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Real estate appraisal, property valuation or land valuation is the process of valuing real property. The value usually sought is the property's market value. When determining the property's market value, the valuation is based on the Highest and Best Use of the real property and is reported in a narrative appraisal report. 

The Appraiser provides this written report on the property value to his or her client. These reports are used as the basis for mortgage loans or other financing, for settling estates and divorces, for tax matters, and so on. Sometimes the appraisal report is used by both parties to set the sale price of the property appraised.

Types of Value:
There are several types and definitions of value sought by a real estate appraisal. Some of the most common are:

  • Market value – the price at which an asset would trade in a competitive sales setting. Market value is usually interchangeable with open market value or fair value. International Valuation Standards (IVS) define market value as “the estimated amount for which a property should exchange on the date of valuation between an educated buyer and a reasonably motivated seller in an arms-length transaction after proper marketing wherein the parties had each acted knowledgeably, prudently, and without undue influence.”


  • Value-in-use – The net present value (NPV) of a cash flow that an asset generates for a specific owner under a specific use. Value-in-use is the value to one particular user, and may be above or below the market value of a property.


  • Investment value – is the value to one particular investor, and is usually higher than the market value of a property.


  • Insurable value – is the value of real property covered by an insurance policy. Generally it does not include the site value.


  • Liquidation value – may be analyzed as either a forced liquidation or an orderly liquidation and is a commonly sought standard of value in bankruptcy proceedings. It assumes a seller who is compelled to sell after an exposure period which is less than the market-normal time-frame.


Determining Value:


There are three general groups of methodologies for determining value. These are usually referred to as the "three approaches to value" which are generally independent of each other:


  1. The Cost Approach
  2. The Direct Comparison Approach and
  3. The Income Approach


The Appraiser can generally choose from the above three approaches to determine value. One or two of these approaches will usually be most applicable, with the other approach or approaches usually being less useful. The appraiser has to think about the "scope of work", the type of value, the property itself, and the quality and quantity of data available for each approach. No overarching statement can be made that one approach or another is always better than one of the other approaches.

Things to Consider:
The Appraiser has to think about the way that most buyers usually buy that type of property. What appraisal method do most buyers use for the type of property being valued? This generally guides the appraiser's thinking on the best valuation method, in conjunction with the available data. For instance, appraisals of properties that are typically purchased by investors (e.g., skyscrapers, office buildings) may give greater weight to the Income Approach. Buyers interested in purchasing single family residential property would rather compare price, in this case the Sales Comparison Approach (market analysis approach) would be more applicable. The third and final approach to value is the Cost Approach to value. The Cost Approach to value is most useful in determining insurable value, and cost to construct a new structure or building.

The Cost Approach:      
The Cost Approach theory is that the value of a property can be estimated by summing the land value and the depreciated value of any improvements. The value of the improvements is often referred to by the abbreviation RCNLD (reproduction cost new less depreciation or replacement cost new less depreciation). Reproduction refers to reproducing an exact replica. Replacement cost refers to the cost of building a house or other improvement which has the same utility, but using modern design, workmanship and materials. In practice, appraisers almost always use replacement cost and then deduct a factor for any functional dis-utility associated with the age of the subject property. An exception to the general rule of using the replacement cost, is for some insurance value appraisals. In those cases, reproduction of the exact asset after the destructive event (fire, etc.) is the goal.

The Cost Approach is considered most reliable when used on newer structures, but the method tends to become less reliable for older properties. The cost approach is often the only reliable approach when dealing with special use properties (e.g., public assembly, marinas).


The Direct Comparison Approach:
The Direct Comparison Approach in real estate appraisal is based primarily on the principle of substitution. This approach assumes a prudent individual will pay no more for a property than it would cost to purchase a comparable substitute property. The approach recognizes that a typical buyer will compare asking prices and seek to purchase the property that meets his or her wants and needs for the lowest cost. In developing the direct comparison approach, the appraiser attempts to interpret and measure the actions of parties involved in the marketplace, including buyers, sellers, and investors. 

Data is collected on recent sales of properties similar to the subject being valued, called comparables. Sources of comparable data include real estate publications, public records, buyers, sellers, real estate brokers and/or agents, appraisers, and so on. Important details of each comparable sale are described in the appraisal report. Since comparable sales aren't identical to the subject property, adjustments may be made for date of sale, location, style, amenities, square footage, site size, etc. The main idea is to simulate the price that would have been paid if each comparable sale were identical to the subject property. If the comparable is superior to the subject in a factor or aspect, then a downward adjustment is needed for that factor. Likewise, if the comparable is inferior to the subject in an aspect, then an upward adjustment for that aspect is needed. From the analysis of the group of adjusted sales prices of the comparable sales, the appraiser selects an indicator of value that is representative of the subject property.

The Income Approach: 
The Income Approach is used to value commercial and investment properties. Because it is intended to directly reflect or model the expectations and behaviors of typical market participants, this approach is generally considered the most applicable valuation technique for income-producing properties, where sufficient market data exists. 

In a commercial income-producing property this approach capitalizes an income stream into a value indication. This can be done using revenue multipliers or capitalization rates applied to a Net Operating Income (NOI). Usually, an NOI has been stabilized so as not to place too much weight on a very recent event. An example of this is an un-leased building which, technically, has no NOI. A stabilized NOI would assume that the building is leased at a normal rate, and to usual occupancy levels. The Net Operating Income (NOI) is gross potential income (GPI), less vacancy and collection loss (= Effective Gross Income) less operating expenses (but excluding debt service, income taxes, and/or depreciation charges applied by accountants).

Alternatively, multiple years of net operating income can be valued by a discounted cash flow analysis (DCF) model. The DCF model is widely used to value larger and more expensive income-producing properties, such as large office towers or major shopping centres. This technique applies market-supported yields (or discount rates) to projected future cash flows (such as annual income figures and typically a lump reversion from the eventual sale of the property) to arrive at a present value indication.


Summary

To complete the valuation process, the Appraiser integrates the information drawn from market research and data analysis from the application of the Approaches to form value conclusions.  An effective integration of all the elements in the process depends on the Appraiser’s skill, experience and judgment.  At Able Evaluations Ltd. we are fully designated, accredited and licensed by both the Appraisal Institute of Canada, as well as the Real Estate Council of Alberta. We adhere to their high standards of Appraisal practice and with a significant number of years of experience, we confidently can provide you with an accurate and detailed appraisal report.

 

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