Three Approaches to Value used by real estate appraisers

~~There are three ways to determine the value of anything, and each plays a part in property appraisal. The most widely-used and accepted in residential practice is the sales comparison approach. This approach bases its opinion of value on what similar properties in the vicinity have sold for recently, with appropriate adjustments for time, acreage, living area, amenities and so on. It is these adjustments where the expertise of the professional appraiser becomes necessary -- no computer can tell you how much or little to mark up for a fireplace without knowing the neighborhood or even talking to Realtors and recent buyers in the area about how important that amenity is in that particular location. Another approach is the cost approach. How much would a property cost to replace, that is, rebuild, minus "accrued depreciation," that is, depreciation that has occurred since the property actually was built? The cost approach includes concepts like "economic life" and "effective age" that are mostly of use in determining the value of special use properties, special purpose properties or properties where subsequent structural improvements greatly impact value. The third approach to value is called the income approach. Some properties generate income for their owners -- the most obvious examples being rental properties such as apartment buildings, non owner-occupied houses and duplexes and the like. The rental income an owner might reasonably expect from a property is part of its value. For a purely owner-occupied residential property, this may not be applicable, but it can be important if the property is to be rented out or used otherwise to generate income, such as a storage facility, cell tower rental and office building.

9. Unacceptable Appraisal Assignments

Can I order a "comp search" without ordering an appraisal?
The following list of unacceptable appraisal assignments is derived from the Appraisal Foundation, the organization that has jurisdiction for setting appraisal standards and guidelines.

Appraisers report that the caller usually makes it clear that they do not want the appraiser to do any fieldwork. Some callers refer to the service requested as a "comp check" while others refer to it as a "preliminary appraisal" or use some terms other than appraisal (such as preliminary evaluation, study, analysis, etc.). Some callers indicate that if the numbers will not work, the appraiser can send a bill for research services or a "preliminary" inspection. Other callers promise future assignments if the appraiser can make the present deal work.

Certain types of conditions are unacceptable in any assignment because performing an assignment under such conditions violates USPAP. Specifically, an assignment condition is unacceptable when it:

  • precludes an appraiser's impartiality. Because such a condition destroys the objectivity and independence required for the development and communication of credible results;
  • Limits the scope of work to such a degree that the assignment results are not credible, given the purpose of the assignment and the intended use of those results; limits the content

7. The MAI Designation

My lender said I need to get an "MAI appraisal". What is it?
The term MAI, which stands for "Member Appraisal Institute", is a registered trademark of the Appraisal Institute. The Appraisal Institute is a trade organization. There is such thing as an "MAI appraisal." Persons requesting an "MAI appraisal" mean that the report should be prepared by an MAI designated member of the Appraisal Institute. Appraisal Institute members are held to higher standards than licensed-only appraisers, but so too are designated members of other appraisal trade organizations.

6. Appraiser Independence

The appraised value of the property depends upon whether the appraisal is conducted for the buyer, seller or lender.

The appraiser has no vested interest in the outcome of the appraisal and should render services with independence objectivity and impartiality - no matter for whom the appraisal is conducted.

I paid for the appraisal. Why am I not entitled to get a copy?
The client is the person who engages the services of the appraiser, usually in the form of an engagement letter. Many times the lender is the one who issues and/or signs an engagement letter, making them the client. It does not matter who pays the bill. Only the client and those who he/she has specifically authorized are allowed to receive a copy of the report from the appraiser. If the person who pays the bill is not the client, verbal or written permission is required for the appraiser to release the appraisal to anyone else.  We are bound by Federal Law and USPAP to adhere to these standards.

4. Opinions and Conclusions Before Ordering an Appraisal  

If I didn't order the appraisal, how can I find out the appraised value?
Only if you ask the person who originated the order and they provide permission in writing. This is one of the most common questions we have and it is often very frustrating for the borrower.  Please understand that our Clients ALWAYS request Confidentiality and we are bound by USPAP and Federal Law NOT to discuss the Appraisal with anyone EXCEPT THE CLIENT.

It doesn't make sense to me to hire you if I don't know you'll come up with the value I need. Can you give me a guarantee?
It is a violation of state laws and the laws of the Appraisal Institute to provide a value opinion without doing an appraisal. Although we cannot provide a guarantee, we can perform a restricted appraisal that will tell you what the property is worth. If the value opinion is acceptable, we can upgrade the report to a summary or self-contained format for a higher fee. We can quote both fees to you so you'll know the best and worst case costs. Surprisingly, the fees are not that different since all the valuation work is done regardless of what report format is prepared.

3. Using the Appraisal

Can I reuse your appraisal for another purpose?
Only if you receive our permission. Be aware that many financial institutions will not accept an appraisal performed for one of their competitors unless the first source provides a written release. Also, we are not required to testify in an assessment reduction case if the appraisal was done for something other than a tax appeal.
When ordering, please provide a list of all users of the report. We cannot change a client's name in a cover letter. We can add report users as necessary, however.

I want to use your appraisal for financing, but don't have a source. Can you prepare your appraisal for any lender?
We can provide some guidance, but you should make sure your lender will accept our report before ordering. Lenders can have different internal guidelines, so knowing what is required helps prevent the additional time it takes to modify a report or do additional report analyses, increasing the time it takes to get a final product to the lender.

I paid for my lender for the appraisal, therefore I should own it.  Also, since I paid for the appraisal why can’t you discuss the value and/or your conclusions with me?
The appraisal is legally owned by the client, unless the lender "releases its interest" in the document, typically in writing to us. If the lender ordered it, they own it. If you just want a copy of the appraisal, under the Equal Credit Opportunity Act you can given a copy of it upon written request of the lender.

Additionally, Appraisers are required by USPAP and Federal Law NOT to discuss the appraisal, valuation conclusions, etc. with anyone EXCEPT the client (typically the lender - whoever ordered the appraisal).  All questions should be directed through the representative you’ve been working with (at the bank, mortgage company, etc.) that engaged Kennedy Real Property Appraisers to perform the Appraisal (see #4 below).

2. Appraisal Cost and Delivery

How much do your appraisals cost?
Every appraisal is different, so we quote fees individually on a per job basis. Generally, prices depend on the number of properties and the complexity of the assignment, though appraisals used as evidence in court cases can command a higher price.
Our fees are calculated based on the number of hours it takes to do a report and the fee structure of the personnel involved, with modification for overtime if a rush assignment is required.

Why do special purpose properties cost more?
Special purpose properties require us to research a wider trade radius, sometimes the entire United States! Fees are based on time estimates, so the more time we have to invest in finding comparable properties, the higher the fee. Also, the market analysis section of the report many times requires a greater amount of research time and it is not uncommon to have to purchase studies performed by industry experts to properly show the dynamics affecting the property type.

What is your typical turnaround time?
Commercial appraisal delivery times typically range from two to three weeks, depending upon the complexity of the property and your needs. It requires one to two weeks to do the research, verify the factual nature of the information, perform a market study of the area and write the report. Typically, delivery times less than three weeks are rush orders and they command a price premium.

How can I help shorten the turnaround time?
The number one way to help shorten the turnaround time is to provide us with the written information we need as soon as possible. Copies of leases, deeds, rent rolls, income and expense statements and other items listed on our engagement letter are the needed as soon as possible. Delay in providing one or more of the necessary items will almost always result in a delay in the appraisal process. If you cannot overnight this information to us before we inspect the property, try to have it available for the person who accompanies us through the building.

If you don't come up with the value I want, do I have to pay for the appraisal?
Yes.  Appraisers must maintain a third party position to your transaction. No appraiser can accept an assignment where bias could be interpreted. Examples of unacceptable appraisal assignments are found at the end here. USPAP has a phrase used verbatim by many appraisal firms on their letters of transmittals:

"Our assignment was not based on the reporting of a predetermined value, a direction in value that favors the cause of the client, the amount of the value opinion, the attainment of a stipulated result or the occurrence of a subsequent event directly related to the value opinion."

USPAP is very clear on this issue. Appraisers cannot be advocates for any client. Although it may seem unusual to some users to have to pay for a report that did not provide them a favorable outcome, appraisers governed by appraisal licensing laws must remain objective.
If there is any uncertainty in the value, clients should have the appraiser perform a restricted appraisal first and then upgrade the report to a summary or self-contained if the value is satisfactory. This is acceptable appraisal practice and one not often suggested by an appraiser.

Why are the fees for commercial appraisals so much higher than residential appraisals?

There are many reasons why there is such a great discrepancy. The most important difference is the amount of time it takes to prepare each type of report. Most skilled residential appraisers can do a residential report in a half-day whereas a skilled commercial appraiser needs at least a week.
Residential reports are on a common form with a standardized property type whereas commercial appraisals are mainly free-form documents with information that varies with the property type. Special use commercial properties take longer and can have a multi-state data search radius, thus making it more time intensive and costly to perform than more common property types such as office and apartments.

Frequently Asked Questions

1. Initiating the Process and or Engaging Services

What's in your commercial appraisals?
You specify what you want within the bounds of the Uniform Standards of Professional Appraisal Practice (the law appraisers are governed by). Generally, an appraisal reads like a narrative report, from 40 to 100+ pages. It details your assignment and provides:

  • an overview of the area, community and neighborhood
  • a detailed site and building description
  • a zoning analysis
  • a highest and best use analysis
  • an in-depth discussion of 1-3 different approaches to value a recommendation of the most appropriate valuation to use

There are many choices available to you according to your needs. Do you appraise properties in areas you don't hold a license?
We can appraise properties anywhere in the United States. In areas that we don't hold state licenses, we obtain temporary certificates. Temporary certificates are necessary for federally regulated transactions such as bank mortgages. There is no such thing as a nationwide appraisal license.

What is the range of services appraisers provide?

Based on their training and experience, appraisers can provide:

  • Tax assessment review, advise and appraisals
  • Advice in eminent domain and condemnation property transactions
  • Dispute resolution - divorce, estate settlements, property partition suits, foreclosures and zoning issues
  • Feasibility studies
  • Market studies
  • Capitalization rate and market ratio studies
  • Market rent and trend studies
  • Expert witness testimony
  • Cost/benefit or investment analyses
  • Land utilization studies
  • Supply and demand analyses

What appraisal approaches will you use in appraising my property?
The three most commonly accepted valuation approaches to value are the cost approach, the sales comparison approach and the income approach (or income approach).
The cost approach combines the value of the land and depreciated site improvements with the depreciated value of the building. The sales comparison approach compares the property to others and adjusts for differences. The income approach takes market rents, subtracts a vacancy allowance and expenses, and takes the resulting net income and turns that into value using a factor.

We are not required to provide all three approaches and it is rare that all three are done. Appraisal theory has largely discredited the cost approach as reflective of market value and commercial appraisers seldom provide it. The sales comparison and income approaches are the primary valuation methods used for commercial properties. Even then, there are times when one of these approaches does not reflect the market and although it might be performed, it is given little or no weight in deciding on the final value conclusion.

How do you determine what approaches to value you will use when you provide a bid?
Having performed many appraisals on a wide range of property types, our fees typically reflect the cost to perform two approaches to value, usually the sales comparison and income approaches. Even if we do not perform an approach, many times we still invest time in searching for data. This occurs most frequently in areas where too few comparable sales occur - we still look for them, but we do not create the market, we merely report it.
There are times when a third party, such as a lender, will require the cost approach to be performed. If that is the case, please tell us beforehand so that we can incorporate this into our estimate. An additional fee will be incurred if we are required to perform a cost approach for a third party and you do not notify us beforehand.

If don't agree with the conclusions found in the appraised value; what can I do about it?

That depends upon many things. The best place to start is to speak with the appraiser(s) who signed the report. It's possible that he/she may have overlooked one or more important factors which affect the value of your property; if you mention it in your conversation, you may find the appraiser willing to reconsider the value conclusion. Of course, if you are not their client (such as when your bank orders the appraisal), they are not required to speak about the appraisal and may be in violation of the law or professional standards if they do so.
It's important to remember that the appraiser is an unbiased third party. Our job is to find out the good and the bad about a property and report it, not to favor a direction. All appraisals are round-tabled by our review staff and carefully scrutinized before they are released, so you get the benefit and knowledge of more people than just those involved with the report.
If you are still dissatisfied, you can get a second opinion by hiring another appraiser or insist that a review appraisal be performed on the original report. If there is a large discrepancy in value, you or a third party may be able to negotiate an intermediate position.

Should I hire a lawyer for a tax appeal?
That's up to you, but commercial property owners almost always have an attorney or tax consultant. Lawyers are especially helpful in tax court. They are also well-trained in negotiation, so you may even get a favorable result without going to trial at all. We cannot represent; we can only be an expert witness for your case.


8. Appraisal Myths & Realities

Will the market value equal assessed value?
While most states support the concept that assessed value approximate estimated market value, this often is not the case. Examples include when interior remodeling has occurred and the assessor is unaware of improvements, or when properties in the vicinity have not been reassessed for an extended period.

Shouldn't market value approximate replacement cost?
Market value is based on what a willing buyer likely would pay a willing seller for a particular property, with neither being under pressure to buy or sell. Replacement cost is the dollar amount required to reconstruct a property in-kind.

My broker performed a market valuation. Why do I need an appraiser to perform one?
There are many reasons why valuations are required to be done by appraisers. First and foremost, the appraiser is an independent, third party. Many times, the appraiser is the only one in the transaction that does not have a vested interest in the outcome. This is the reason for the creation of the appraisal industry in the 1930's.
Another important difference between a broker's valuation and that performed by an appraiser is that a licensed appraiser is bound by USPAP, whereas a broker is not.

What are the differences between an informal appraisal and a formal one?
Those outside the appraisal profession have different interpretations of formal and informal reports. When a client simply wants "a number" and not a long document, he/she will often call it an informal appraisal. Those outside the appraisal field often refer to a "letter of opinion" report as an informal report, although terms such as "update appraisal", "re-certification of value" and "evaluation of real property collateral" have also been used. When USPAP became effective in the late 1980's, appraisers no longer used this terminology because a letter of opinion and the derivatives above became a violation of multiple USPAP regulations. Now known as the restricted report format, appraisers are required to do substantially more work to issue this type of report.  Please note that if we even give a “ball park” verbal estimate that is considered an appraisal by USPAP and not permitted.
Again, the three type of report formats: self-contained, summary and restricted are summarized below.

In this report option, the appraiser provides all of his/her data and rationale that was used in the development of the appraisal. All conclusions and data sources are fully disclosed and discussed. Two practical tests can be used to determine if a report is a self-contained document:

    1. The content of the report fully describes the data, reasoning and each conclusion to such a degree that there is no need to consult other data sources or to inquire how the appraiser reached a conclusion.
    2. Information sources cited within the report are included in the document, within reason. Citing a book does not require the inclusion of the book in the addenda, but market studies or other material articles cited in a report should be included, especially if the appraiser relied upon them for supporting important conclusions. This is the type of report most often needed for commercial property lending.

In the summary report, the appraiser summarizes his/her findings rather than fully describing them. This is a much shorter report than a self contained and many lenders accept this reporting type. Most residential appraisals are done on forms that are summary reports along with non-complex commercial assignments. The appraiser may summarize the data and his/her conclusions without explaining the full reasoning behind them.

Restricted Report:
This is the shortest type of report. A restricted report only states the conclusions of the appraiser with no explanation on how they were derived. Restricted reports are generally used internally or when a value must be reported quickly. Many clients order restricted reports when time is of the essence and then have them upgraded to a summary or self contained in the future.
An important caveat is that USPAP does not allow a restricted report to be used by anyone other than the client or someone intimately familiar with the property, so if the appraisal will be viewed by other third parties, a summary or self-contained must be prepared. Appraisers cannot "recertify" this type of report to any other lender.

What is the difference between a valuation and an appraisal?
The words valuation and appraisal are used interchangeably. There is no difference between them. The confusion began when lenders started using the term "evaluations" in the early 1990's, implying that they were not appraisals. Soon, the "e" in evaluations was omitted. This issue has been addressed at length by the appraisal community and the Appraisal Foundation (the creators of USPAP) and an evaluation was found to be an appraisal. As discussed earlier, there are six possible combinations of appraisal and report; evaluations are not among them.

5. Different Report Types and Options 

I see there are three types of reports I can order. What's the difference?
The final appraisal product delivered to you depends on the type of report specified by our agreement. The parameters of the three types of appraisal reports as defined in USPAP are shown in the table below. The primary difference is in the terms describe, summarize and state. Describe means to provide a comprehensive level of detail, summarize is providing a more concise presentation of the information and state means to provide a minimal presentation of the information.

What type of report do I need?
The appraiser is in the best position to tell you what type of report you need. He/she is required by USPAP to determine the scope of the assignment, the function of the appraisal and use of the report. To do that, he/she will need to understand your needs, so the appraiser is in the best position to recommend one or more of the above choices and to counsel you on what choice(s) would be inappropriate. 
Typically, for mortgage financing or legal work you will need at least a Summary Appraisal.  Restricted Appraisals are typically suitable for internal valuation.
Self Contained Appraisals are the most expensive and detailed, while Restricted Appraisals are very brief.  Please note that the type of report you order does not mean the final value  estimate will be different in that format (Self Contained, Summary or Restricted).  Value estimates will always be the same.  Basically, the difference with report types is the amount of information illustrated/presented within the body as noted in the table above.