Appraisal Industry

The Appraisal Process

The process of estimating the value of real estate is called appraisal. An accepted residential valuation process, prescribed by professional appraiser organizations and found in numerous textbooks, is reflected in the Uniform Residential Appraisal Report form required by Freddie Mac (Form 70) and Fannie Mae (Form 1004). Use of the uniform report enforces established reporting standards, fosters quality control, and facilitates review and underwriting. Research reveals that actual valuation behavior may deviate from the prescribed process. Nonetheless, the prescribed process (enumerated below) remains the backbone of appraisal methodology.

• 1.
  An appraisal begins with the definition of the appraisal problem. An appraiser must specify a valuation date (commonly the date the appraiser inspects the subject) and examine a legal description that fixes the property's exact location. Whereas most appraisal assignments call for valuing the highest ownership interest in real estate, called the fee simple interest, occasionally appraisers are asked to value partial interests such as the landlord's interest (called the leased fee), the tenant's interest (called the leasehold), mineral rights, air rights, or easements. Therefore, the appraiser must identify the exact property rights being valued. The purpose of an appraisal is usually to estimate market value. Other types of value may be required, for example investment value or insurable value, so an appraiser should define the actual type of value being estimated. Any assumptions or limiting conditions that might impact the analysis or value judgment should also be stated.
• 2.
  Appraisers gather general information and data that will help them understand forces influencing the subject's value. The prescribed perspective is to focus first on the broad local area and then on the specific neighborhood. Important variables like area infrastructure, level of taxation, zoning and construction codes, subdivision regulations, school quality, level of public services, and social trends (for example, preferences for in-town versus suburbs) will facilitate a sense of an area's economic viability and stability as well as an understanding of current and likely levels of housing supply and demand. A neighborhood is a subunit of the local area, often without clear boundaries, defined by its compatible population and land uses. Identifying the economic, social, and physical characteristics that can influence property values helps appraisers determine how well positioned the neighborhood is to capture and retain market share. Appraisers may examine income level, occupation, and employment status of residents; amount of developable land; ratio of renters to owners; vacancy levels; perceptions of neighborhood safety; and linkages to the greater community, including employment centers, schools, retail centers, and cultural, recreational, social, and entertainment activities.
• 3.
  After considering general information, appraisers contemplate subject property characteristics that create, enhance, or inhibit value. These include physical qualities of the site like size, topography, shape, frontage, drainage, soil and subsoil conditions; legal features of the property, including title (who owns the various property rights), zoning, and covenants (private agreements running with the title that might limit the use of the property); and location characteristics, notably the quality of site exposure and accessibility to neighboring activities [Page 27]and infrastructure. Finally, the quantity and quality of subject capital improvements, including all buildings, must be identified and evaluated.
• 4.
  Appraisers estimate market value based on highest and best use, which is a property's most productive and hence most valuable possible and permitted use. The process of estimating highest and best use is a filtering exercise. From the pool of all candidate uses, uses that are not physically possible given the subject's physical characteristics are removed. From the surviving candidates, all those uses that are not legally permissible given the subject's legal characteristics are removed. Considering the subject's economic characteristics, all surviving uses that are not capable of generating a positive market value are removed. Of those uses that have survived the physical, legal, and economic filters, the use that generates the greatest value is considered the highest and best use. While seeming complex, the highest and best use judgment for most actual residential appraisals is straightforward and will be simply that use consistent with the contributing improvements. The highest and best use of a viable home on a residential lot in a stable residential neighborhood is likely residential.
• 5.
  Appraisers use three related approaches to value: the cost approach, the sales comparison approach, and the income approach. Not every approach is applicable to every assignment. The appraiser decides which approaches are applicable and collects data necessary to support them. To support the cost approach, the appraiser gathers (a) transaction information on unimproved (vacant) sites that are comparable to the subject site and (b) information on the current cost to reproduce all subject improvements (the subject residence and all other buildings and improvements on the site). To support the sales comparison approach, the appraiser gathers transaction information on residences that are comparable to the subject. To support the income approach, the appraiser gathers market rental information on residences comparable to the subject and transaction information on residences comparable to the subject that were rented when sold.
• 6.
  Using the gathered supporting data, the appraiser calculates estimates of subject value. The rationale for the cost approach is that informed buyers are not justified in paying more for a property than the cost of buying a similar site and constructing replica improvements on it. To approximate this ceiling price, the appraiser uses current cost data to estimate the reproduction cost with new improvements and subtracts estimated accrued depreciation. Accrued depreciation is any loss in value suffered by the improvements from age or obsolescence. The appraiser then adds the value of the site estimated by comparing the subject site to recently sold comparable sites. The rationale for the sales comparison approach is that informed buyers are not justified in paying more for a property than the price of reasonable substitutes. This reservation price is estimated by adjusting the transaction prices of comparable residences for dissimilarity; for example, the appraiser might add to the price if the comparable house is smaller than the subject house or subtract from the price if the comparable house is in better condition than the subject house. The rationale for the income approach is that informed buyers are not justified in paying more for a property than the present value of cash flow generated from leasing the property. To estimate this price, the appraiser projects the subject's potential market rent, then converts this rent into an estimate of value based upon how much other buyers have paid for rental income as reflected in transaction information from similar properties rented when sold. Depending on the market data available, the appraiser will derive up to three different indications of value.
• 7.
  Regardless of how many indications are generated, these estimates must finally be reconciled into a single judgment of value. This is done by considering the relative merits of each approach in terms of quantity and quality of supporting data as well as the relevance of each approach to the assignment and then choosing that single value most logical and supportable by the analysis and gathered data. An appraiser's value estimate is generally conveyed in a written report that should include at least the value opinion itself, a definition of the value being estimated, an adequate description of the property being valued, the date of valuation, the property rights being valued, and all supporting data and analyses.

Industry Advocacy and Regulation

Professional appraiser associations such as the Appraisal Institute, the National Association of Independent Fee Appraisers, and the American [Page 28]Society of Appraisers advocate for their memberships and also play important roles in raising professional standards and ethics, advancing methodologies, and protecting the public interest. These organizations typically award designations to their qualifying members that serve as signals of quality to those relying upon appraisal services.

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