse an assignment and refer it to a more qualified person. A good appraiser also knows when to use outside experts such as title companies, timber cruisers, home inspectors, surveyors and engineers. Access to Real Estate Data A truly qualified appraiser has access to a large amount of real estate data relating to the types of properties he or she appraises. Many appraisers build and maintain their own databases, confirming and augmenting the standard sales data available from the local multiple listing service or MLS (which often contains errors or is incomplete). State Licensing and Private Designations All states now have standard licensing requirements for appraisers, the result of sweeping reform legislation enacted in the wake of the savings and loan scandal of the late 1980s. Fraudulent or incompetent appraisers now face license revocation, fines and even prison terms.
The catch is that most states only require licensed appraisers for federally-related lending assignments. And these same lenders that appraisers were supposed to keep honest have found ways to influence values or avoid the use of appraisers altogether.
The tiny appraisal profession is represented by over a dozen professional organizations, each offering a plethora of private designations. The most prestigious is the MAI designation conferred by the Appraisal Institute. With state licensing in effect, there has been some movement to unify the profession into one national organization similar to the National Association of Realtors. Supply and Demand An under-supplied “seller’s market” tends to drive prices up while an over-supplied “buyer’s market” tends to drive prices down. Real estate agents often have a better feel for supply and demand than appraisers do because they work with buyers and sellers every day. Appraisers normally rely on comparable sales, which keeps them slightly out of date and out of touch with the market.
Supply (the number of properties for sale) tends to move more slowly than demand (the number of qualified buyers). Supply is also easier to identify than demand. It’s a simple matter to count the number of properties listed for sale on the local MLS. Counting the number of qualified and motivated buyers at any given time is more difficult.
In an urban area where real estate sales are driven by employment, new jobs are a good indication of demand. However, in rural areas where real estate sales are more discretionary (like the decision to buy a boat) it’s more difficult to determine demand. The Three Approaches The three standard approaches to value are the sales comparison approach, the cost approach and the income approach.
The sales comparison approach is the most widely used. It involves selecting three or more comparable sales and then adjusting the sales up or down by dollar amounts to arrive at a value for the property being appraised. This approach works well in cookie-cutter urban subdivisions but is more difficult to apply in rural areas.
The cost approach combines an estimate of the land value with an estimate of the depreciated replacement cost of the improvements. This works best for new construction, but is also appropriate for unique and unusual properties where there are no truly comparable sales.
The income approach converts anticipated income (including rent and the future sale of the property) into value by the use of ratios and multipliers. This approach works well for standard investment grade properties, but is less accurate for owner-occupied, mixed-used and “trophy” properties.
The most reliable estimates of value are produced by using a combination of all three approaches and then reconciling the different indications of value into a final estimate. Statistical and Graphic Analysis The appraisal profession is gradually accepting a more statistical approach to estimating value with the help of powerful personal computers and the widespread availability of real estate data. Statistical analysis requires a large amount of data and the use of sophisticated calculations which were beyond the reach of most appraisers only a few years ago.
Some appraisers are incorporating geographic information systems (GIS) into their offices. A GIS is a database linked to a series of computerized maps. Using a GIS it’s possible to calculate and map such things as the number of potential customers (as well as their age and household income) within a 30 minute drive of a Wal-Mart store.
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Chet Boddy, Real Estate Appraisal, Sales and Consulting
43300 LR Airport Road, #59, Little River, CA 95456
707-937-4011, office
707-937-4818, fax
chet@chetboddy.com
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Copyright © 2002 Chet Boddy, All Rights Reserved
Chet Boddy is a Certified General Real Estate Appraiser, Realtor“ and real estate consultant who has lived on the Mendocino Coast since 1976. Look for this and other real estate columns on Chet’s web site at www.chetboddy.com
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