Finance Terms
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What is an Appraisal?
A Real Estate Appraisal is a service performed by an appraiser that develops an opinion of value based upon the highest and best use of real property. The highest and best use is that use which produces the highest possible value for the property. This use must be profitable and probable. Also of importance is the definition of the type of value being developed and this must be included in the appraisal ie fair market value condemnation value quick sale value etc. The most common type of value sought being the fair market value.
There are three usual approaches to determining the fair market value of a property cost approach sales comparison approach and income approach. The appraiser will determine which of the approaches is applicable and develop an appraisal based upon information from each individual market area. Costs income and sales vary widely from area to area and particular importance is given to the specific location of the property.
The Cost Approach is sometimes called the Summation Approach. The theory is that the value of a property can be estimated by summing the land value and the depreciated value of any improvements. It is the land value plus the cost to reconstruct any improvements less the depreciation on those improvements. The value of the improvements is sometimes abbreviated to RCNLD—reproduction cost new less depreciation or replacement cost new less deprecation. 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.
The Sales Comparison Approach looks at the price or price per unit area of similar properties being sold in the marketplace. Simply put the sales of properties similar to the subject are analyzed and the sale prices adjusted to account for differences in the comparables to the subject to determine the fair market value of the subject. This approach is generally considered the most reliable IF good comparable sales exist.
The income approach capitalizes an income stream into a present value. This can be done using revenue multipliers or single-year capitalization rates of the net operating income. The Net operating income (NOI) is gross potential income (GPI) less vacancy (= Effective Gross Income) less operating expenses (but excluding debt service or depreciation charges applied by accountants). Alternatively multiple years of net operating income can be valued by a discount 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.
Automated Valuation Models (AVMs) are growing in acceptance. These rely on statistical models such as multiple regression analysis and geographic information systems (GIS). While AVMs can be quite accurate particularly when used in a very homogeneous area there is also evidence that AVMs are not accurate in other instances. This is most evident where there is a renewal or "revitalization" of a particular area or neighborhood. There can exist within a single city block homes that are in poor condition to homes that have been completely rehabilitated and are in good to excellent condition.